Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Whether a particular taxpayer is entitled to a deduction under subsection 20(12) of the Act in respect of an amount of US taxes paid on income earned through a US LLC.
Position: Yes.
Reasons: The requirements of subsection 20(12) are met in the situation described.
December 15, 2015
Ms. Stephanie Melin HEADQUARTERS
Senior Programs Officer Income Tax Rulings
Individual Returns Directorate Directorate
Assessment, Benefit and Service Branch Kimberly Duval
2014-056037
Deduction of Foreign Non-Business Income Tax - Subsection 20(12) of the Income Tax Act
We are writing this letter in response to your email to us wherein you requested our comments as to whether a particular individual (“Taxpayer”) would be entitled to a deduction under subsection 20(12) of the Income Tax Act (the “Act”) in respect of the foreign non-business income tax paid by Taxpayer in a particular fact situation. We apologize for the delay in our response.
Facts
The facts, as we understand them, are as follows:
- Taxpayer, a citizen of the United States (U.S.) but a resident in Canada for purposes of the Act and the Canada – U.S. Tax Convention (the “Treaty”), owns XXXXXXXXXX% shares of a Canadian unlimited liability company (“ULC”). ULC is treated as a partnership (a fiscally transparent entity) for U.S. tax purposes, while it is treated as a Canadian resident corporation for Canadian income tax purposes.
- ULC owns XXXXXXXXXX% of a U.S. limited liability company (“Holding LLC”) which owns XXXXXXXXXX U.S. limited liability companies (“LLCs”). Holding LLC and LLCs are each disregarded entities for U.S. tax purposes but are treated as non-resident corporations for Canadian tax purposes. LLCs earn active business income in the U.S.
- For the taxation year under review, there were no distributions of income by either Holding LLC or ULC and as such, there was no income reported for Canadian income tax purposes. From a U.S. tax perspective, the partnership income reported by ULC was allocated and taxed to each of its members, so that Taxpayer paid income tax to the U.S. in respect of his XXXXXXXXXX% share ownership in ULC.
Based on these facts, you have asked for our comments as to whether Taxpayer will be entitled to a deduction under subsection 20(12) of the Act (or, alternatively, under the Treaty) in respect of the amount of U.S. taxes paid.
Subsection 20(12) of the Act allows a taxpayer under certain conditions to claim a deduction for foreign taxes paid by the taxpayer. Specifically, for ease of reference, the provision reads as follows:
In computing the income of a taxpayer who is resident in Canada at any time in a taxation year from a business or property for the year, there may be deducted any amount that the taxpayer claims that does not exceed the non-business income tax paid by the taxpayer for the year to the government of a country other than Canada (within the meaning assigned by subsection 126(7) read without reference to paragraphs (c) and (e) of the definition “non-business income tax” in that subsection) in respect of that income, other than any of those taxes paid that can, in whole or in part, reasonably be regarded as having been paid by a corporation in respect of income from a share of the capital stock of a foreign affiliate of the corporation.
In the situation described in your email to us, Taxpayer is a resident in Canada, has a source of income for Canadian income tax purposes (i.e., the shares in ULC) and paid tax to the government of the U.S. on income which for U.S. tax purposes is considered to be earned by Taxpayer through LLCs.
The tax paid by Taxpayer in this situation is a non-business income tax within the meaning assigned by subsection 126(7) of the Act (as modified by subsection 20(12)). The CRA has previously stated that the U.S. taxes paid by the Canadian resident individual on the allocation of income from a LLC where the individual indirectly holds an interest in the LLC through a corporate entity that is fiscally transparent for U.S. tax purposes (i.e., the ULC) would be considered foreign non-business income tax for purposes of the deduction under subsection 20(12). This position is based on the fact that the U.S. taxes are considered to have been paid by the taxpayer in relation to, or in respect of, the shareholdings of ULC and not in relation to any business carried on by the taxpayer himself.
Similarly, based on a broad interpretation of the phrase “in respect of” as established by the Canadian courts, the deduction claimed by Taxpayer in this situation is in respect of Taxpayer’s income sourced to the shares in ULC. There is a logical connection between the income from ULC and the U.S. taxes paid by Taxpayer because if Taxpayer did not own such shares, no U.S. taxes would have been paid. As stated in the decision by the Tax Court of Canada in FLSmidth Ltd. v. The Queen (2012 TCC 3) (upheld by the Federal Court of Appeal (2013 FCA 160)):
… I find that there is no requirement in subsection 20(12) that the foreign tax be paid on the taxpayer's income from a business or property, but that it is sufficient that the payment of the tax be connected with or related to that income.
With respect to the fact that no distribution of income was made by ULC in the particular year, it remains the long-standing position of the CRA that it is not necessary to actually receive income from a source in order for an amount to be deductible.
Lastly, since the U.S. taxes in this case were paid by an individual and not by a corporation, the carve-out rule for foreign affiliates does not apply.
As a result, based on our interpretation of the relevant provisions and taking into consideration the comments expressed by the courts in the FLSmidth case, we are of the view that all of the conditions of subsection 20(12) of the Act are met in this situation and therefore, the deduction under subsection 20(12) in respect of the U.S. tax paid by Taxpayer should be allowed.
Since the deduction is available under the Act, there is no need to analyze the Treaty.
We trust that these comments will be of assistance to you.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer.
Yours truly,
Vitaliy Anissimov
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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