CRA considered that a negative ACB deemed gain from shares situated in Japan had a Canadian source for FTC purposes (i.e., no FTC)

Canco paid Japanese income tax on the capital gain reported on the distribution by it of its shares of a Japanese subsidiary ("Forco") to its non-resident parent as a dividend-in-kind, and claimed a foreign tax credit against the Canadian income tax payable on the taxable portion of the s. 40(3) gain realized as a result of a dividend distribution from Forco earlier in the year.  Canco took the position that the s. 40(3) gain had a Japanese source because that was the location of the shares and Forco.  However, CRA indicated that "a taxable capital gain resulting from a deemed disposition of property is considered to be Canadian-source income, which therefore cannot be included in the foreign non-business income for purposes of claiming a FTC."  Moreover, Article 21 of the Treaty did not apply to re-source the s. 40(3) deemed gain to Japan because it was not taxed in Japan.

A further difficulty was that the gain on the distribution was subsequently determined to be nil (as the shares had a nil value) – yet Canco did not apply for a refund of the Japanese capital gains tax and instead claimed the FTC as described above.  Not surprisingly, CRA applied Meyer to state that "the tax paid to the Japanese tax authorities was voluntary and as such, should not be considered to be a ‘tax’."

Neal Armstrong.  Summaries of 23 July 2014 Memo 2014-0525231I7 under s. 126(1) and Treaties- Art. 24.