28 February 2002 Internal T.I. 2001-0069447 - Foreign Tax Credit for U.S. Citizen

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Various issues regarding foreign tax credits for U.S. citizens resident in Canada

Position: See Memo

Reasons: See Memo

		February 28, 2002

	Indira Bisnath	International Section I
	T1 Process Review	S. Leung
	Assessing and Collections Division	952-4666

		2001-006944

Foreign Tax Credit and The Equivalent to the Subsection 20(11)
Deduction For U.S Citizens Resident in Canada

We are writing in reply to your correspondence of February 8, 2001, requesting our comments on the above-noted subject matter in the two situations that you outlined in your correspondence.

As we have not been provided with the full information of the two situations and as you only requested us to comment on certain specific areas in the first situation and to provide general comments on the second situation, we have not outlined the facts of the two situations in this memorandum. The relevant facts will reveal themselves in our comments below.

Our comments below will also be general in nature. You may be aware that we do not have enough information to provide an exact computation of foreign tax credit or the equivalent to subsection 20(11) deduction referred to in paragraph 5 of Article XXIV of the Canada-United States Income Tax Convention (the "Convention").

Situation #1 involving XXXXXXXXXX

(A) Our comments on your specific requests:

1) We agree with you that the amount of U.S. tax of $XXXXXXXXXX representing the gross amount of U.S. tax before U.S. foreign tax credit should be used to compute CitizenTax¹ on U.S. source interest, dividends and pension.

2) It appears that the computation of TreatyTax² on each of U.S. interest, U.S. dividends and U.S. pension is correct provided that the amount of each of these income items is the correct amount. In this regard, see our comments in 5) below.

3) In computing the equivalent to subsection 20(11) deduction pursuant to subparagraph 5(a) of Article XXIV of the Convention as it relates to U.S. source interest income, we maintain that the deduction should be: CitizenTax on such interest income exceeds 15% of gross amount of such income (i.e., not 10% of such income even though we only allow a tax credit equal to 10% of such income under the Convention). This is because subsection 20(11) of the Income Tax Act (the "Act") only provides a deduction in an amount by which the foreign tax exceeds 15% of the gross income from property. As paragraph 5(a) of Article XXIV of the Convention provides a deduction equivalent to the subsection 20(11) deduction, such deduction should be similar to the deduction provided in subsection 20(11) of the Act.

(B) Other Comments

4) We do not know how you arrived at the denominator of US$XXXXXXXXXX for the formula in computing the CitizenTax of each item of income. In Appendix B of our paper entitled "Some Aspect of Taxation of U.S. Citizens Resident in Canada", we use the formula: "net amount of a particular item of U.S. source income divided by U.S. adjusted taxable income and multiplied by the U.S. tax before U.S. foreign tax credit" to compute CitizenTax of a particular item of income. In the example included in that Appendix, the net amount of a particular item of U.S. source income is that amount of income net of itemized deductions allocated to such item of income. The adjusted taxable income is the amount by which the adjusted gross income exceeds the itemized deductions. In Situation 1, the adjusted gross income as shown in Form 1040X amended U.S. tax return is US$XXXXXXXXXX and the itemized deductions are US$XXXXXXXXXX. Therefore, the adjusted taxable income for computing CitizenTax purposes is US$XXXXXXXXXX. If, for some reasons, you decided not to take into account the itemized deductions in arriving at the net income of a particular item of income (for example, you may not have the details of the itemized deductions), to be consistent, you should then use the adjusted gross income of US$XXXXXXXXXX, not US$XXXXXXXXXX, as the denominator to compute CitizenTax.

5) We are not sure that U.S. source interest income is US$XXXXXXXXXX. This amount may be correct if you take it from the Schedule B of the U.S. 1040 Individual Income Tax Return. However, Schedule 4 of the Canadian tax return seems to show that the total U.S. source interest income is US$XXXXXXXXXX.

Situation #2 involving XXXXXXXXXX

The taxpayer claimed a deduction of $XXXXXXXXXX under subsection 20(11) of the Act and a foreign tax credit of $XXXXXXXXXX under subsection 126(1) of the Act. However, we have the following comments.

1) It appears that the taxpayer simply ignored the effect of the provisions of the Convention in filing his XXXXXXXXXX income tax return in Canada.

2) We do not understand why, pursuant to the Schedule "Allocation of Foreign Taxes to Foreign Income", all the U.S. taxes were allocated to investment types of income only (i.e., why no U.S. tax was allocated to salaries and wages, capital gains, pension income, etc.). Is it because the U.S. foreign tax credit has been provided to wipe out all the taxes on such income which is all sourced to Canada?

3) We found that the amount of investment income of CAN$XXXXXXXXXX shown on the Schedule "Foreign Income and Taxes Paid by Country" is different from the amount of US$XXXXXXXXXX x 1.4858 (or CAN$XXXXXXXXXX) shown on the Schedule "Allocation of Foreign Taxes to Foreign Income".

4) Based on the amounts shown on the Schedule "Allocation of Foreign Taxes to Foreign Income" and assuming that "rent and royalty" are royalties and are taxed under the Convention at a 10% rate, the equivalent to subsection 20(11) deduction should be CAN$XXXXXXXXXX (i.e., U.S. tax of US$XXXXXXXXXX minus 15% of US$XXXXXXXXXX and then multiply by 1.4858). The foreign tax credit should be CAN$XXXXXXXXXX. It should be noted that U.S. tax on rent from real property is not subject to subsection 20(11) of the Act and the U.S. tax rate on such rental income is not limited by the Convention to 10%. Therefore, one should not mix up rent with royalty for the purposes of computing foreign tax credit and the equivalent to the subsection 20(11) deduction.

5) To correctly compute foreign tax credit and the equivalent to the subsection 20(11) deduction, first you should allocate to each of the spouses income of each source, the itemized deductions, and personal exemption. Then, you should compute CitizenTax on each U.S. source income of the taxpayer. From there, you then compute the equivalent to the subsection 20(11) deduction for interest, dividends and royalties. Before computing the foreign tax credit, you should find out what is the AlienTax³ and Treaty Tax for each item of U.S. source income. For example, some type of U.S. investment income is not subject to U.S. tax if the owner is not a U.S. citizen and certain royalty may, under the Convention, be taxed in the U.S. at zero rate if the owner is not a U.S. citizen.

We trust you will find the above to be of assistance. If you have any questions regarding the above, please do not hesitate to contact Simon Leung at 952-4666.

For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the CCRA's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their database. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Request for this latter version should be made by you to Jackie Page at (819)994-2898. The severed copy will be sent to you for delivery to the client.

for Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch

ENDNOTES

¹ As described in more detail in our paper entitled "Some Aspects of Taxation of U.S. Citizens Resident in Canada", CitizenTax on a particular item of income is the amount of tax which a U.S. citizen resident in Canada would have to pay to the U.S. under the Internal Revenue Code on that item of income before taking into account the provisions of the Convention.

² As described in more detail in our paper entitled "Some Aspects of Taxation of U.S. Citizens Resident in Canada", TreatyTax on a particular item of income sourced to the U.S. in accordance with paragraph 3 of Article XXIV of the Convention is the amount of tax that the U.S. would be allowed to collect under the income provisions of the Convention if the recipient of the income were a Canadian resident for the purpose of the Convention but not a U.S. citizen.

³ As described in more detail in our paper entitled "Some Aspects of Taxation of U.S. Citizens Resident in Canada", AlienTax on a particular item of income is the amount of tax that a non-resident alien of the U.S. would have to pay under the Internal Revenue Code on that item of income which has been sourced to the U.S.

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