20 February 2003 External T.I. 2002-0143605 - Deductions-US Citizens resident in Canada

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 CCRA.

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

Principal Issues: (i) Interaction of Articles XI and XXIV of the Canada-U.S. Income Tax Convention (1980) (the "Tax Convention"). Can a subsection 20(12) deduction be taken on withholding in excess of 10% and less than 15% by the United States on property income?

(ii) Calculation of income from a particular country for purposes of s.126 of the Income Tax Act.

(iii) Meaning of "paid by the taxpayer for the year".

Position: (i) A subsection 20(12) deduction cannot be taken.

(ii) The foreign tax credit does not limit a taxpayer to claiming a credit equal to the Canadian tax otherwise payable on that particular source of income. Amounts deducted under subsection 20(12) reduce income from that particular country for section 126 purposes.

(iii) Where a foreign country uses a tax year other than a calendar year, the tax "paid by the taxpayer for the year" in the foreign jurisdiction is the taxes actually paid prorated on a calendar year basis.

XXXXXXXXXX 								2002-014360
T. Cook
February 20, 2003

Re: Various Foreign Tax Issues

Dear XXXXXXXXXX:

We are writing in reply to your letter of May 24, 2002, in which you asked three separate questions regarding the application of subsections 20(11), 20(12) and 126(1) of the Income Tax Act (the "Act"). We apologize for the delay in responding. Your questions are addressed in order below.

Question 1

The maximum withholding tax rate on interest under Article XI of the Canada-United States Income Tax Convention (1980) (the "Tax Convention") is 10% of the gross interest paid. You state that paragraph 5 of Article XXIV of the Tax Convention then permits, pursuant to subsection 20(11) of the Act, U.S. citizens resident in Canada to take a deduction from income for Canadian tax purposes in respect of U.S. tax paid in excess of 15%. Paragraph 5 applies if the interest would have been subject to tax in the United States even if someone who was not a U.S. citizen had earned it. You also note that in technical interpretation #9524810, we took the view that a foreign tax credit of no more than 10% would be available in respect of U.S. source interest income.

Your understanding is that the Canada Customs and Revenue Agency (the "CCRA") considers the amount of U.S. tax paid between 10% and 15% to be ineligible for a deduction under subsection 20(12) of the Act. As such, U.S. tax paid between 10% and 15% becomes a "nothing" on the Canadian income tax return, as it is not eligible for either a foreign tax credit or a deduction from income. You wish confirmation that this is the CCRA's view and the rationale for that view.

Our Comments

Paragraph 2 of Article XXIX of the Tax Convention states that nothing in the Tax Convention shall be construed as preventing the United States from taxing its citizens as if there were no Tax Convention. However, paragraph 3 of Article XXIX goes on to provide that nothing in paragraph 2 of Article XXIX shall affect the obligations undertaken by either Canada or the United States in various specific Articles, including Article XXIV. Therefore the Tax Convention does not restrict the ability of the United States to tax its citizens but the Tax Convention does impose specific rules on both Canada and the United States with respect to the taxation of U.S. citizens resident in Canada.

Article XXIV sets out the rules for relieving double taxation in the case of U.S. citizens resident in Canada. In the context of the example you gave, paragraph 5 of Article XXIV requires Canada to give a deduction roughly equivalent to that in subsection 20(11). In particular, paragraph 5(a) of Article XXIV modifies the deduction by requiring that the deduction not be reduced by any credit or deduction for Canadian taxes allowed in computing the U.S. tax on such items. That is, the deduction is based on the taxpayer's gross U.S. tax liability rather than his or her final tax liability. This treatment is more generous than that available under the Act (a subsection 20(11) deduction is based on the taxpayer's final foreign tax liability). It is our understanding that the rationale for paragraph 5(a) of Article XXIV is to avoid the circularity issue that would otherwise arise.

Paragraph 5(b) provides that Canada shall allow a deduction from Canadian tax (i.e., a foreign tax credit) on items of income governed by paragraph 5. The foreign tax credit need not exceed the amount of tax that would have been paid to the United States if the resident of Canada were not a citizen of the United States. As a result, the foreign tax credit provided is limited to the lesser of the tax allowed by the Tax Convention and the tax levied by the United States on non-citizens. Paragraph 5(c) of Article XXIV then sets out the rules for the foreign tax credit to be given by the United States with respect to Canadian income taxes.

Since paragraph 5 of Article XXIV does not contemplate Canada providing tax relief other than that discussed above, it is our view that a subsection 20(12) deduction cannot be taken where paragraph 5 of Article XXIV applies. However, we would point out that Canadian income taxes paid will be eligible, as provided in paragraph 5(c), for a foreign tax credit in the United States. The interaction between the provisions of the Act and the Tax Convention can become very complex in the context of U.S. citizens resident in Canada, and as a result, only general comments have been provided. If you are dealing with a specific situation, we would invite you to provide the full particulars to the relevant Tax Services Office. The Income Tax Rulings Directorate would then be happy to provide any additional assistance required.

Question 2

Your second question deals with an individual resident in Canada that has U.S. source income. You ask us to assume that U.S. tax has been correctly allocated to particular items of U.S. source income and that the appropriate treaty limits have been adhered to. Under subsection 126(1) of the Act, all foreign taxes relating to sources of non-business income from each foreign country are added together to provide a non-business-income tax amount on a country-by-country basis. Similarly, the taxpayer's net incomes and losses from all sources are aggregated on a country-by-country basis, as required by subparagraph 126(1)(b)(i) of the Act. You note that for a particular source of non-investment income (but not business income), the U.S. tax paid may be in excess of the Canadian tax otherwise payable on that source. As such, "excess" U.S. taxes may have been paid on a particular source of U.S. income.

As a result of the way in which non-business-income taxes paid and non-business income from various sources are aggregated on a country-by-country basis for purposes of subsection 126(1), you ask:

? whether it is permissible for the "excess" foreign tax paid on the U.S. non-investment income to be utilized against U.S. source investment income; and

? whether any amount deducted under subsection 20(12) for U.S. taxes paid also reduces the taxpayer's non-business income from the United States as calculated under subparagraph 126(1)(b)(i).

Our Comments

Under subsection 126(1), a taxpayer's total foreign tax credit is calculated on a country-by-country basis. For each country, a taxpayer is entitled to a credit equal to the lesser of the total non-business-income taxes paid to the government of that country and the Canadian tax otherwise payable on the taxpayer's non-business income from that country. A taxpayer's non-business income for each country is determined under subparagraph 126(1)(b)(i) and it is calculated as the excess of qualifying incomes over qualifying losses from that country. There is only one "basket" per country for a taxpayer's non-business-income taxes paid and only one basket per country for a taxpayer's non-business income.

As a result, foreign taxes paid on a source of income in a foreign country in excess of the Canadian tax otherwise payable on that particular source may be included in calculating the foreign tax credit for that country. The limitation set out in subsection 126(1) in this regard is that the foreign tax credit for a particular country cannot exceed the Canadian tax otherwise payable on the non-business income arising from that country. Therefore, it is permissible, other circumstances allowing, for "excess" foreign tax paid on the U.S. non-investment income to be used against U.S. source investment income in calculating a taxpayer's foreign tax credit.

With respect to the second part of your question, it is our view that any amount deducted under subsection 20(12) of the Act will reduce both the taxpayer's total non-business-income taxes paid and the taxpayer's non-business income from the particular country for foreign tax credit purposes. As stated in paragraph 8 of Interpretation Bulletin IT-506, Foreign Income Taxes as a Deduction from Income, in calculating the foreign tax credit in respect of the relevant foreign country where a deduction under subsection 20(12) has been taken, equivalent reductions in non-business-income tax and the amount of net income used in calculating the non-business income for that country, must also be made.

The reduction in non-business income is required because subsection 20(12) generally provides that in calculating a taxpayer's income from a business or property (i.e., a particular source) there may be deducted any non-business-income tax paid to a foreign government in respect of that income. Therefore, when a deduction is taken under subsection 20(12), it reduces the taxpayer's income from that particular source. The definition of "qualifying incomes" in subsection 126(7) of the Act provides that qualifying incomes from sources in a country means incomes from sources in the country (determined in accordance with subsection 126(9) of the Act). Since qualifying incomes are based on incomes from sources in the country, they are reduced by the amount of the subsection 20(12) deduction.

As noted in our comments to the previous question, the interaction between the provisions of the Act and the Tax Convention can be very complex in the context of U.S. citizens resident in Canada. If you are addressing a specific situation involving a U.S. citizen resident in Canada, we would invite you to provide the full particulars to the relevant Tax Services Office.

Question 3

A number of countries use a reporting period for tax purposes that differs from the calendar year. For example, the U.K. tax year ends in the first part of April. If an individual is reporting U.K. source income on a calendar year basis, what is the appropriate method of determining the U.K. tax "paid by the taxpayer for the year"? You ask us to assume that the ultimate foreign tax liability is determined from the U.K. tax return and not through non-resident withholding.

Our Comments

This issue was dealt with in Question 4 of the Revenue Canada Round Table held as part of the Canadian Tax Foundation's 1989 Annual Conference. At that time, we stated that:

The department's policy is to accept apportioned amounts of foreign income and foreign taxes paid when a foreign country's taxation year differs from Canada's (calendar) taxation year. The income and taxes are to be apportioned on the basis of the portion of income earned during the calendar year. Evidence of payment of foreign taxes is to accompany each return in which a foreign tax credit is claimed.

We trust that these comments are of assistance to you. As stated in paragraph 22 of Information Circular 70-6R5, the opinion expressed in this letter is not a ruling and consequently is not binding on the CCRA.

Yours truly,

Jim Wilson
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch