10 April 2003 External T.I. 2003-0003095 - Foreign non-business income tax

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: 1. Based on paragraph 6(e) of IT-506, are foreign taxes paid in respect of a capital gain deductible under 20(12)? 2. Whether a portion of foreign tax withheld which was not available for a foreign tax credit could be considered an outlay or expense made or incurred for purposes of making the disposition for purposes of subparagraph 40(1)(a)(i).

Position: 1. No deduction available. 2. No.

Reasons: 1. Wording of IT was based on wording of subsection 20(12) at the time the IT was issued. Wording of subsection was changed effective for 1992 and subsequent years and Finance indicated that the deduction would be available only in respect of foreign taxes paid in respect of income from business or property. 2. Outlays in respect of foreign taxes were as a result of the fact that the property had increased in value so it could not be said that they were made or incurred for purposes of making the disposition. This reflects the position taken in 2002-0128865 and is supported by comments of the TCC in Avis Immobilien G.M.B.H.

XXXXXXXXXX D. Yuen
2003-000309
April 10, 2003

Dear XXXXXXXXXX:

Re: Deduction of Foreign Non-Business Income Tax

We are writing in response to your letter dated February 13, 2003, wherein you requested our comments on the situation described below. Unless otherwise stated, all references to a statute herein are to the Income Tax Act (Canada), R.S.C. 1985 (5th supp.) c. 1, as amended.

Situation

A Canadian resident has disposed of capital property and the gain is liable to tax in a foreign country. The taxpayer will claim a reserve under subparagraph 40(1)(a)(iii) for Canadian tax purposes while being taxed on the full amount of the gain in the foreign country. As a result, the taxpayer's foreign tax credit in respect of the foreign taxes paid for the year will be limited due to the difference in the amount of gain reported in the two countries in that year.

Your Questions

1. Paragraph 6(e) of Interpretation Bulletin IT-506 implies that foreign tax attributable to a taxable capital gain or a portion thereof may be deducted under subsection 20(12), notwithstanding that capital gains are not income from business or property. Is this correct?

2. If a taxpayer is unable to fully utilize the foreign taxes withheld to claim a foreign tax credit, could the unused portion of the taxes be considered an outlay or expense made or incurred for the purpose of making the disposition and deducted in computing the gain under subparagraph 40(1)(a)(i)?

3. Where a taxpayer has claimed a capital gain reserve, it is your view that foreign taxes withheld in the year of disposition would not be eligible for a foreign tax credit in a year subsequent to the year of disposition because the taxes would not have been paid for that subsequent year. Is this correct?

Our Comments

1. Until 1991, subsection 20(12) began with the words "In computing the income of ...". This would indicate that foreign taxes paid in respect of capital gains would have been deductible under that prior language. Since IT-506 is dated January 5, 1987, the comment in subparagraph 6(e) would have been written when the old wording of subsection 20(12) was in force. Subsection 20(12) was amended by Bill C-15 effective for 1992 and subsequent taxation years. The Technical Notes of the Department of Finance indicate that the amendment was made to ensure that the deduction was available only with respect to foreign taxes paid in respect of income from business or property. Thus under the current wording any foreign taxes paid in respect of a capital gain would not be deductible under subsection 20(12).

2. In the case of Avis Immobilien G.M.B.H. v. Her Majesty The Queen 94 DTC 1039 (T.C.C.) ("Avis") the court was requested to determine whether a foreign exchange loss that arose on the repayment of a bank loan was incurred for the purpose of making a disposition of certain property which had been acquired with the proceeds of the loan. Since the bank did not agree to deal with the purchaser, it became necessary for the taxpayer to repay the bank loan in advance of the disposition of the property. In concluding that the foreign exchange loss was not an outlay or expense enumerated in subparagraph 40(1)(a)(i), the court stated the following:

At pages 1045-1046. "The words 'for the purpose of' are susceptible of different meanings depending on whether the purpose is immediate or ultimate, direct or indirect or initial or final. Subparagraph 40(1)(a)(i) provides a rule for determining what outlays and expenses may be deducted in calculating a taxpayer's capital gain. The words 'for the purpose of' in subparagraph 40(1)(a)(i) are directed to the action of making a particular disposition. The outlays and expenses in that provision are directed to a particular disposition and no other."

At page 1046. "The words 'for the purpose of' in subparagraph 40(1)(a)(i) mean 'for the immediate or initial purpose of' and not the eventual or final goal which the taxpayer may have in mind. To give the words the latter meaning would permit the most indirect or most distantly related outlay or expense to reduce the amount of the gain. This could not have been Parliament's intent.

We are not dealing in subparagraph 40(1)(a)(i) with the computation of income from a business, which is of an ongoing nature, but, rather, expenses or outlays made or incurred to dispose solely of capital properties. The statutory provision under consideration sets out a rule to determine a taxpayer's capital gain from the disposition of property and only expenses or outlays to be applied in reducing the gain are those incurred or made directly for the purposes of making the disposition. Subparagraph 40(1)(a)(i) does not contemplate expenses or outlays which may have merely facilitated the making of the disposition or which were entered into on the occasion of the disposition."

The court went on to point out that foreign currency losses are specifically dealt with in subsection 39(2). Accordingly, the taxpayer could not succeed in its attempt to incorporate subsection 39(2) into subsection 115(1) and in turn a deemed disposition of the type contemplated by subsection 39(2) into a disposition of taxable Canadian property within subsection 115(1).

In your case, the foreign taxes withheld as a result of the disposition were not directly incurred for the purpose of making the disposition but rather to offset a foreign tax liability that arose because the property had appreciated in value during the period it was held. Moreover, foreign taxes are specifically dealt with under the provisions of section 126 and subsections 20(11) and (12). Consistent with the rationale in Avis, it would be inappropriate for an outlay in respect of foreign tax to be included in the computation of a gain or loss under subparagraph 40(1)(a)(i). On the basis of all of the above, it is our view that the unused portion of the taxes withheld would not be considered an outlay or expense made or incurred for the purpose of making the disposition.

3. We agree with your view that a foreign tax credit in respect of foreign taxes withheld in a prior year could not be claimed under subsection 126(1) in a subsequent year since the definition of "non-business income tax" found in subsection 126(7) refers to "any income or profits tax paid by the taxpayer for the year." (emphasis added)

Other Comment

Your letter refers to foreign taxes "withheld" on capital property. In preparing our response, we have assumed that such tax is the taxpayer's final income tax liability in the foreign country in respect of the capital gain realized on the disposition. In other words, we assume it qualifies as a "non-business income tax" as defined in subsection 126(7).

These comments are provided in accordance with the guidelines set out in paragraph 22 of Information Circular IC 70-6R5 dated May 17, 2002, issued by the Canada Customs and Revenue Agency (the CCRA) and are not considered binding on the CCRA.

Yours truly,

Olli Laurikainen
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch