3 December 2019 CTF Roundtable Q. 2, 2019-0824381C6 - Foreign taxes paid

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: 1. What exchange rate should be used in converting foreign taxes paid to Canadian dollars? 2. May a foreign tax credit be claimed in respect of UK taxes payable but not yet paid?

Position: 1. Both the use of the exchange rate for the day the taxes were paid and the use of the rates used to convert the foreign income to Canadian dollars are acceptable. 2. In order for a foreign tax credit to be claimed in respect of UK income tax, the tax must actually be paid.

Reasons: 1. The day that the taxes are paid is the day the amount arises for the purposes of s. 126; pursuant to the discretionary power given to the CRA to accept alternate exchange rates to convert foreign currency amounts, the CRA accepts the use of the rates used to convert the foreign income giving rise to the tax. 2. Rulings has previously stated that the words “subject to Canadian laws” in income tax conventions addressing the avoidance of double taxation result in the provisions of s. 126 still applying – these provisions require that for a foreign tax credit to be claimed, the foreign taxes must be paid.

2019 CTF Annual Conference

CRA Roundtable

Question 2: Foreign taxes paid

Section 126 permits credits for foreign taxes paid for the relevant taxation year. The requirement that the tax be “paid” creates issues in practice which we would ask that the CRA comment on.

A. Folio S5-F2-C1 indicates that the foreign taxes paid should be translated to Canadian funds at a rate consistent with that used to translate the underlying income. Where the foreign tax is paid at a different time than the income arose (common where withholding taxes do not apply), does the CRA consider it acceptable for the taxpayer to translate at the foreign exchange rate(s) applicable:

i. On the date(s) on which the foreign income was earned or received (i.e. the same time the income became taxable, consistent with the “taxes payable” approach)?

ii. On the date(s) on which the foreign taxes were paid (i.e. consistent with the “taxes paid” approach, on which the credit is allowed)?

iii. On either date, as either would be a reasonable approximation of the actual foreign taxes paid, in Canadian funds?

B. The Canada-US Treaty, Article XXIV(2)(a)(i) provides that “income tax paid or accrued to the United States on profits, income or gains arising in the United States” are deductible from Canadian taxes on those items. Article XXIV(2)(a)(ii) provides that individuals can also claim most social security taxes paid, without the word “accrued”. The Canada-UK Treaty Article 21(1)(a) refers to tax payable in the UK. Does the CRA concur that, where taxes are accrued but not paid to a nation with a Tax Treaty using such terminology, a foreign tax credit may be claimed for taxes payable, even if they have not yet been paid?

Does the CRA concur that, where taxes are accrued but not paid to a nation with a Tax Treaty using such terminology, a foreign tax credit may be claimed for taxes payable, even if they have not yet been paid?

For the sake of simplicity, our responses to these questions assume that the Canadian dollar is the tax reporting currency of the hypothetical taxpayer discussed within.

CRA Response (A)

For the sake of simplicity, our responses to these questions assume that the Canadian dollar is the tax reporting currency of the hypothetical taxpayer discussed within.

Paragraph 261(2)(a) of the Act requires that taxpayers determine their Canadian tax results in Canadian currency. Paragraph 261(2)(b) also requires that an amount relevant to a taxpayer’s Canadian tax results that is expressed in a currency other than the Canadian dollar must be converted to Canadian dollars using the relevant spot rate for the particular day on which the amount arises.

The term relevant spot rate for a particular day is defined in subsection 261(1) as being, in general terms, the exchange rate quoted by the Bank of Canada for that day. The definition also permits, when the term is being used in applying paragraph 261(2)(b), another rate to be used as the relevant spot rate, provided that the alternate exchange rate is acceptable to the CRA.

To qualify for a foreign tax credit, section 126 requires that the foreign tax be actually paid. Therefore, the CRA considers the date of payment of the foreign tax to be the day that the foreign tax becomes relevant to section 126. Accordingly, in applying paragraph 261(2)(b) to convert the foreign currency amount of the taxes paid to Canadian dollars, the date of payment of the foreign taxes is considered to be the day that amount “arises”.

As stated above, when applying paragraph 261(2)(b), an exchange rate other than the rate quoted by the Bank of Canada may be used if the CRA considers that other rate acceptable. In this respect, in converting amounts of foreign taxes to Canadian dollars, the CRA considers it acceptable to use as the relevant spot rate the same exchange rate at which the income itself was converted. More specifically, as stated in Income Tax Folio S5-F2-C1 — Foreign Tax Credit at Paragraph 1.42: “For business income, this conversion (to Canadian dollars) could be done monthly, quarterly, semi-annually or annually, using the average rate for the period, depending on the taxpayer's normal method of reporting income.”

In this regard, it should be noted that, as discussed at Paragraph 1.6.1 of Income Tax Folio S5-F4-C1 — Income Tax Reporting Currency, where exchange rates fluctuate significantly, the CRA may not accept the use of the average exchange rate for a period to convert income amounts to Canadian currency. In such a situation, the use of an average exchange rate to convert foreign income tax in order to determine the taxpayer’s foreign tax credit would also not be accepted.

Accordingly, a taxpayer may use either of these methods of conversion in determining their foreign taxes paid, provided that the chosen method is consistently applied from one year to all others.

CRA Response (B)

Article 21 of the Canada-United Kingdom Income Tax Convention (the “UK Treaty”) addresses the elimination of double taxation. As pointed out in the question, subparagraph (1)(a) of the Article deals with the method by which Canada agrees to relieve a taxpayer’s Canadian income tax liability in respect of the taxpayer’s UK income taxes. Subparagraph (1)(a) of the UK Treaty expressly provides that the relief described in the subparagraph is “subject to the existing provisions of the law of Canada regarding the deduction from tax payable in Canada of tax paid in a territory outside Canada and to any subsequent modification of those provisions”. Many of Canada’s income tax treaties contain a similar “subject to Canadian laws” clause, including Canada’s income tax treaty with the United States (the “US Treaty”).

The Income Tax Rulings Directorate has previously commented on the “subject to Canadian laws” clause in Article XXIV of the US Treaty in Technical Interpretation 2015-0601781E5. The view expressed in that interpretation was that the “subject to Canadian laws” clause “… means that a Canadian resident is subject to the limitations on claiming a foreign tax credit found in the Canadian legislation, and more specifically in section 126 of the Act…”.

In our view this same interpretation applies in respect of subparagraph (1)(a) of Article 21 of the UK Treaty. Accordingly, the relief described in that subparagraph is subject to the limitations on claiming a foreign tax credit found in section 126 of the Act. Section 126 requires, in order for a foreign tax credit to be claimed in respect of foreign income taxes, that those foreign income taxes be actually paid by the taxpayer. Accordingly, notwithstanding that the CRA may allow UK income tax to be converted to Canadian currency using exchange rates from the year in which the income giving rise to the tax was earned, in order for a foreign tax credit to be claimed in respect of UK income tax, the tax must actually be paid.

Jeffrey Johns
2019-082438
December 3, 2019