13 May 2026 IFA Roundtable Q. 7, 2026-1087951C6 - Foreign tax credit and deemed year-end

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: In a situation where a taxpayer has three taxation years in the calendar year for purposes of the Act but only one taxation year for U.S. tax purposes, can the entire amount of U.S. taxes paid on a capital gain be allocated to the taxation year in which the capital gain arose for purposes of the foreign tax credit?

Position: yes.

Reasons: In the scenario presented, it is reasonable to allocate the foreign taxes to the Canadian taxation year in which the capital gain was realized.

2026 IFA Annual Conference – CRA Roundtable

7. Foreign Tax Credit and Deemed Year Ends

Hypothetical Facts and Transactions

• A corporation resident in Canada (“Canadian Target”) owns all the outstanding shares of the capital stock of a corporation resident in the United States (“U.S. Target”). U.S. Target principally derives its value from U.S. real estate.
• As of January 1 of the calendar year in which the transactions take place, Canadian Target is a Canadian-controlled private corporation (“CCPC”), as defined in subsection 125(7).(footnote 1) Canadian Target does not carry on business in the U.S.
• U.S. Target is a foreign affiliate and a controlled foreign affiliate of Canadian Target, as defined in subsection 95(1).
• On May 1 at noon, an arm’s length corporation resident in the U.S. (“U.S. Buyer”) and its wholly-owned Canadian resident corporation (“U.S. Buyer Sub”) sign an “out from under” binding agreement to respectively purchase the shares of U.S. Target and Canadian Target.
• The share purchase agreement entitles U.S. Buyer Sub to a right described in paragraph 251(5)(b).
• On November 30:
• at 11:00 am, Canadian Target sells all of its shares of U.S. Target to U.S. Buyer. Canadian Target realizes a capital gain on the sale.
• at 11:06 am, U.S. Buyer Sub purchases all of the outstanding shares of Canadian Target.

Income and Taxation Years in Canada

• Canadian Target and U.S. Target both use the calendar year as their financial year and as their taxation year.
• On May 1, Canadian Target loses its CCPC status pursuant to paragraph (a) of that definition in subsection 125(7) and paragraph 251(5)(b). Accordingly, Canadian Target’s taxation year is deemed to end immediately before noon on that day, pursuant to subsection 249(3.1) (the “First Stub Year”), and a new taxation year starts at noon on May 1.
• On November 30 at 11:06 am, there is an acquisition of control of Canadian Target when U.S. Buyer Sub acquires all of its outstanding shares. Canadian Target makes the election under subsection 256(9), such that pursuant to paragraphs 249(4)(a) and 251.2(2)(a), its taxation year beginning at noon on May 1 ends on November 30 immediately prior to the time of the acquisition of control (the “Second Stub Year”).
• On December 31, Canadian Target reestablishes a calendar year-end, such that its taxation year beginning at 11:06 am on November 30 ends on December 31, pursuant to paragraphs 249(4)(a) and 249.1(1)(a) (the “Third Stub Year”).
• Canadian Target’s three “stub” taxation years are as follows:
• January 1 to May 1 at 11:59 am (First Stub Year);
• May 1 at noon to November 30 at 11:05 am (Second Stub Year); and
• November 30 at 11:06 am to December 31 (Third Stub Year).
• Before the Second Stub Year ends immediately prior to 11:06 am on November 30, Canadian Target realizes a capital gain on the disposition of the shares of U.S. Target to U.S. Buyer.

Income and Fiscal Period in the U.S.

• Canadian Target’s fiscal year in the U.S. runs from January 1 to December 31 (i.e., there is no stub year in the U.S.).
• In accordance with the Convention Between Canada and The United States of America With Respect to Taxes on Income and on Capital Signed on September 26, 1980, as Amended by the Protocols Signed on June 14, 1983, March 28, 1984, March 17, 1995, July 29, 1997 and September 21, 2007 (“Canada-U.S. Tax Treaty”), the U.S. taxes Canadian Target in its U.S. fiscal year on the gain realized on the sale of the shares of U.S. Target to U.S. Buyer, because they principally derive their value from U.S. real estate.

Question

For a foreign tax credit (“FTC”) to be available to Canadian Target pursuant to subsection 126(1), the U.S. tax paid needs to be “for the year” in which the credit is claimed.

In the hypothetical situation provided above, since all of the U.S. tax is attributable to the capital gain that occurred in the Second Stub Year (the May 1 to November 30 taxation year), does the CRA agree that Canadian Target can claim a FTC in the Second Stub Year for the entire amount of U.S. tax? If not, would that tax be prorated over other taxation years and, if so, how?

CRA Response

The CRA has publicly addressed the interpretation of subsection 126(1) in a number of different factual situations over the years. While the result in each case depends on the particular facts and circumstances, the underlying principle is the same: a Canadian resident is taxable on taxable income earned in a taxation year, and where that income is also taxed in another country, the taxpayer may be entitled to claim a FTC under subsection 126(1) for foreign non-business income tax “paid for the year.”

In response to question 4 at the 1989 Canadian Tax Foundation Conference Roundtable, the CRA stated that where the tax paid to a foreign country is for a period that differs from the taxation year as established under the Act, it is appropriate to apportion the amount of foreign income and foreign tax paid to determine the amount of a foreign tax credit for a given year. The CRA went on to suggest that the apportionment would be “on the basis of the portion of income earned during the calendar year” (the taxation year in that question ended on December 31).

This approach was further developed in CRA document 2003-0051241E5, which recognizes that the appropriate method of allocating foreign taxes for a foreign fiscal period that does not match the Canadian taxation year may depend on the manner in which the underlying foreign income is earned. In that document, the CRA considered a simple timing mismatch between a Canadian taxation year ending on August 31 and a foreign taxation year ending on December 31.

The CRA stated that where the foreign income is earned evenly throughout the year, a proration of the foreign tax over time, such as by reference to the number of days in the relevant period, will generally be reasonable. On the other hand, where the foreign income is earned on a seasonal basis, it may be more appropriate to apportion the foreign tax by reference to the gross profit or net income earned during the relevant period.

In the present hypothetical situation, although the amount of tax potentially attributable to the gain realized by Canadian Target would have been determinable at the time of the sale, the total amount of foreign tax payable for the fiscal period ending December 31 would likely only have been ascertained and paid after that date. In our view, the relevant question for purposes of subsection 126(1) is therefore how that foreign tax should reasonably be allocated among the Canadian taxation years that overlap the foreign fiscal period.

For purposes of section 126, the foreign taxes are best apportioned on the basis of the portion of income earned during the Canadian taxation year. The method of apportionment must be reasonable in the circumstances. In addition, the method adopted by the taxpayer should generally be applied consistently from year to year. For example, where a taxpayer has a seasonal source of foreign income and allocates the related foreign tax to the taxation year corresponding to the season in which the income is earned, the taxpayer would ordinarily be expected to continue using that method on a consistent basis in subsequent years.

In the hypothetical situation presented, Canadian Target’s only U.S. tax liability is attributable to the capital gain realized immediately prior to 11:06 am on November 30, and that gain falls within Canadian Target’s Second Stub Year. In the absence of other relevant facts suggesting a different result, it would appear reasonable to allocate all of the U.S. tax relating to that gain to Canadian Target’s Second Stub Year for purposes of subsection 126(1).

We also note that CRA document 2000-0029575 bears certain similarities to the present question, as it involved a capital gain on the disposition of shares and three Canadian taxation years overlapping the foreign fiscal period in respect of which the foreign tax was paid. In that case, which involved the partnership income computation rules, the CRA concluded, relying on its 1989 position, that the foreign tax should be prorated on the basis of the number of days during which each Canadian taxation year overlapped the U.S. fiscal period.

However, CRA document 2000-0029575 should be read in light of the later comments in CRA document 2003-0051241E5 and the present analysis. Although it was not expressly stated in CRA document 2000-0029575, it appears that the corporation claiming the FTC had earned other income, either directly or through a partnership, and that daily apportionment was considered reasonable on those facts. Had the capital gain been the corporation’s only income, as in the present hypothetical, the conclusion would appear to be the same as in this response.

Finally, there may be exceptional circumstances in which a taxpayer has consistently historically allocated foreign taxes to Canadian taxation years on a straight-line basis, but wishes to adopt a different approach in relation to an unusual transaction, such as the realization of a substantial gain that materially distorts the amount of foreign tax for a particular foreign fiscal period. In such cases, it would be advisable to consult the CRA to determine whether a different allocation method would be acceptable in light of the particular facts.

For example, if Canadian Target had also earned other income taxable in the U.S. during the same calendar year, it might be reasonable to apportion the U.S. tax for that year between the capital gain and the other income. The portion of the U.S. tax relating to the capital gain would, in that case, remain allocable to the Second Stub Year. The allocation of U.S. tax relating to the other income among the three stub years would depend on the nature of that income and the period over which it was earned. Where the other income was earned evenly throughout the period, an allocation based on days may be appropriate. Where the income was earned on a highly seasonal basis, a different method of apportionment may be required in order to reasonably relate the U.S. taxes to the relevant Canadian stub taxation years to which the income pertains.

K. Graham and Y. Moreno
2026-108795
May 13, 2026

Response prepared in collaboration with:

Allison Thomas
Section 12, Reorganizations Division

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1. All statutory references in this document are to the Income Tax Act (“Act”).