13 May 2026 IFA Roundtable Q. 6, 2026-1098321C6 - Foreign tax credit on U.S. tax paid on the redemption of shares of a U.S. corporation

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: Where the shares of a U.S. resident corporation are held by a Canadian resident corporation, whether U.S. tax paid on the repurchase by the U.S. resident corporation of the shares of its capital stock, the proceeds from which are treated as a taxable dividend under U.S. tax law but as proceeds of disposition under the Act, is creditable under section 126.

Position: The availability of a foreign tax credit will depend on the particular facts and circumstances.

Reasons: Under Article XXIV(3)(a) of the Canada-U.S. Tax Treaty (the "Treaty"), the gain is considered U.S. source for purposes of Article XXIV if the gain is taxed in the U.S. in accordance with the Treaty. However, a foreign tax credit under subsection 126(1) will not be available if the U.S. tax paid can "reasonably be regarded as having been paid by the taxpayer in respect of income from a share of the capital stock of a foreign affiliate of the taxpayer".

2026 IFA Annual Conference – CRA Roundtable

Question 6 - Foreign tax credit on U.S. tax paid on the redemption of shares of a U.S. corporation

This question was submitted by STEP Canada for the STEP CRA Roundtable at the upcoming 2026 STEP Canada National Conference. At CRA’s request, STEP Canada has agreed that the question be presented at the 2026 IFA Annual Conference.

Question

A Canadian corporation (“CanCo”) owns all the shares of a U.S. corporation (“USCo”), a corporation that is resident in the United States (the “U.S.”) for purposes of the Income Tax Act R.S.C. 1985 (5th Supp., c.1., as amended, the “Act”)(footnote 1) and the Canada-U.S. Tax Convention (the “Treaty”).

USCo repurchases some of the shares (the “Repurchased Shares”) owned by CanCo, and CanCo continues to own all of the issued and outstanding shares of USCo after the repurchase.

All of the proceeds from the repurchase (the “Repurchase Proceeds”) are deemed to be a dividend under the U.S. Internal Revenue Code (the “US Code”), on which a 5% U.S. withholding tax is imposed. CanCo does not elect under subsection 93(1). As a result, for purposes of the Act, CanCo is not treated as having received a dividend from USCo, but rather realizes a capital gain from the disposition of the Repurchased Shares.

Can CanCo claim a foreign tax credit pursuant to subsection 126(1) for the U.S. withholding tax paid by CanCo on the Repurchase Proceeds received from the disposition of the Repurchased Shares?

CRA Response

In general, subsection 126(1) permits a taxpayer to claim a foreign tax credit against Part I income tax otherwise payable, in respect of tax paid for the year to the government of a country other than Canada. The amount of foreign tax credit cannot exceed the Part I tax payable in respect of the taxpayer’s “qualifying incomes … from sources in that country”. In the absence of any qualifying incomes from sources in the U.S., a foreign tax credit would not be available to CanCo for the U.S. tax it paid on the Repurchase Proceeds.

Paragraph 2(a) of Article XXIV Elimination of Double Taxation of the Treaty provides that:

“subject to the 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 (which shall not affect the general principle hereof)
(i) income tax paid or accrued to the United States on profits, income or gains arising in the United States, […]
[…]
shall be deducted from any Canadian tax payable in respect of such profits, income or gains;” [emphasis added]

Paragraph (3)(a) of Article XXIV of the Treaty provides that, for purposes of Article XXIV (elimination of double taxation):

“profits, income or gains (other than gains to which paragraph 5 of Article XIII (Gains) applies) of a resident of a Contracting State which may be taxed in the other Contracting State in accordance with the Convention (without regard to paragraph 2 of Article XXIX (Miscellaneous Rules)) shall be deemed to arise in that other State […]” [emphasis added]

The double taxation relief in paragraph 2(a) of Article XXIV of the Treaty applies “subject to the provisions of the law of Canada regarding the deduction from tax payable in Canada”, which include the foreign tax credit rules in subsection 126(1). Hence, where the U.S. may charge income tax on profits, income or gains in accordance with the Treaty, the profit, income or gain is deemed to arise in the U.S. for purposes of Article XXIV of the Treaty and by extension, the profit, income or gain is “qualifying incomes … from sources in that country”, meeting that condition under subsection 126(1).

On whether the U.S. may charge income tax on profits, income or gain when it comes to a dividend, paragraph 3 of Article X Dividends of the Treaty provides that, for purposes of Article X, a “dividend” means:

“[…] income from shares or other rights, not being debt-claims, participating in profits, as well as income that is subjected to the same taxation treatment as income from shares under the laws of the State of which the payer is a resident.” [emphasis added]

The question indicates that all of the Repurchase Proceeds are deemed to be a dividend and taxed as such under the US Code. Therefore, it is a dividend that may be taxed in the U.S. according to Article X of the Treaty. Consistent with that, the question indicates that all of the Repurchase Proceeds have been taxed in the U.S. Therefore, the gain realized on the disposition of the Repurchased Shares is deemed to arise in the U.S. for purposes of Article XXIV of the Treaty and is sourced to the U.S. for purposes of section 126.

The foreign tax credit is not available under subsection 126(1) on foreign tax that can “reasonably be regarded as having been paid by the taxpayer in respect of income from a share of the capital stock of a foreign affiliate of the taxpayer”(footnote 2) (referred herein as the “exception”).

The words “in respect of” have been interpreted as “probably the widest of any expression intended to convey some connection between two related subject matters”(footnote 3). The phrase “reasonably regarded … in respect of” in the exception above is broad. Its scope is to be determined in light of the main objective of that exception, which is to prevent a taxpayer from claiming relief from taxation under the Act twice on the same source of income (once in the form of a deduction under subsection 113(1) and also in the form of a foreign tax credit under subsection 126(1)).

The surplus pools of USCo that are relevant for determining deductions to CanCo under subsection 113(1) might incorporate elements of current and accumulated earnings and profits as determined under the US Code. Should the Repurchase Proceeds be taxed in the U.S. as a dividend to the extent of USCo’s current and accumulated earnings and profits, the exception would likely apply.

The determination of whether that exception applies is to be made case-by-case and is informed by its objective and the relevant circumstances, which would include the factors discussed above.

The exception and its objective might be relevant in determining whether obtaining a tax benefit in the form of a foreign tax credit results in a misuse or abuse of the provisions of the Act under subsection 245(4) where the other conditions of application of section 245 are met.

Gina Yew
2026-109832
May 13, 2026

FOOTNOTES

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

1. Unless otherwise indicated, all statutory references are to the Act.

2. See paragraph 126(1)(a).

3. See Slattery (Trustee of) v. Slattery, [1993] 3 S.C.R. 430, and Nowegijick v. The Queen, [1983] 1 S.C.R. 29.