28 June 1989 Income Tax Severed Letter 8-0275 - Whether foreign income taxes levied on resident corporations qualify as a foreign tax paid in respect of dividends received

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.

This is in reply to your memorandum of March 20, 1989 wherein you requested our opinion as to whether or not foreign income taxes levied on resident corporations would qualify as a foreign tax paid in respect of the dividends received by the above taxpayer.

We have reviewed several sources of material in the library to determine the nature of taxation in Singapore and Malaysia together with tax treaty negotiation files. The material indicates that both countries have a complete imputation systems of taxation. That is, the company is entitled to deduct tax from the gross dividends it declares at the same rate it pays income tax and therefore the company recovers any tax it has paid on the profits. Where a company distributes all of its profits and pays only recoverable taxes, it would appear that the gross dividend declared would be equal to its pre-tax profits. The shareholders include the gross dividend declared in income and receive a credit against their Singapore or Malaysian tax. Non-resident shareholders are treated in the same manner and no additional tax is withheld on the payment of the divident.

Paragraph 2 of Article x of the Canada - Malaysian Income Tax Agreement (the "Agreement") provides that dividends paid by a company which is a resident of Malaysia to a resident of Canada may be taxed in both states. Paragraph 5 of that article provides that dividends paid by a company which is a resident of Malaysia to a resident of Canada shall be exempt from any tax in Malaysia which is chargeable on dividends in addition to the tax chargeable in respect of the income of the company. Paragraphs 2 and 3 of Article X of the Canada - Singapore Income Tax Convention (the "Convention") provide for similar treatment. Accordingly, it would appear that the treatment proposed under both the Agreement and the Convention contemplated granting a foreign tax credit in accordance with Canadian rules that could be equal to but no greater than the 40 per cent tax rate charged on the gross amount of the dividend.

Based on the documentation we have reviewed the Malaysian and Singapore companies in effect declare a gross dividend and withhold 40% tax on that gross on behalf of both the resident and non-resident taxpayer. The amount withheld becomes a tax credit which is applied against the shareholders' tax liability or refunded if in excess of that liability.

Paragraph 3 of article X of the Convention and paragraph 5 of Article X of the Agreement provided that Singapore and Malaysia will not impose a tax on dividends in addition to the 40% tax chargeable on the profits of the company which are distributed to the shareholder. Accordingly a Canadian taxpayer is entitled to claim a foreign tax credit based on amounts actually paid by him, including the application of his tax credit, on the gross dividend but such a claim cannot exceed the 40% rate required to be paid on their behalf by the company on the payment of the dividend. However, you should require that the Canadian resident taxpayer provided evidence to establish that he has paid the tax to Singapore and/or Malaysia.

The attached appendix "A" indicates that Canada collects approximately the same amount of tax where an individual is required to report the gross dividend declared (equal to the pre-tax profits of the company) and is granted a foreign tax credit based on 40% tax withheld on his behalf as compared with an individual who reports a dividend paid out of after tax profits and is given a foreign tax credit based on 15% withholding tax, the normal treaty rate.

In XXX case it appears he has included the gross amount of the dividends in income and provided you are satisfied that the tax was paid by him, including the application of his credit, thereon at a 40 per cent rate, he would be permitted a subsection 20(11) deduction from Canadian income equal to 25 per cent of the tax paid on his behalf on the dividends. It is our view that the excess profits tax is a tax chargeable on the individual and does not relate to tax chargeable on the income of the company as referred to in paragraph 5 of Article X of the Agreement and therefore the excess profits tax on the dividend will not be creditable in Canada. In the case of Malaysia XXX will be granted a subsection 20(11) deduction and a foreign tax credit on the dividend based on tax paid of XXX. The portion of the tax payable that relates to the XXX director's fees will also subject to a foreign tax credit.

In the case of Singapore the rules described above with respect to dividends received from Malaysia will also apply under paragraphs 2 and 3 of Article X of the Agreement with Singapore. The XXX which was payable on filing would reflect the tax paid in Singapore on the income from trade partnerships, property and interest and the foreign tax credit rules would apply to these amounts.

We trust the comment are suitable for your purposes.

Appendix "A"

#1                  #2
Company Profits in Country A       $100                $100
Foreign Tax                          40                 NIL
Dividends Paid                       60                 100
Tax Paid on Dividends         (15%)$  9           (40%)$ 40
Canada
Dividend Income                    $ 60                $100
Less 20(11) deduction               NIL         (40-15)  25
Income                             $ 60                $ 75
Tax 40% (Federal and Provincial)   $ 24                $ 30
Foreign Tax Credit                    9         (40-25)  15
Tax on Dividend in Canada          $ 15                $ 15*

* The tax paid in Canada on the dividend will be less in case #2 where the rate of tax in Canada is less than the 40% tax in the Foreign jurisdiction. However it is unlikely that an individual will be investing in a foreign jurisdiciton where he is in paying tax in Canada at a rate less than 40%.