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 Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
Foreign tax credit computation for U.S. citizens resident in Canada
Position:
Paragraphs 4, 5 and 6 of Article XXIV of Canada-U.S. Income Tax Convention should be followed.
Reasons:
One of the main purpose of Article XXIV, in addition to elimination of double taxation, is to allocate tax revenue to the contracting states in accordance with the provisions of that Article.
September 2, 1997
Some Aspects of Taxation of U.S. Citizens Resident in Canada
TABLE OF CONTENTS
Summary 2
Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Article XXIV - A Summary 8
Paragraph 3 (8); Subparagraph 4(a) (9); Subparagraph 4(b) (9); Paragraph 5 (10); Paragraph 6 (10)
Article XXIV - In Detail 10
Canadian Tax Credits for Taxes Paid or Accrued to the U.S. (10); Subparagraph 4(a) (14); Subparagraph 4(b) (17); Paragraph 5 (18); Paragraph 6 (20)
Illustrations 20
Conclusion 20
APPENDIX A 22
General Tax Treatment Under the U.S. Internal Revenue Code of Various Items of Income of U.S. Citizens and Non Resident Aliens of the U.S. (22)
APPENDIX B 25
Application of the Formula in Determining CitizenTax on a Particular Item of U.S. Source Income (25)
APPENDIX C 29
An Example of Computing Canadian Foreign Tax Credit (29)
APPENDIX D 37
Suggested Steps to determine foreign tax credits allowed to U.S. citizens resident in Canada under Article XXIV of the Convention (37); Flow-chart of The Steps Described Above (40)
APPENDIX E 42
TreatyTax Rates on Certain U.S. Source income Received by a Canadian Resident Who is not a U.S. Citizen (42)
APPENDIX F 44
Definitions of CitizenTax, AlienTax and TreatyTax (44)
APPENDIX G 46
U.S. Progressive Tax System -- CitizenTax may not be the same as AlienTax on certain items of U.S. source income (46)"
APPENDIX H . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
Rev. Rul. 79-28 (49)
Summary
This paper deals with Canadian foreign tax credits allowable to U.S. citizens resident in Canada in accordance with paragraphs 3, 4, 5 and 6 of Article XXIV of the Canada-United States Income Tax Convention, as amended by the Third Protocol (the Convention). In this regard, the following principles are discussed:
- Notwithstanding the savings clause each of Canada and the United States must provide credits for income taxes of the other state;
- The credits are computed in a manner not only to eliminate double tax but to limit U.S. tax to rates applicable to non-resident aliens of the U.S. (i.e. for these purposes residents of Canada who are not U.S. citizens);
- The Convention sourcing rule applies to each type of income dealt with in the Convention as if there were no savings clause;
- Canada is only required to provide a credit for U.S. taxes on income sourced to the U.S. by the Convention sourcing rule;
- Canadian credit need not exceed the amount of U.S. taxes that would have been paid if the person were not a U.S. citizen;
- The U.S. includes amounts in the computation of income as if the Convention did not exist;
- However, the U.S. must grant a tax credit for Canadian taxes paid on all sources of income after Canada provides credits on U.S. source income;
- Canadian credit applies to U.S. taxes payable prior to U.S. credit for Canadian taxes and is not reduced by such U.S. credit;
- Separate but similar rules apply to dividends, interest and royalties sourced to the U.S. and subject to tax in the U.S. even if the residents of Canada were not U.S. citizens; and
- The application of the rules requires a determination of the amount of tax paid in each Contracting State on each type of income.
The paper provides an example and suggests certain steps in computing foreign tax credit for U.S. citizens resident in Canada and in conclusion encourages the field officers to refer complicated cases to Income Tax Rulings and Interpretations Directorate.
Introduction
The purpose of this paper is to clarify the Department's position with respect to the taxation of U.S. citizens who are resident in Canada for the purposes of the Canada-United States Income Tax Convention (1980) as amended by the Third Protocol to the Convention (the Convention).
This paper does not deal with U.S. alternative minimum tax,1 U.S. credit for prior years' alternative minimum tax, U.S. state income taxes and U.S. social security and medicare tax. For a discussion of Canadian foreign tax credit with respect to U.S. alternative minimum tax and U.S. credit for prior years' alternative minimum tax, please refer to a separate paper dealing with those subjects. In addition, the paper does not deal with U.S. income taxes paid with respect to income earned by a U.S. subchapter S corporation (SCorp.) or a U.S. limited liability corporation (LLC). Situations involving U.S. taxes paid with respect to such corporations need to be reviewed on a case by case basis.
In order to avoid further complexity, it is assumed that U.S. tax rates on U.S. source income which are not restricted by the Convention are the same for a U.S. citizen resident in Canada (taxable on world-wide income) as they would for a resident of Canada who is not a U.S. citizen (taxable on U.S. source income only) earning that income. In this regard, the difference in marginal tax rates on different levels of income has not been taken into account. However, see Appendix G for further discussion of this topic.
The U.S. taxes its citizens on their world income. In paragraph 2 of Article XXIX of the Convention (the savings clause) the U.S. has reserved its right to tax its citizens as if the Convention did not exist. However, each Contracting State under subparagraph 3(a) of Article XXIX of the Convention has, in spite of the savings clause, agreed to meet its obligations under the paragraphs and Articles of the Convention listed in that subparagraph . The listed provisions are in fact exceptions to the savings clause. Article XXIV (Elimination of Double Tax) of the Convention is one of those exceptions. Thus, in the case of the U.S. with respect to its citizens resident in Canada it is obligated to provide them with tax credits with respect to Canadian taxes paid on certain income in accordance with the provisions of paragraphs 4 and 5 of Article XXIV of the Convention.
Unless stated otherwise, hereafter a reference to a paragraph in the paper (including the footnotes therein) is a reference to the paragraph of Article XXIV of the Convention.
Taxation among contracting states is usually established in such a manner that the state of source has the first right of taxation followed by the state of residence and then the state of citizenship. As evidenced by the savings clause the U.S. in general maintains its first right of taxation on the basis of citizenship. In the case of U.S. citizens resident in Canada, by agreeing to meet its obligations to provide tax credits for Canadian taxes as set out in paragraphs 4 and 5, the U.S. has in effect subordinated its first right of taxation based on citizenship to the state of source and the state of residence. For the purpose of determining the amount of tax credit that each of the U.S. and Canada must provide on various items of income received by a U.S. citizen resident in Canada, paragraphs 4 and 5 provide the following: (i) the source of the various items of income is determined under the sourcing rule of the Convention which applies as if the savings clause did not exist; (ii) Canada need not grant a credit for U.S. taxes paid by a U.S. citizen who is a resident of Canada in excess of the U.S. taxes that would otherwise be paid on the same income if the resident of Canada were not a U.S. citizen; and (iii) the U.S. is obliged to give a credit for taxes paid to Canada, on the entire income of U.S. citizens resident in Canada, including income which has a U.S. source (as determined in accordance with the Convention) and in respect of which Canada has given a credit, to the extent that the credit given by the U.S. does not reduce the amount of its tax that would be paid by a resident of Canada who was not a U.S. citizen.
For illustrative purposes consider2 a U.S. citizen resident in Canada who is present in the U.S. in the calendar year for less than 183 days and who derives income in that year of $25,000 from an employment exercised in the U.S. for a Canadian employer who does not have a permanent establishment in the U.S. In accordance with the sourcing rules of paragraph 3, which as noted above applies as if the savings clause did not exist, because the U.S. may not tax such income of a Canadian resident under Article XV of the Convention, such income is resourced to Canada. The subordination of the U.S.'s right to tax based on citizenship to the state of source and residence on such income can be shown as follows. The U.S. tax without taking into account the Convention on such income, say, at 40% is $10,000. If Canada's tax rate on such income is 55%, Canadian income tax will be $13,750. If the U.S. had not agreed to meet its obligations under Article XXIV of the Convention the U.S. would keep its tax of $10,000. Canada would provide a tax credit of that amount and would receive $3,750 of the overall tax burden of $13,750 (ignoring foreign exchange). However, pursuant to paragraph 4, Canada is not obliged to give a tax credit for U.S. tax on this income. On the other hand, pursuant to paragraph 4 the U.S. is obliged to give a credit of up to $10,000 against its tax of $10,000 and thus U.S. tax after such tax credit is nil. Consequently, the total income tax liability of $13,750 (i.e. the amount equal to the Canadian rate of tax) is collectable by Canada. If the Canadian tax rate is 35% instead of 55%, Canadian tax is $8,750. The U.S. grants a credit of $8,750 against its tax of $10,000 resulting in U.S. tax of $1,250. While the U.S. has subordinated its right to tax its citizens in general on such income, it is allowed to collect taxes if the Canadian rate of tax is less than the U.S. rate so that the overall tax burden is at least equal to the U.S. rate. It should be noted that if it were not for the savings clause, by virtue of Article XV of the Convention the U.S. would not be allowed to tax the income described above even if Canadian tax rates were lower than U.S. tax rates.
Change the income to business income of $25,000 attributable to a permanent establishment of a person situated in the U.S. For the purpose of computing the tax credit that each state is obliged to grant, as the U.S. may tax such income of a Canadian resident under Article VII of the Convention, such income is sourced to the U.S. Assume U.S. tax under the Internal Revenue Code (the "Code") on such income for a resident of Canada whether or not he is a U.S. citizen is 40% or $10,000. Assume the Canadian tax on such income at 55% is $13,750. Under paragraph 4 Canada is obliged to give a credit of $10,000 against its tax resulting in net Canadian tax of $3,750. Under paragraph 4 the U.S. is obliged to give a credit for Canadian tax paid on such income after Canada has provided its credit for U.S. taxes. However, such credit can not reduce the U.S. tax paid to an amount less than the amount the U.S. could collect if the person were not a U.S. citizen. In other words, the limit is the amount of U.S. tax any other Canadian resident would have to pay. In such a case for a Canadian resident Article VII of the Convention does not restrict the amount of U.S. tax. Therefore, such a Canadian resident would have to pay $10,000 in taxes to the U.S. The result is that the U.S. is not obliged to provide any credit on this business income and will collect taxes of $10,000. In this case the U.S. has simply maintained its first right to tax as state of source.
If this example is changed so that business income is attributable to a permanent establishment situated in Canada, for the purpose of determining the tax credits each state must provide, such income is sourced to Canada. Thus Canada is not obliged to grant any credit for U.S. taxes on such income and the U.S. is obliged to grant a credit for Canadian taxes paid with the result that, unless U.S. tax rates are greater than Canadian rates, there is no U.S. tax.
Where the Convention restricts the U.S. right to tax, for example, to a specific rate of 15% such as that provided for periodic pension payments which arise in the U.S., Canada is only obliged to provide a credit equal to the restricted amount of tax and the U.S. has to provide a credit for Canadian taxes paid after the application of such credit by Canada but only to the extent that the U.S. tax exceeds the restricted amount of 15%.
In general for a U.S. citizen resident in Canada, as shown in each of the preceding examples, the result of Canadian and U.S. tax credits combined, taking into account the Convention, is that the person is taxed in each State as if the person had been a resident of Canada and had not been a U.S. Citizen. The state of source exercises the first right to tax followed by the state of residence. Generally this is accomplished by each country first including the world-wide income of the U.S. citizen resident in Canada in the computation of income for tax purposes, then subjecting that income to the normal rate of tax in each country and then allowing tax credits against such taxation as determined in accordance with the Convention.
For Canadian tax purposes, if a U.S. citizen who is a resident of Canada for purposes of the Convention chooses not to claim any treaty benefits under the Convention and pays U.S. income tax in excess of what is required by the Convention, as the Convention has removed the obligation to pay the excess U.S. tax, Canada would consider the overpayment of U.S. tax as a voluntary payment and not an income or profit tax eligible for a foreign tax credit under section 126 of the Act or a deduction under either subsection 20(11) or 20(12) of the Act. Such a person would not be treated differently than any other persons resident in Canada for purposes of the Convention where the Convention removes the obligation to pay U.S. income taxes. In addition, it is clearly not appropriate for Canada to provide tax credits or deductions for U.S. taxes which may be paid on income earned from sources in Canada by such a person.
One of the purposes of Canada's tax treaties with other countries besides the avoidance of double taxation and the prevention of fiscal evasion of income taxes is to allocate and limit taxing powers of two Contracting States.3 For example, under Article XVIII of the Convention the rate of tax imposed by the U.S. on U.S. source periodic pension payments paid to a resident of Canada who is not a U.S. citizen is limited to 15% of the gross amount of the periodic pension payments. Under paragraph 4, Canada is only required to grant a tax credit to that extent. The U.S. is obligated to grant a credit for the balance of the Canadian income tax to the extent that the U.S. income tax exceeds the limit allowed under the Convention. The effect is to give Canada a greater share of the overall tax burden than would have resulted had Canada simply granted a credit for U.S. taxes paid as would have been the case if the Convention was read without reference to paragraph 4. If Canada were to grant a credit under section 126 of the Act in this circumstance for the U.S. taxes paid in excess of that required by the Convention, it would be in direct conflict with the clear intention of the Convention of limiting the U.S. tax on income of U.S. citizens who are resident in Canada (as determined in accordance with Article IV of the Convention). It should be noted that if excess U.S. taxes are paid by a U.S. citizen who is a resident of Canada for purposes of the Convention, pursuant to the Convention such person is entitled to a refund of such excess U.S. taxes from the U.S. tax authorities.
Article XXIV - A Summary
Paragraph 3
It should be noted that paragraphs 4 and 5 apply to a person who is a resident of Canada for the purposes of the Convention and who is also a U.S. citizen. Paragraph 3 provides a sourcing rule for the income of residents of a Contracting State for the purposes of the Convention for the purposes of Article XXIV of the Convention. This rule applies without regard to the savings clause. Therefore, the source of income under that rule is determined in the same manner for a U.S. citizen resident in Canada as for any other person who is a resident of Canada for the purposes of the Convention. In general under this rule, income of a resident of Canada which may be taxed in the U.S. in accordance with the provisions of the Convention is deemed to be sourced to the U.S. Income of such person that may not be taxed in the U.S. under the provisions of the Convention is sourced to Canada.
Subparagraph 4(a)
Subparagraph 4(a) provides that Canada is only required to provide a credit for any U.S. taxes paid or accrued to the U.S. on income that has a U.S. source as determined under paragraph 3. It further provides a rule that limits the amount of credit Canada is required to grant for such taxes to the amount of the taxes that the U.S. would collect if the income was sourced in the U.S. (in accordance with paragraph 3) and was received by a resident of Canada who was not a U.S. citizen. In addition to other U.S. source income, this subparagraph applies to dividends, interest and royalties sourced to the U.S. and which would be exempt from tax under the Code if the recipient of such income was a resident of Canada but not a U.S. citizen (i.e. a non-resident alien of the U.S.) but not other dividends, interest and royalties sourced to the U.S.
Subparagraph 4(b)
Subparagraph 4(b) provides a rule for determining the amount the U.S. is required to grant as a credit for taxes paid or accrued to Canada on all the taxpayer's income after the application of the credit, if any, provided for in subparagraph 4(a). The credit so granted by the U.S. shall not reduce the amount of the tax that the U.S. would collect if the income was sourced in the U.S. (in accordance with paragraph 3) and was received by a resident of Canada who was not a U.S. citizen. Subparagraph 4(b) does not apply to dividends, interest and royalties sourced to the U.S. under paragraph 3 and subject to tax under the Code if the resident of Canada were not a U.S. citizen.
Paragraph 5
Paragraph 5 deals with dividends, interest and royalties sourced to the U.S. and subject to tax under the Code if the resident of Canada were not a U.S. citizen. It provides that Canada allow a deduction equivalent to the subsection 20(11) deduction as provided in the Income Tax Act (the "Act") in respect of taxes paid or accrued to the U.S. on such income prior to any credit for Canadian income taxes and then operates in a manner similar to paragraph 4.
Paragraph 6
Paragraph 6 provides a rule for the resourcing of U.S. source income for purposes of the Code to the extent required to permit the U.S. to grant the credit required by subparagraphs 4(b) and 5(c) on U.S. source income.
Where there is an inconsistency between the tax credits provided by the domestic tax law of a Contracting State and the Convention, the rules of paragraphs 4 and 5 prevail. For instance, the credits and the equivalent to the subsection 20(11) deduction that Canada must provide are based on taxes paid or accrued to the U.S. prior to the application of any credits for taxes paid or accrued to Canada and the credits the U.S. must provide include credits for taxes paid or accrued to Canada on U.S. source income.
To summarize, paragraphs 4 and 5 determine what portion of the total taxes paid by a U.S. citizen resident in Canada goes to each of the Contracting States. In addition to the elimination of double taxation, these paragraphs provide that the U.S. portion of the total taxes paid is reduced to the amount of taxes that would be paid or accrued to the U.S. if the taxpayer who is a resident of Canada were not a U.S. citizen (i.e. a non-resident alien of the U.S.).
Article XXIV - In Detail
Canadian Tax Credits for Taxes Paid or Accrued to the U.S.
Pursuant to paragraphs 4 and 5, Canada is only required to provide a credit for taxes paid or accrued to the U.S. on U.S. source income against Canadian taxes on such income. As will be described below there are five important factors which impact on the determination of the amount of taxes paid or accrued to the U.S for which Canadian tax credit will be given.
The first is that the taxes of both States have to be determined for each item of income on an item by item basis.
The second is the determination of the amount of U.S. tax on each item of income that would be payable to the U.S. by the U.S. citizen resident in Canada before any credits for Canadian taxes on that item of income.
The third is that Canada need not provide a tax credit for the amount of U.S tax referred to in the second factor on a particular item of income in excess of the taxes that would be paid to the U.S. on that item of income if the resident of Canada were not a citizen of the U.S.
The fourth is that a resident of Canada who is not a U.S. citizen (i.e. a non-resident alien of the U.S.) is subject to tax on certain income under the Code without reference to the Convention at rates different from those applying to U.S. citizens and that residents of Canada who are not U.S. citizens are entitled pursuant to the Convention to relief from U.S. taxation on certain items of income sourced to the U.S.
The fifth is that the amount of U.S. tax on U.S. source income for which Canada will give a credit is not reduced by the credit provided by the U.S. for Canadian taxes on such income. In addition, under paragraph 5 the equivalent to the subsection 20(11) deduction provided by Canada can not be reduced by any credit the U.S. provides for Canadian taxes paid on the relevant income.
In order to determine the amount of taxes paid or accrued to the U.S. on a particular item of income for which Canada must provide a credit, it is required to determine three amounts each of which will be referred to hereafter as follows.
"CitizenTax"4
CitizenTax on a particular item of income is the amount of tax which a U.S. citizen resident in Canada would have to pay to the U.S. under the Code on that item of income before any credit for Canadian taxes on such income and before taking into account the provisions of the Convention. (Note that the U.S. taxes its citizens on their world-wide income.) CitizenTax may be reduced by the credit or a portion of the credit for prior years' alternative minimum tax ("MTC") claimed. In this regard, please refer to Appendix B and the paper titled "Alternative Minimum Tax and Credit for Prior Year Minimum Tax of the United States and their Effect on Canadian Foreign Tax Credit for U.S. Citizens Resident in Canada" for further detail.
"AlienTax"
Alientax on a particular item of income is the amount of tax that a non-resident alien of the U.S. (e.g. a Canadian resident who is not a U.S. citizen) would have to pay under the Code on that item of income which has been sourced to the U.S. This tax could be different from the Citizentax on the same item of income. For example, a non-resident alien of the U.S. who receives certain portfolio interest is exempt from tax under the Code on such income while a citizen of the U.S. is not. (See Appendix A for the definition of portfolio interest and other items of income exempt from U.S. tax if received by a non-resident alien of the U.S. It is planned to verify the information in that appendix with U.S. Internal Revenue Service and determine if there are other items of U.S. source income which, if paid to a non-resident alien of the U.S., would be subject to a lower rate of tax under the Code than that provided by the Convention.) Other items of income of a non-resident aliens such as rents, annuities, dividends, interest and royalties all of which are not effectively connected to a trade or business of a permanent establishment in the U.S. are subject to a withholding tax rate of 30% under the Code while such income is taxed in the hands of a U.S. citizen under the normal progressive rates of taxation provided in the Code. Except for rental or royalty income from real property, AlienTax on such items of income is usually greater than TreatyTax (see below for the definition of TreatyTax).
On certain items of U.S. source income such as pension income, employment income,5 business income effectively connected to a permanent establishment in the U.S., and rental or royalty income from real property, a non-resident alien of the U.S. will be taxed at the normal progressive rates in the same manner as a U.S. citizen. In such a case in respect of those items of income, AlienTax will be equal to CitizenTax.6
"TreatyTax"
TreatyTax on a particular item of income sourced to the U.S. in accordance with paragraph 3 is the amount of tax that the U.S. would be allowed to collect under the income provisions of the Convention7 if the recipient of the income were a Canadian resident for the purpose of the Convention but not a U.S. citizen. As mentioned earlier, for paragraphs 4 and 5 to apply the person must be a resident of Canada for the purpose of the Convention. Therefore, TreatyTax on a particular item of income can be determined from a particular income provision of the Convention which allows the U.S. to tax that item of income in the hands of a Canadian resident. Where the income provisions of the Convention do not restrict the amount of U.S. taxation on an item of income sourced to the U.S., TreatyTax and CitizenTax will be the same.8 Where the income provisions of the Convention restrict the amount of the U.S. tax, TreatyTax will be the restricted amount.
As discussed in the following paragraphs the impact of the five factors mentioned above is that the amount of taxes paid or accrued to the U.S. for which Canada must provide a credit will be the least of CitizenTax, AlienTax and TreatyTax. (Where any two of these three amounts are equal but less than the third amount, one of the amounts that are equal would be considered to be the least amount for this purpose; where all three amounts are equal, any one of the three amounts would be considered to be the least amount for this purpose.)
The starting point of the computation under paragraphs 4 and 5 is the computation of CitizenTax. The following formula9 can be used to determine CitizenTax on a particular item of income.
Net income of that item of income x U.S. tax before foreign tax
U.S. adjusted taxable income credit on U.S. tax return
It is not always appropriate to use this formula to compute CitizenTax on a particular item of U.S. source income. This formula may not be appropriate where U.S. tax rates on some items of income are not the same as those on other items of income. For example, the maximum tax rate for a single individual on a net capital gain in the U.S. for 1995 is 28% while the maximum rate for that year that applies to other income (such as employment income) is 39.6%. Therefore, where a U.S. citizen has a capital gain subject to tax at a rate which is lower than the rate on employment income, it is necessary to determine how much U.S. tax is payable on the capital gain as well as on the other income before the appropriate amount of Canadian tax credit and, the equivalent to subsection 20(11) deduction, if any, can be calculated.
Appendix B gives an example of the calculation of CitizenTax on a particular item of income.
Subparagraph 4(a)
Subparagraph 4(a) states that Canada has to provide a tax credit only in respect of income which is sourced to the U.S. by paragraph 3. Subparagraph 4(a) further provides that such Canadian tax credit need not exceed the U.S. tax that would be paid on such income sourced to the U.S. if the resident of Canada were not a U.S. citizen. Taking into account that for certain items of income the Convention limits the amount of tax the U.S. may collect, the tax that would be paid to the U.S. if the resident of Canada were not a U.S. citizen means the lesser of (a) AlienTax which is the tax levied under the Code on a non-resident alien of the U.S.10 and (b) TreatyTax which is the tax that the U.S. is allowed to levy under the income provisions of the Convention on a Canadian resident who is a non-resident alien of the U.S.11 This means that the credit that Canada must provide is the least of CitizenTax, AlienTax and TreatyTax.12 For example, in the case of periodic pension income sourced to the U.S. in accordance with paragraph 3 and received by a resident of Canada who is a U.S. citizen, if CitizenTax (or AlienTax as it is equal to CitizenTax in this case) is greater than 15% of the gross amount of such income (TreatyTax), Canada is only required to grant a credit equal to 15% of the gross amount of such income. On the other hand, if CitizenTax (or AlienTax) is less than 15% of the gross amount of the pension payments, Canada is only required to grant a credit equal to CitizenTax (or AlienTax).
It should be noted that the Code exempts certain U.S. bank deposit interest and U.S. source portfolio interest paid to non-resident aliens of the U.S. from U.S. taxation.13 For such portfolio interest, AlienTax will be nil. In such a case, since such income is not subject to U.S. tax if the recipient were a resident of Canada but not a U.S. citizen, effective after 1995 paragraph 4 instead of paragraph 5 will apply. For example, a resident of Canada who is a U.S. citizen receives bank deposit interest which would be exempt from U.S. tax if such interest were received by a non-resident alien of the U.S (i.e. AlienTax is nil). Assume the taxpayer's CitizenTax is 30% on such income. The tax rate according to paragraph 2 of Article XI is limited to 10% (TreatyTax). In this example, paragraph 5 would not apply because the requirement that the income be subject to tax in the U.S. if the taxpayer were not a U.S. citizen is not met. Instead, paragraph 4 would apply. As AlienTax of nil is less than CitizenTax of 30% and TreatyTax of 10%, pursuant to subparagraph 4(a) Canada is not obliged to give any credit for U.S. taxes.
However, pursuant to paragraph 5 as it applied to the taxation years prior to 1996 for dividends, interest and royalties sourced to the U.S. in accordance with paragraph 3, Canada is required to provide credits for taxes paid or accrued to the U.S. even if the Code provided for an exemption from U.S. tax if such income was paid to a non-resident alien of the U.S. This point will be elaborated below in the section titled "Paragraph 5".
Assume that a U.S. citizen resident in Canada earns employment income from services rendered in the U.S. and pursuant to Article XV such employment income could not be taxed in the U.S. if earned by a Canadian resident non-U.S. citizen. Because there is no reference to Article XV (Dependant Personal Services) in paragraph 3 of Article XXIX, it has been argued that the savings clause is not overridden, that the U.S. is entitled to tax its citizen on this income as if the Convention did not exist and that the rules in Article XXIV that provide relief from double taxation do not apply. The result, the argument goes, is that Canada must provide a credit with respect to U.S. taxes paid in these circumstances.
In our view, such an argument does not prevail. It overlooks the fact that the U.S. is required to honour its obligation undertaken under Article XXIV of the Convention and the existence of the "three bite" principle (i.e. source, residence and citizenship in the order listed) embodied in that Article. It further ignores the fact that Article XV is not being applied to the U.S. citizen, but that Article is only referred to for the purposes of applying paragraph 3 of Article XXIV which deals with the source of income for the purposes of subparagraph 4(a),14 As paragraph 3 applies without reference to the savings clause, the source of income for the purpose of Article XXIV is determined in the same manner for a U.S. citizen resident in Canada as it is for any other persons resident in Canada.15 Pursuant to subparagraph 4(a), as the employment income is not sourced to the U.S., Canada is not obliged to give a credit. Although the U.S. is allowed to tax the employment income in accordance with the savings clause, it is obliged under subparagraph 4(b) to provide a credit for Canadian tax paid on such income as determined after any credit for U.S. taxes. As subparagraph 4(a) does not require Canada to give any credit for U.S. taxes on income sourced to Canada within the meaning of paragraph 3, there would not be any credit against Canadian taxes for U.S. taxes paid on such employment income. In other words, subparagraph 4(a) determines the amount of credit Canada must grant for U.S. taxes and subparagraph 4(b) effectively removes the obligation of the U.S. citizen resident in Canada to pay U.S. taxes to the extent of the credit provided therein. The alternative argument suggested above ignores the agreement between the two States on how the tax burden on such income of a U.S. citizen resident in Canada should be split between Canada and the U.S.
Subparagraph 4(b)
Subparagraph 4(b) provides that the U.S. must provide a tax credit for taxes paid or accrued to Canada on the taxpayer's income after the application of the credit that Canada must provide by virtue of subparagraph 4(a). The U.S. is obliged to grant a tax credit against its taxes on all income of the taxpayer including income sourced to Canada, income which is deemed by paragraph 3 to be sourced to Canada, and income which is sourced to the U.S. but which would not be subject to U.S. tax if paid to a resident of Canada who is not a U.S. citizen.16 In other words, the obligation of the U.S. to provide a tax credit is not confined to Canadian taxes with respect to income for which Canada must provide a tax credit pursuant to subparagraph 4(a).17
Where the U.S. is required to provide a credit for Canadian taxes paid on U.S. source income, paragraph 6 provides that such income, to the extent that the U.S. is required to provide such a credit, shall be resourced to Canada for the purposes of the Code.
The U.S. is not required to grant a credit for taxes paid on U.S. source income that would result in U.S. taxes being less than what they would have been if the taxpayer who is a resident of Canada had not been a U.S. citizen. For example, in the case of periodic pension payments sourced in the U.S., if both the CitizenTax and AlienTax on such income are 40% and TreatyTax is 15%, U.S. tax after U.S. tax credit is not required to be reduced below 15% of the amount of the pension payments (i.e. TreatyTax).
However, in the case of employment income for services exercised in the U.S., which, if received by a Canadian resident non-U.S. citizen, would otherwise be exempt from U.S. tax by virtue of Article XV of the Convention (and would thus not be considered to arise in the U.S. in accordance with paragraph 3), Canada is not required to grant a tax credit for U.S. tax otherwise payable on such income because the income is not sourced to the U.S. Pursuant to subparagraph 4(b), the U.S. must grant a credit for taxes paid or accrued to Canada on such income. As a result, generally there is no U.S. tax on such income unless the rate of tax in the U.S. is higher than that in Canada. For an illustration of this point, please refer to the example in the "Introduction" section above.
Paragraph 5
Paragraph 5 has been amended to apply if the U.S. citizen resident in Canada receives dividends, interest or royalties which are sourced to the U.S. by paragraph 318 and which would be subject to tax in the U.S. if the person were not a U.S. citizen (i.e. AlienTax is greater than zero). (If such income would not be subject to U.S. tax if received by a resident of Canada who was not a U.S. citizen, paragraph 4 applies.) This change results from the amendment to paragraph 5 in the Third Protocol to the Convention and applies to 1996 and subsequent taxation years. For 1995 and previous taxation years, paragraph 5 would apply to dividends, interest and royalties sourced to the U.S. even if such income would have been exempt from U.S. tax if paid to a resident of Canada who was not a U.S. citizen (see Appendix A for examples of interest income of a non-resident alien of the U.S. exempt from U.S. tax). In such a case the tax for which Canada would provide a credit would be the lesser of CitizenTax and 15% of the gross amount of the income.19 For example, a resident of Canada who is a U.S. citizen received interest from a deposit with the U.S. bank in 1994. Assume CitizenTax on such income was 40%. Even though the interest would be exempt from U.S. tax if received by a non-resident alien of the U.S., Canada would be obliged to allow an equivalent to a subsection 20(11) deduction of 25% of such income (i.e., 40% minus 15%) and a credit of 15% of such income. The U.S. would be obliged to give a tax credit for Canadian tax paid after the application of the Canadian tax credit for U.S. tax but such U.S. tax credit should not reduce the U.S. tax to less than 15% of such income.
For 1996 and subsequent taxation years, paragraph 5 as amended by the Third Protocol provides that the tax credit granted by Canada for U.S. tax paid or accrued on income need not exceed the amount of U.S. tax paid or accrued on such income if the Canadian resident were not a U.S. citizen. The Canadian credit is, therefore, equal to the least of CitizenTax, AlienTax (if it is greater than zero)20 and TreatyTax on such income.
Except for providing that Canada must allow for a deduction from income of an amount, based on the amount of CitizenTax21 on such income, equivalent to a deduction under subsection 20(11) of the Act, paragraph 5 applies to 1996 and subsequent years in much the same manner as paragraph 4 applies to other U.S. source income, as illustrated below.
First, if CitizenTax on dividend, interest or royalty income exceeds 15% of the gross amount of such income, Canada must allow a deduction from the income in the amount of the excess. Such a deduction can not be reduced by any credit against U.S. taxes for taxes paid or accrued to Canada on such income as referred to in subparagraph 5(c). Second, Canada must provide a credit against Canadian taxes on such income in an amount equal to the least of CitizenTax, AlienTax and TreatyTax on such income. Third, the U.S. must provide a credit for taxes paid or accrued to Canada on such income after the application of the tax credit for U.S. taxes described above. However, the U.S. is not obligated to give a credit for taxes paid or accrued to Canada that will reduce CitizenTax below the lesser of AlienTax and TreatyTax. In Example B in the commentary of Article XXIV in the Technical Explanation to the Third Protocol, CitizenTax on dividend income of $100 is $40. AlienTax which is the withholding rate under the Code is assumed to be 30%, i.e. $30. TreatyTax is $15 pursuant to Article X of the Convention. Under paragraph 5 the U.S. is not obligated to give a tax credit for taxes paid or accrued to Canada that will reduce CitizenTax of $40 below TreatyTax of $15 (i.e. the U.S. tax credit on such income will not be greater than $25). In that example, since the Canadian tax is $20, the credit provided by the U.S. is only $20 resulting in U.S. tax of $20 instead of $15 on the dividend. The fact that in that example the U.S. could collect tax of $20 is because after the equivalent to the subsection 20(11) deduction allowed in Canada, Canadian income tax on the dividend before foreign tax credit is less than the excess of CitizenTax over TreatyTax.
Paragraph 6
Paragraph 6 provides for the resourcing of the amount of income from the U.S. to Canada for the purpose of computing the credit provided for in subparagraphs 4(b) and 5(c) under the rules of the Code.
Illustrations
We include in Appendix C an example to illustrate the application of the provisions of paragraphs 4, 5 and 6 described above.
In Appendix D we outline certain suggested steps to follow in assessing the claim for Canadian foreign tax credit for U.S. taxes paid by U.S. citizens resident in Canada and a flow-chart to illustrate these steps.
Conclusion
The above sets out our interpretations of paragraphs 4 and 5 and serves as a starting point for the Tax Services Offices ("TSO's") to review the claim for foreign tax credit by taxpayers who are U.S. citizens resident in Canada. We anticipate that the computation of Canadian foreign tax credit for some taxpayers may be more complicated than what was shown in the example in Appendix C. We encourage the referral of the more complex cases to the Rulings Directorate as these cases may have to be examined on a case-by-case basis. If in practice the Tax Services Offices encounter any difficulty in applying the principles and the procedures described above, they should not hesitate to call Ken Major (telephone number (613) 957-2124) or Simon Leung (telephone number (613) 957-2115). They will be glad to be of assistance.
APPENDIX A
General Tax Treatment Under the U.S. Internal Revenue Code of Various Items of Income of U.S. Citizens and Non Resident Aliens of the U.S.
This Appendix deals with the general tax treatment under the U.S. Internal Revenue Code of various items of income of U.S. citizens and non-resident aliens of the U.S. The contents of this Appendix will be verified with the I.R.S.
U. S. Citizen and Non-resident Alien Tax Bases Under the Code
U. S. Citizens
Non-resident Aliens
All U.S. passive income
U.S. passive income with some exceptions1
All U.S. employment income
U.S. employment income with some exceptions2
All foreign employment income (may be eligible for Sec. 911 foreign earned income exclusion)
All foreign passive income
All capital gains from U.S. sources
U.S. real estate gains and gains effectively connected to a U.S. trade or business
All capital gains from foreign sources
All business income
Income connected to a U.S. trade or business
Certain income earned by controlled foreign corporations
1. Subject to certain exceptions, a non-resident alien's U.S. source income that is not effectively connected with a U.S. trade or business of the recipient is subject to a U.S. withholding tax of 30% of such gross income. Income subject to the 30% tax includes interest, dividends, royalties, rents and other fixed or determinable annual or periodic income.
For 1996 and subsequent taxation years, where the Code exempts such income if received by a non-resident alien of the U.S., Canada is not required to grant a credit for U.S. tax paid by a U.S. citizen resident in Canada on the income earned on certain investments which is exempt from U.S. tax. Some common examples of items of income not effectively connected with a U.S. trade or business of the recipient which are exempt from U.S. tax if received by a non-resident alien of the U.S. (i.e., AlienTax is nil) are:
(i)interest on U.S. bank deposits and interest on amount held by insurance company under an agreement to pay interest there on (Code Sec. 861(c) and 871(i)); and
(ii) "portfolio interest" received from U.S. sources (Code 871(b) and 888(c)). Under paragraph 871(h)(2) of the Code, "portfolio interest" means interest received by non-resident aliens on two categories of portfolio investments. The first is any obligation that is not in registered form but meets the following three requirements:
(a) arrangements exist that are reasonably designed to ensure that such obligations will be sold or resold only to non-U.S. persons;
(b) the interest is payable only outside of the U.S.; and
(c) on the face of the obligation, there is a statement that any U.S. person who holds it will be subject to limitations under the U.S. tax law.
The second type of obligation is any registered obligation with respect to which the U.S. person who would otherwise be required to withhold tax from interest paid on the obligation has received a statement stating that the beneficial owner is not a U.S. person.
Other examples which are not as common are proceeds from a wager placed in certain games (Code section 871(j)) and dividends from an 80/20 company (Code section 871(i)(2)(B)).
It should be noted that if the interest income is exempt under the Convention (namely, under paragraph 3(a) of Article XI of the Convention), such income is sourced to Canada for the purposes of paragraphs 4 and 5 and Canada is not required to provide any foreign tax credit.
2. A non-resident alien of the U.S. who performs personal services in the U.S. for compensation in the tax year is considered to engage in a trade or business in the U.S. and the compensation will be taxed at the normal progressive tax rates. However, this does not extend to personal services performed by a non-resident alien individual who is temporarily present in the U.S. for 90 days or less during the tax year and whose compensation does not exceed U.S.$3,000 and the services are performed (a) for a non-resident alien individual, foreign partnership, or foreign corporation not engaged in a U.S. business, or (b) for a branch office or place of business maintained in a foreign country or U.S. possession by a U.S. citizen or resident or by domestic partnership or corporation (Code Sec. 864(b)(1)). Such compensation of the non-resident alien individual is exempt from U.S. tax (i.e., AlienTax is nil). No exemption is available if such compensation exceeds U.S.$3,000. In this regard, it should be noted that if employment income from services rendered in a calendar year in the U.S. is U.S.$10,000 or less, such income is sourced to Canada and there is no TreatyTax. As a result, the U.S.$3,000 exemption referred to in this paragraph will not impact on the computation of Canadian tax credits under subparagraph 4(a).
APPENDIX B
Application of the Formula in Determining CitizenTax on a Particular Item of U.S. Source Income
In the formula
Net income of that item of U.S. source income x U.S. tax before foreign tax
U.S. adjusted taxable income22 credit on the U.S. tax return
"net income of a particular item of U.S. source income" means income of that item less (i) expenses directly related to the earning of such item of income; (ii) foreign earned income exclusion claimed under Code section 911 related to such item of income; and (iii) the appropriate amount(s) of standard deduction or itemized deductions which is taken into account under (i) and which is allocatable to such item of income as shown in the example below.
"U.S. adjusted taxable income" means taxable income on line 37 plus personal exemption on line 36 of Form 1040 U.S. Individual Income Tax Return for the year 1995 ("Form 1040"). A copy of that form is attached.
"U.S. tax before foreign tax credit" on the U.S. tax return means the total amount of U.S. tax on line 40 of Form 1040 (for 1995) less the credits on line 41 (Credit for child and dependent care expenses) and line 42 (Credit for the elderly or the disabled) and the mortgage interest credit (from Form 8396) on line 44 of Form 1040 (for 1995). (This is the amount of U.S. tax for purposes of computing U.S. tax credit under the Code.) In the year where a credit for prior year minimum tax credit ("MTC") is claimed, the amount of the U.S. tax before foreign tax credit may be reduced by a portion or all of the MTC claimed. For further details, please refer to the paper entitled "Alternative Minimum Tax and Credit for Prior Year Minimum Tax of the United States and their effect on Canadian Foreign Tax Credit For U.S. Citizens Resident in Canada", in particular, Example F of that paper.
The following example illustrates how the net income of a particular item of U.S. source income should be calculated. All amounts are in U.S. dollars.
Mr. Y has the following income and expenses:
• Wages for services performed in the U.S. $12,400
• Dividend income from sources within the U.S. $3,000
• Wages for services performed in Canada $100,000
• Interest income from sources in Canada $1,000
• Dividend income from sources in Canada $4,000
Gross income $120,400
• Un-reimbursed employment expenses -- $3,400 of which $1,000
were attributable to wages earned in the U.S. and $2,400 were
attributable to wages earned in Canada
• Interest on home mortgage in Canada -- $2,900
• Real estate tax -- $940
• Charitable contribution -- $480
• Personal exemption -- $2,500
Mr. Y qualifies to exclude $70,000 of the wages earned in Canada as a foreign earned income deduction under Code section 911 for U.S. tax purposes. As a result, his adjusted gross income for U.S. tax purposes is $50,400 (i.e. $120,400 - $70,000).
Mr. Y must prorate the employment expenses attributable to the wages earned in Canada between the wages he includes in his U.S. tax return and the amount he excludes as foreign earned income. He calculates his remaining employment expenses as follows:
( $30,000 x Canadian expense of $2,400) + U.S. expense of $1,000 = $1,720
$100,000
Mr. Y is entitled to the following itemized deductions:
• Interest on home mortgage $2,900
• Real estate tax 940
• Charitable contribution 480
• Allowable employee expenses ($1,720 less
2% of Adjusted gross income of $50,400) 712
$5,032Mr. Y's allowable personal exemption is $2,500. Therefore, his taxable income on line 37 of his U.S. income tax return is $42,868 (i.e. adjusted gross income on line 32 of $50,400 less allowable itemized deductions on line 34 of $5,032 and allowable personal exemption on line 36 of $2,500).
The U.S. adjusted taxable income for purposes of the formula is $45,368 (i.e. taxable income of $42,868 plus allowable personal exemption of $2,500).
To determine the net employment income from sources in the U.S., we need to calculate the expenses and deductions allocated to such income as follows:
• Allowable employee expense deduction allocated to U.S. wages
$1,000 x $712 = $ 414
$1,720
• Interest on home mortgage*
$12,400 x $2,900 = 713
$50,400*
• Real estate tax and charitable contribution**
$12,400 x ($940 + $480) = 146
120,400**
$1,273Therefore, MR. Y's net U.S. source employment income after itemized deductions
= $12,400 - $1,273 = $11,127
To determine Mr. Y's net dividend income from sources in the U.S., we need to calculate the allowable itemized deductions allocated to such income as follows:
• Interest on home mortgage
$ 3,000 x $2,900 = $ 173
$50,400
• Real estate tax and charitable contribution
$ 3,000 x ($940 + $480) = 35
$120,400
$ 208
Therefore, Mr. Y's net dividend income after itemized deductions
= $3,000 - $208 = $2,792
Assuming U.S. tax before tax credit on Mr. Y's U.S. tax return was U.S.$12,800, CitizenTax on net employment income and on net dividend income will be computed as follows:
CitizenTax on net employment income
= $11,127 x $12,800 = $3,139
$45,368
CitizenTax on net dividend income
= $ 2,792 x $12,800 = $788
$45,368
* For the purpose of allocating home mortgage interest only, gross income does not include wages that qualified for the foreign earned income exclusion. This is how the U.S. allocates such item for purposes of computing their foreign tax credit (please refer to page 6 of 1995 Instruction for Form 1116 Foreign Tax Credit (Individual, Estate, Trust, or Nonresident Alien Individual) issued by the I.R.S.
** For the purpose of allocating other itemized deductions which are not definitely allocatable to income from any source, gross income from all sources includes the $70,000 of wages that qualify for the foreign earned income exclusion. Here we also follow the U.S. rules in allocating itemized deductions for purposes of computing their foreign tax credit (see page 23 of the I.R.S. Publication 514 Foreign Tax Credit for Individuals for 1995 Returns).
APPENDIX C
An Example of Computing Canadian Foreign Tax Credit
Assume the following:
• Mr. X is a U.S. citizen who is a resident of Canada for the purpose of the Convention.
• The taxation year is 1993.
• Mr. X had an adjusted taxable income of U.S.$40,000 consisting of the following types of net income. (For the sake of simplicity, ignore the U.S. foreign earned income exclusion and the standard or itemized deductions and assume that net dividend income and net pension income are equal to their respective gross amounts.)
• Net dividends sourced to the U.S. of U.S.$2,000;
• Net periodic pension payments sourced to the U.S. of U.S.$10,000;
• Net employment income from employment exercised in the U.S. (but sourced to Canada by paragraph 3 of Article XXIV) of U.S.$8,000; and
• Canadian source income of U.S.$ 20,000.
• Mr. X's U.S. federal income tax otherwise payable (before tax credit) on his 1993 U.S. tax return was U.S.$8,000.
• No credit for prior year minimum tax was claimed in the U.S.
• The foreign exchange rate was U.S.$1 = Cdn.$1.25
In this example AlienTax on U.S. net employment income and periodic pension income would be equal to CitizenTax on such income23 and AlienTax on U.S. net dividend income would be 30% of the gross amount of the dividend income, which is greater than TreatyTax of 15% on the dividend income. As a result, AlienTax is ignored in this example.
As noted in Appendix B, the formula in determining CitizenTax on a particular item of U.S. source income is
Net income of that item of U.S. source income x U.S. tax before foreign tax
U.S. adjusted taxable income credit on the U.S. tax return
1.With respect to U.S. source net dividend income of U.S.$2,000:
(a)CitizenTax is
U. S. $2,000 x U.S.$8,000 = U.S.$400
U. S.$40,000
(b)TreatyTax is 15% of U.S.$2,000 = U.S.$300
(c)The lesser of CitizenTax and TreatyTax = U.S.$300
Pursuant to subparagraph 5(b), Canada allows a foreign tax credit not exceeding 15% of the dividend income of U.S.$2,000, i.e., U.S.$300 (Cdn.$375).
In accordance with subparagraph 5(a), the difference between U.S.$400 and U.S.$300 (i.e., U.S.$100 or Cdn.$125) will be allowed as the equivalent to a deduction under subsection 20(11) of the Act.
Pursuant to subparagraph 5(c), the U.S. must provide a credit for taxes paid or accrued to Canada but such credit shall not reduce the U.S. tax below U.S.$300. Therefore, in this case, the maximum tax credit that the U.S. will provide is U.S.$100.
Pursuant to paragraph 6, for U.S. foreign tax credit purposes, an amount of U.S.$500 (i.e., U.S.$100 divided by the average U.S. tax rate of 20%)24 would be considered to be sourced to Canada.
2.With respect to U.S. source net periodic pension income of U.S.$10,000:
(a) CitizenTax is
U. S.$10,000 x U.S.$8,000 = U.S.$2,000
U. S.$40,000
(b)TreatyTax is 15% of U.S.$10,000 = U.S.$1,500
(c)The lesser of CitizenTax and TreatyTax is U.S.$1,500
Pursuant to subparagraph 4(a), Canada is required to allow a foreign tax credit not exceeding 15% of U.S.$10,000 (Cdn.$12,500) or U.S.$1,500 (Cdn.$1,875) because, under paragraph 2 of Article XVIII of the Convention, that would be the amount of U.S. tax payable by Mr. X on such income if he were not a U.S. citizen (i.e. TreatyTax). Therefore, Canada would allow a credit of Cdn.$1,875.
Pursuant to subparagraph 4(b), the U.S. is required to allow a tax credit for the Canadian tax paid or accrued after the tax credit granted by Canada for the U.S. tax at 15% of such pension income. The U.S. credit so allowed shall not reduce that portion of U.S. tax that is deductible from Canadian tax, in this case, 15% of U.S.$10,000 or U.S.$1,500.
Pursuant to paragraph 6, for U.S. foreign tax credit purposes, an amount of $2,500 (i.e., $500 divided by the average tax rate of 20%) would be considered to be sourced to Canada.
3.With respect to U.S. source net dependent personal service income resourced to Canada under the Convention:
Pursuant to subparagraph 4(a), Canada is not obliged to grant any foreign tax credit for U.S. tax payable in respect of such income because by virtue of subparagraph 2(a) of Article XV and subparagraph 3(b) of Article XXIV, the income is deemed to arise in Canada. It should also be noted that, if Mr. X was not a U.S. citizen, the U.S. would not be allowed to tax such income by virtue of subparagraph 2(a) of Article XV.
Pursuant to subparagraph 4(b), the U.S. shall allow a tax credit for Canadian tax paid or accrued on such income. Unless the U.S. tax rate on such income is higher than that of Canada which is usually not the case, there should be no U.S. tax on such income.
4. With respect to Canadian source income:
Pursuant to subparagraph 4(a), because the income is not U.S. source income, Canada is not obliged under the Convention to grant any foreign tax credit for U.S. tax payable in respect of such income. (As the income is Canadian sourced and as the U.S. tax would not have been payable if Mr. X were not a U.S. citizen, Canada is not obliged to grant a foreign tax credit under the Act because such U.S. tax is not a non-business-income tax for the purposes of the Act.)
Subparagraph 4(b) requires that the U.S. provide a tax credit for taxes paid or accrued to Canada on such income. Unless the U.S. tax rate on such income is higher than the rate in Canada there should be no U.S. tax on such income.
5. Determine the taxable income of Mr. X for 1993 under the Act:
Total income $50,000
Less: Equivalent of subsection 20(11) deduction (125)
Taxable income $49,875
6. Determine Canadian tax after Canadian tax credit:
Basic Federal tax on taxable income of $49,875
after personal tax credit of, say, $2,800 $ 7,504
Federal surtax (3% of $7,504) 225
Ontario tax (58% of $7,504) 4,352
Canadian tax before foreign tax credit $12,081
Less: Federal foreign tax credit:
15% of pension income of $12,500 $1,875
15% of dividend income of $2,500 375 (2,250)
Canadian tax after foreign tax credit $ 9,831
7.Pursuant to subparagraph 4(b), the foreign tax credit granted by the U.S. for the Canadian tax paid or accrued shall not reduce that portion of the U.S. tax below the rate of tax provided in the Convention if the resident of Canada were not a U.S. citizen. For example, the U.S. foreign tax credit shall not reduce the U.S. taxes on pension income below 15% of that income. Also, pursuant to paragraph 5, the foreign tax credit granted for Canadian tax paid or accrued on the U.S. source dividend income shall not reduce the U.S. taxes below 15% of the amount of such dividend income. For U.S. tax credit purposes, Canadian tax after foreign tax credit must be computed for each item of income to determine the amount of the U.S. tax credit that would be allowed for that item of income. Canadian tax after foreign tax credit for the various items of U.S. source income in this case can be computed as follows:
(i) On U.S. source dividend income, Canadian tax after foreign tax credit is
(Dividend income less deduction x Cdn. tax before FTC) - FTC
Canadian taxable income
($2,500 - $125 x $12,081) - $375 = $575 - $375 = $200
$50,000 - $125
In U.S. dollar, Canadian tax on dividend income after FTC = U.S.$160 (i.e., $200 divided by the exchange rate of 1.25)
Maximum U.S. tax credit for such Canadian tax is U.S.$100 which is the lesser of Canadian tax of U.S.$160 and the difference between CitizenTax of U.S.$400 and U.S. source base tax of U.S.300 (i.e., 15% of dividend income of U.S.$2,000)
(ii) On U.S. source pension income, Canadian tax after foreign tax credit is
( $12,500 x $12,081) - $1,875 = $3,028 - $1,875 = $1,153
$50,000 - $125
In U.S. dollar, Canadian tax on U.S. source pension income after foreign tax credit is U.S.$922 (i.e., $1,153 divided by 1.25).
Maximum U.S. tax credit for such Canadian tax is U.S.$500 which is the lesser of Canadian tax of U.S.$922 and the difference between CitizenTax of U.S.$2,000 on such pension income and the U.S. source base tax of $1,500 (i.e., 15% of U.S. source periodic pension income of $10,000).
(iii) On U.S. source employment income resourced to Canada, Canadian tax is
$10,000 x $12,081 = $2,422
$50,000 - $125 In U.S. dollar Canadian tax on such employment income is U.S.$1,938 (i.e., $2,422 divided by 1.25)
Maximum U.S. tax credit for such Canadian tax is U.S.$1,600 which is the lesser of Canadian tax of U.S.1,938 and the difference between CitizenTax of U.S.$1,60025 on such income and U.S. source base tax of nil.
(iv) On Canadian source income, Canadian tax is
$25,000 x $12,081 = $6,056 or U.S.$4,845
$50,000 - $125Since CitizenTax is U.S.$4,000,26 maximum U.S. tax credit is U.S.$4,000.
In summary, the maximum tax credit for Mr. X for 1993 that would be granted by the U.S. for Canadian tax paid or accrued would be U.S.$6,200.27
In this case, Mr. X's 1993 U.S. tax liability should be U.S.$1,800 which is the difference between total U.S. tax of U.S.$8,000 and the maximum U.S. tax credit of U.S.$6,200.
8. The result in this example is that Mr. X's Canadian tax liability for 1993 was Cdn.$9,831 and his U.S. tax liability was U.S.$1,800 (Cdn.$2,250) totalling $12,081 in Canadian currency, which, except for the effect of the equivalent of the subsection 20(11) deduction available to him, would be equal to the total tax liability of a resident of Canada who is not a U.S. citizen and who has the same amounts of income of the same types.
9. On an adjusted gross income of U.S.$40,000 for U.S tax purpose, normally there would not be any U.S. alternative minimum tax ("AMT") liability. If we assume that there is an AMT of U.S.$500 in addition to the regular U.S. tax and that the AMT arises solely because of the alternative minimum tax foreign tax credit ("AMTFTC") 90% limitation rule28 (i.e., it is attributable to Canadian source income or U.S. source income resourced to Canada), then certain amount of the AMT in respect of the U.S. source income resourced to Canada may be creditable for Canadian tax purposes.
In this example, it is assumed that all of the AMT is attributable to Canadian source income and U.S. source income resourced to Canada. The aggregate of all Canadian source income and U.S. sourced income resourced to Canada is U.S.$31,000 which consists of U.S. source dividend income resourced to Canada of U.S.$500 (see point 1 above), U.S. source pension income resourced to Canada of U.S.$2,500 (see point 2 above), U.S. source employment income resourced to Canada of U.S.$8,000 (see point 3 above) and Canadian source income of U.S.20,000.
(i) The portion of the AMT of U.S.$500 allocatable to that portion of the U.S. source dividend income resourced to Canada is
U.S.$500 x U.S.$500 = U.S.$8
U. S.$31,000
Since a maximum tax credit equal to the treaty rate of 15% of the gross amount of the dividend has already been granted by Canada in computing regular U.S. tax, the AMT on this resourced portion of the dividend would not be creditable in Canada. No additional deduction under subsection 20(11) or 20(12) of the Act should be allowed because an equivalent to the subsection 20(11) deduction has already been allowed on the basis of U.S. tax otherwise payable (before credit for Canadian tax) on the dividend income and such U.S. tax otherwise payable is greater than the actual U.S. tax paid including the AMT.
(ii) The portion of the AMT of U.S.$500 allocatable to that portion of the U.S. source periodic pension income resourced to Canada is
U.S.2,500 x $U.S.$500 = U.S.$40
U.S.$31,000
Such amount of AMT is creditable for Canadian tax purposes.
(iii) The portion of the AMT of U.S.$500 allocatable to U.S. source net dependent personal service income resourced to Canada is
U.S.$8,000 x U.S.$500 = U.S.$129
U.S.$31,000
This amount of AMT is creditable in Canada as it is an income or profits tax on income sourced to the U.S. for purposes of the Act.
The balance of the AMT of U.S.$331 (i.e., U.S.$500 minus U.S.$40 minus U.S.$129) would not be creditable in Canada because it is attributable to either Canadian source income or that portion of U.S. source dividend income resourced to Canada.
For further discussion of Canadian foreign tax credit for U.S. AMT, please refer to a separate paper titled "U.S. Alternative Minimum Tax and Credit for Prior Year Minimum Tax of the United States and their Effect on Canadian Foreign Tax Credit For U.S. Citizen Resident in Canada.
APPENDIX D
Suggested Steps to determine foreign tax credits allowed to U.S. citizens resident in Canada under Article XXIV of the Convention:
1. Determine in which country each item of income arises in accordance with paragraph 3 of Article XXIV of the Convention. If the income does not arise in the U.S. as determined in that paragraph,29 Canada is not obliged to grant a tax credit for U.S. tax paid or accrued on such income.
2. Determine for each item of income arising in the U.S. whether paragraph 4 or paragraph 5 of Article XXIV of the Convention applies. Paragraph 4 applies to all such income except as noted in 3 below.
3. Determine the amounts of dividends, interest and royalties arising in the U.S. and whether paragraph 4 or paragraph 5 of Article XXIV applies. For 1995 and prior years paragraph 5 of Article XXIV applies for all such income; but for 1996 and subsequent years paragraph 5 of Article XXIV only applies if such income is subject to tax under the Code if paid to a non-resident alien of the U.S.,30 otherwise paragraph 4 of Article XXIV applies. Note that where paragraph 4 of Article XXIV applies, there will not be allowed any equivalent to the subsection 20(11) deduction.
4. Where paragraph 4 of Article XXIV applies to the item of income arising in the U.S., proceed as follows:
(a) Determine the amount of CitizenTax (before the granting of a foreign tax credit by the U.S.) on each item of U.S. source income.31
(b) Determine the amount of AlienTax on each item of U.S. source income. (Refer to Appendix B for examples of income that entails no AlienTax (i.e., such income that will be exempt from U.S. tax under the Code if received by a non-resident alien of the U.S.).
(c) Determine the amount of TreatyTax on each item of such income32 (i.e., the rate of tax under the Convention assuming the savings clause does not apply).
(d) Compare the amount of CitizenTax on each item of U.S. source income to the lesser of AlienTax and TreatyTax on that item of income.
(e) Allow a tax credit in Canada only for the least of the three amounts referred to in (d).33
5. For 1995 and previous taxation years, where paragraph 5 of Article XXIV applies, proceed as follows:
(a) Allow the equivalent to the subsection 20(11) deduction for the amount of CitizenTax on dividends, interest and royalties sourced to the U.S. under the Convention in excess of 15% of the gross amount of such income;34 and
(b) Allow a tax credit against Canadian taxes on such income equal to the lesser of CitizenTax on such income35 and 15% of the gross amount of such income.
6. For 1996 and subsequent taxation years, where paragraph 5 of Article XXIV applies (i.e., where the dividends, interest and royalties sourced to the U.S. under the Convention are subject to U.S. tax if paid to a non-resident alien of the U.S.), proceed as follows:
(a) Allow the equivalent to the subsection 20(11) deduction for the amount of CitizenTax on the dividends, interest and royalties in excess of 15% of the gross amount of such income; and
(b) Allow a tax credit against Canadian taxes on such income as determined following the steps set out in 4 above.
7. The above steps should be followed where no U.S. AMT arises. In the event that U.S. AMT arises, it should be noted that not all the AMT rules apply in contravention of the Convention, only the AMTFTC 90% limitation rule does.36 Therefore, if the AMT arises not because of the application of the AMTFTC 90% limitation rule (for example, because of the exclusion preferences [i.e., permanent difference] such as certain itemized deductions), each situation shall be dealt with on a case by case basis.
Where AMT arises solely because of the application of the AMTFTC 90% limitation rule, Canada would provide tax credits only for AMT attributable to U.S. source income resourced to Canada. For exceptions and further details as well as the steps to follow when this occurs, please refer to the paper titled "U.S. Alternative Minimum Tax and Credit for Prior Year Minimum Tax and their Effect on Canadian Foreign Tax Credit For U.S. Citizens Resident in Canada".
8. Should a U.S. citizen resident in Canada claim to opt out of the Convention, any regular U.S. tax paid in excess of that required by the Convention is considered to be a voluntary tax. Therefore, in such a case, foreign tax credits for regular U.S. tax should be computed as set out in steps 1 to 6 above and for U.S. AMT as set out in 7 above.
Flow-chart of The Steps Described Above
Application of Paragraphs 4 and 5 of Article XXIV
With respect to each item
of income, did the income arise
in the U.S. in accordance with
paragraph 3 of Article XXIV?
yes no
Was the income dividend, Canada is not obliged
interest or royalty? to grant a tax credit
yes no
Provide a tax credit
Was it received before 1996? equal to the least of
CitizenTax, AlienTax
and TreatyTax
yes no
Allow an equivalent to the Would it be subject to U.S.
subsection 20(11) deduction tax under the Code if paid to a
non-resident alien of the U.S.?
Provide a tax credit equal to
the lesser of the CitizenTax
and 15% of the gross income
yes no
Allow an equivalent to the Canada is not obliged
subsection 20(11) deduction to grant a tax credit
or an equivalent to
Provide a tax credit equal the subsection 20(11)
to the least of CitizenTax, deduction
AlienTax and TreatyTax
Note: With respect to U.S. AMT, please refer to the paper titled "Alternative Minimum Tax and Credit for Prior Year Minimum Tax of the United States and their Effect on Canadian Foreign Tax Credit for U.S. Citizens Resident in Canada". With respect to U.S. state income tax, please refer to the issue sheet titled "Foreign Tax Credit for U.S. State Income Tax".
Appendix E
TreatyTax Rates on Certain U.S. Source income Received by a Canadian Resident Who is not a U.S. Citizen
Employment income other than that exempt under
paragraph 2 of Article XV of the Convention No Restriction
Employment income exempt under paragraph 2 of (No TreatyTax)3
Article XV of the Convention
Periodic pension payments 15%
Dividends as defined in the Convention1 15%
Interest as defined in the Convention1
except that exempt under the Convention 10%
Interest exempt from U.S. tax pursuant to
paragraph 3 of Article XI (No TreatyTax)3
Royalties as defined in the Convention1
except that exempt under the Convention 10%
Royalties exempt from U.S. tax pursuant to
paragraph 3 of Article XII (No TreatyTax)3
Capital gains on the disposition of real
property or a real property interest2 or
on personal property forming part of the
business property of a permanent establishment
or fixed base in the U.S. No restriction
Capital gains other than those described above (No TreatyTax)3
Income from real property as defined in the
Convention including rents and royalties from
real property No restriction
Self-employment income attributable to a
permanent establishment or a fixed base in
the U.S. No restriction
Self-employed income not attributable to a fixed
base in the U.S. (No Treatytax)3
Lump sum pensions or annuities No restriction
U.S. social security payments
-- before 1996 (No TreatyTax3 -- See
Old Article XVIII(5))
-- after 19954 No restriction -- See
New Article XVIII(5)1 which is not connected to a permanent establishment in the U.S.
2 defined under the Internal Revenue Code of the U.S.
3 income resourced to Canada
4 However, see News Release, dated April 9, 1997, issued by the Department of Finance stating that the tax treatment of such payments would revert back to that prior to 1996
APPENDIX F
Definitions of CitizenTax, AlienTax and TreatyTax
CitizenTax37CitizenTax on a particular item of income is the amount of tax which a U.S. citizen resident in Canada would have to pay to the U.S. under the Internal Revenue Code (the "Code") on that item of income before any credit for Canadian taxes on such income and before taking into account the provisions of the Convention. (Note that the U.S. taxes its citizens on their world-wide income.) CitizenTax may be reduced by the credit or a portion of the credit for prior years' alternative minimum tax ("MTC") claimed. In this regard, please refer to Appendix B and the paper titled "Alternative Minimum Tax and Credit for Prior Year Minimum Tax of the United States and their Effect on Canadian Foreign Tax Credit for U.S. Citizens Resident in Canada" for further detail.
AlienTax
Alientax on a particular item of income is the amount of tax that a non-resident alien of the U.S. (e.g. a Canadian resident who is not a U.S. citizen) would have to pay under the Code on that item of income which has been sourced to the U.S. This tax could be different from CitizenTax on the same item of income. For example, a non-resident alien of the U.S. who receives certain portfolio interest is exempt from tax under the Code on such income while a citizen of the U.S. is not. (See Appendix A for the definition of portfolio interest and other items of income exempt from U.S. tax if received by a non-resident alien of the U.S.)
Other items of income of a non-resident aliens such as rents, annuities, dividends, interest and royalties all of which are not effectively connected to the conduct of a trade or business of a permanent establishment in the U.S. are subject to a withholding tax rate of 30% under the Code while such income is taxed in the hands of a U.S. citizen under the normal progressive rates of taxation provided in the Code. Except for rental or royalty income from real property, AlienTax on such items of income is usually greater than TreatyTax (see below for the definition of TreatyTax).
On certain items of U.S. source income such as pension income, employment income, business income effectively connected to a permanent establishment in the U.S., and rental or royalty income from real property, a non-resident alien of the U.S. will be taxed at the normal progressive rates in the same manner as a U.S. citizen. In such a case in respect of those items of income, AlienTax will be equal to CitizenTax.38
TreatyTax
TreatyTax on a particular item of income sourced to the U.S. in accordance with paragraph 3 is the amount of tax that the U.S. would be allowed to collect under the income provisions of the Convention39 if the recipient of the income were a Canadian resident for the purpose of the Convention but not a U.S. citizen. For paragraphs 4 and 5 to apply the person must be a resident of Canada for the purpose of the Convention. Therefore, TreatyTax on a particular item of U.S. source income can be determined from a particular income provision of the Convention which allows the U.S. to tax that item of income in the hands of a Canadian resident. Where the income provisions of the Convention does not restrict the amount of U.S. taxation on an item of income sourced to the U.S., TreatyTax and CitizenTax will be the same. Where the income provisions of the Convention restrict the amount of the U.S. tax, TreatyTax will be the restricted amount.
APPENDIX G
U.S. Progressive Tax System -- CitizenTax may not be the same as AlienTax on certain items of U.S. source income
As discussed in the paper, the term "the amount of the tax that would be paid to the U.S. if the resident of Canada were not a U.S. citizen" used in subparagraphs 4(a), 5(b) and 5(c) means the lesser of AlienTax and TreatyTax. In determining AlienTax on a particular item of income, it has been suggested that not only that such item of income may be exempt or taxed at a different rate under the Code if received by a non-resident alien of the U.S. is relevant but also that such item of income may be subject to a lower progressive tax rate as a result of the fact that a non-resident alien of the U.S. is only taxed on his or her U.S. source income in the U.S. as opposed to world-wide income. In other words, because of the progressive tax system of the U.S., the U.S. tax paid by a non-resident alien of the U.S. on an item of U.S. source income may be less than the U.S. tax on that item of income imposed on a U.S. citizen who must report world-wide income. Example A in the commentary on Article XXIV in the Technical Explanation to the Convention seems to suggest that that is the case although it does not come out to say so. In that example, the total U.S. tax on a $100 taxable income was $40. Hence, CitizenTax on income of $75 for services performed in the U.S. would be $30 (i.e., $75/$100 x $40). However, an assumption was made in the example that the U.S. tax on that $75 U.S. source income was $25 if the taxpayer were not a U.S. citizen. That tax of $25 appears to be AlienTax being calculated by using the lower progressive tax rates.
Such an interpretation would mean that a U.S. citizen resident in Canada is required to perform a separate set of tax calculation as if he or she were not a U.S. citizen. In other words, he or she would need to compute his or her U.S. tax as if he or she were to fill out Form 1040NR, a U.S. tax return for a non-resident alien of the U.S. This would add complexity to the process.
The above interpretation will have some significance only on certain items of U.S. source income such as employment,40 pension and business income (i.e., income which is effectively connected with the conduct of a U.S. trade or business) where CitizenTax may be computed at a marginal rate which is greater than that at which AlienTax is computed. On items of income such as dividends, interest and royalties, AlienTax is the U.S. withholding rate of 30%. As TreatyTax on such items of income (other than royalties from real property) is probably the lowest (10% to 15%) it does not matter whether CitizenTax is greater than AlienTax.41
The following table would help to indicate how significant the difference is between CitizenTax and AlienTax on employment income of a taxpayer whose filing status is single, taking into account the difference in U.S. marginal tax rates.
U. S. Source Employment Income Not Resourced to Canada
Total Income
$23,350
Avg rate = 15%
$56,550
Avg rate = 22.63%
$117,950
Avg rate = 26.99%
$256,500
Avg rate = 31.86%
$400,000
Avg rate = 34.63%
$500,000
Avg rate = 35.63%
$ 23,350
0
N/A
N/A
N/A
N/A
N/A
$ 56,550
$1,782
0
N/A
N/A
N/A
N/A
$117,950
$2,800
$2,466
0
N/A
N/A
N/A
$256,500
$3,937
$5,220
$5,744
0
N/A
N/A
$400,000
$4,584
$6,786
$9,011
$7,105
0
N/A
$500,000
$4,817
$7,352
$10,191
$9,670
$4,000
0
The table shows that for U.S. source employment income of U.S.$117,500 (with no other U.S. source income) and total income of U.S.$400,000, the difference in tax between a U.S. citizen and a non-resident alien (with a filing status of "single") is about U.S.$9,000 (i.e., CitizenTax is greater than AlienTax by about U.S.$9,000). If the U.S. source employment income is U.S.$256,500 (with no other U.S. source income) and the total income remains the same as U.S.$400,000, the difference in tax is about U.S.$7,100. Hence, the higher the U.S. source income, the lesser the tax difference.
Our experience to-date in actual files is limited but it indicates that it is the exception rather than the rule where taxpayers who are U.S. citizens resident in Canada receiving U.S. source employment income or business income which is not resourced to Canada in accordance with the Convention. If every taxpayer who is a U.S. citizen resident in Canada is required to recalculate his or her U.S. tax taking into account the progressive tax rates as if he or she were a non-resident alien of the U.S., it would put an additional compliance burden on the shoulders of the taxpayer and would add complexity to the process of determining Canadian foreign tax credit. It may not be worthwhile to implement such a requirement as there may only be a few cases where the U.S. progressive tax rates would make a significant difference in the taxpayer's U.S. tax on a particular item of U.S. source income. Taking that into consideration we suggest that no taxpayers or only those taxpayers whose total income exceeds a certain threshold amount and who receive a significant amount of U.S. source employment income, business income effectively connected to a permanent establishment in the U.S., or rents or royalties from U.S. real property need to compute AlienTax taking into account the progressive tax rates in the U.S.
In order to avoid adding complexity to this paper, in all circumstances this paper treats AlienTax on such items of income the same as CitizenTax.
1except for a brief discussion of Canadian foreign tax credit for U.S. alternative minimum tax ("AMT") on U.S. source income in Appendices C and D attached. AMT is dealt with in a separate paper titled "Alternative Minimum Tax and Credit for Prior Year Minimum Tax of the United States and their Effect on Canadian Tax Credit for U.S. Citizens Resident in Canada".
2The reader is asked to accept the result set out in this example. The actual mechanics of the operation of paragraphs 4 and 5 are explained in more detail later in this paper.
3Robertson, J.A. in the case of Stanley Coblentz v. The Queen ([1996] 3 CTC 295 (FCTD), decision rendered on September 30, 1996) commented that the purposes underlying Canada's tax treaties are not as limited as usually thought [namely, the elimination of double taxation and the prevention of fiscal evasion of taxes on income and capital]. He then referred to David A. Ward's article "Canada's Tax Treaties" (1995) 43 Cdn. Tax J. 1719 at 1728: "It might be more accurate to say that the main or principal purpose of Canada's tax treaties is to allocate and limit taxing powers of the two Contracting States."
4CitizenTax does not include U.S. alternative minimum tax which arises solely as a result of the application of the rule in the U.S. which limits the foreign tax credit for U.S. alternative minimum tax purposes to 90% of the tentative minimum tax before such credit. This rule is hereafter referred to as the "AMTFTC 90% limitation rule". For further detail, please refer to the paper titled "Alternative Minimum Tax and Credit for Prior Year Minimum Tax of the United States and their Effect on Canadian Foreign Tax Credit for U.S. Citizens Resident in Canada".
5Except that which is exempt from U.S. tax (see Appendix A for further details)
6see Appendix G for further discussion on this subject matter
7that is, the provisions in Article VI to Article XXII of the Convention
8In general on such income AlienTax will also equal to TreatyTax and CitizenTax. Please refer to Appendix G for a discussion on the impact of progressive rates of taxation in the U.S. for a non-resident alien of the U.S. versus a U.S. citizen.
9Refer to Appendix B for further details of how to apply the formula.
10See in Appendix A attached examples of income exempt from U.S. tax if received by a non-resident alien of the U.S.
11See Appendix E for treaty tax rates of some of the items of income.
12See above if any two or all three of these amounts are equal.
13See Appendix A for further details.
14A reference is made in Example A in the commentary on Article XXIV in the Technical Explanation to the Convention for determining the source of income for the purpose of paragraph 3(a) of Article XXIV. That example implies that if the U.S. is not allowed to tax the income under Article XV if the taxpayer were not a U.S. citizen, such income would not arise in the U.S. in accordance with paragraph 3 of Article XXIV.
15The sourcing rule in paragraph 3 applies in the manner set out in this paper for the various types of income covered by the Convention. For example, if paragraph 3 of Article XI applies to exempt from U.S. taxation interest received by a resident of Canada, such interest would be considered to be Canadian source income for the purposes of the Convention. With respect to the priority of the U.S. treaty sourcing rule over the sourcing rule under the Code, please refer to a copy of Rev. Rul. 79-28 issued by I.R.S. attached as Appendix H.
16See Appendix A for examples of such income.
17It has been argued that under paragraph 4(b) the U.S. is not required to provide a tax credit for Canadian taxes paid on income which is not sourced to the U.S. but is taxed in the U.S. because the taxpayer is a U.S. citizen. The language of paragraph 4(b) does not support such an argument. However, even if paragraph 4(b) was considered to only apply to income sourced to the U.S. under the Convention, paragraph 1 of Article XXIV would apply to income sourced to Canada under the Convention and the result would be the same.
18Note that if income, if received by a resident of Canada, is exempt from U.S. tax by virtue of the operation of a provision of the Convention, such income is considered to be Canadian source income.
19For 1995 and previous taxation years there is no need to compute AlienTax under paragraph 5.
20To-date we are not aware that the U.S. levies tax under the Code on interest, dividends or royalties (as defined in the Convention) sourced in the U.S. and received by a non-resident alien at a rate greater than 0% but lower than 30% unless such income is effectively connected with a U.S. trade or business in which case paragraph 4 applies, not paragraph 5. Therefore, AlienTax of such items of income would either be nil or 30%. If it is nil (i.e. if the income is not subject to U.S. tax had the resident of Canada not been a U.S. citizen), paragraph 5 of Article XXIV would not apply. Instead, paragraph 4 would apply and there would not be any equivalent to the subsection 20(11) deduction. If AlienTax is 30%, it would be greater than TreatyTax (which would generally be in the range of 10% to 15%) on such income and all we need to do is to compare TreatyTax with CitizenTax.
21It is not the lesser of AlienTax and CitizenTax. If AlienTax is nil, paragraph 5 would not apply. If AlienTax is greater than zero, it would only affect subparagraphs 5(b) and 5(c) but not the equivalent to subsection 20(11) deduction referred to in subparagraph 5(a) because the phrase "if the resident of Canada were not a U.S. citizen" is not found in subparagraph 5(a).
22If the taxpayer incurs deductible losses (net of all income or gains) in Canada which can be used to offset U.S. source income for U.S. tax purposes, this denominator should be the total amount of the U.S. source income before the application of the Canadian net losses.
23see Appendix G for further discussion in this area
24i.e., U.S. tax otherwise payable x 100% = $ 8,000 x 100% = 20%
U.S. taxable income $40,000
25i.e., U.S.$8,000 x average U.S. tax rate of 20%
26i.e., U.S.$20,000 x average U.S. tax rate of 20%
27i.e., U.S.$100 pertaining to dividend income, U.S.$500 pertaining to periodic pension payment, U.S.$1,600 pertaining to employment income and U.S.$4,000 pertaining to Canadian source income.
28see a separate paper titled "U.S. Alternative Minimum Tax and Credit for Prior Year Minimum Tax of the United States and their Effect on Canadian Foreign Tax Credit for U.S. Citizen Resident in Canada" in which this term is explained in more details.
29for example, employment income exempt under paragraph 2 of Article XV as stated in Appendix
30see Appendix A for examples of interest and dividend income which are exempt from U.S. tax under the Code if received by a non-resident alien of the U.S. (i.e., AlienTax is nil)
31see Appendix B for determining CitizenTax on a particular item of U.S. source income
32see Appendix E for TreatyTax rates of certain items of U.S. source income
33see Appendix C for an example of this procedure
34see footnote 30
35there is no need to consider AlienTax
36see section 1012(aa) of the Technical and Miscellaneous Revenue Act of 1988 of the U.S.
37see footnote 4 respect to the impact of U.S. Alternative Minimum Tax on the computation of CitizenTax
38see Appendix G for further discussion on this subject matter
39that is, the provisions in Article VI to Article XXII of the Convention
40i.e., U.S. source employment income not resourced to Canada in accordance with the Convention. If the employment income is resourced to Canada, such income does not arise in the U.S. and we do not need to calculate CitizenTax and AlienTax as Canada is not obliged to grant any tax credit for U.S. tax paid on such income under paragraph 4 of Article XXIV.
41This could also apply to periodic pension payment as the TreatyTax rate is 15% which may be lower than CitizenTax rate or AlienTax rate depending on which tax bracket the taxpayer is in.
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DRAFT
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