3 November 1998 External T.I. 9810115 - FOREIGN TAX CREDIT AND S-CORPORATIONS

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:

(1) First scenario: (a) whether the tax paid in respect of a capital gain arising from the disposition of a U.S. real property to the extent it relates to portion of the gain accruing prior to immigration forms part of "non-business-income tax" under paragraph 126(1); and

(b) whether the foreign tax credit that is calculated under subsection 126(1) in respect of the aforesaid U.S. tax can be applied against Canadian tax otherwise payable on all U.S. source non-business income.

(2) Second scenario: (a) whether the tax paid by an individual Canadian resident who is a shareholder of a U.S. S-corporation to the U.S. government in respect of the income of the U.S. S-corporation, is deductible by the individual under subsection 91(4) of the Act;

(b) if paragraph 5 of Article XXIX of the Canada-U.S. Income Tax Convention (1980) (the “Treaty”) is applicable, whether income of the U.S. S-corporation that is deemed to be FAPI of the individual, is foreign source income for the purpose of computing the individual's foreign tax credit under subsection 126(1); and

(c) whether the aforesaid U.S. tax paid by the individual in respect of the income of the U.S. S-corporation forms part of "non-business-income tax" for the purpose of computing the individual’s foreign tax credit under paragraph 126(1).

Position:

(1) . First scenario: Yes to both questions (a) and (b).

(2) . Second scenario: No to question (a), and yes to questions (b) 			and (c).

Reasons:

(1) (a).	Tax on the gain meets the definition of "non-business-				income tax" in subsection 126(7). 

(1) (b). Subsection 126(1) permits the foreign tax credit to be 				applied against Canadian tax otherwise payable on all U.S. 				source non-business income.

(2) (a). The tax paid by the individual on the income of the U.S. 				S-corporation is not "foreign accrual tax" under subsection 95(1).
(2) (b). Income of the U.S. S-corporation to the individual is 				income from the shares of the U.S. S-corporation held by the 				individual and is therefore U.S. source income from a property.

(2) (c). Provided that paragraph 5 of Article XXIX of the Treaty 				is applicable, tax on the income of the U.S. S-corporation that is 				paid by the individual meets the definition of "non-business-				income tax" in subsection 126(7).

							5-981011
XXXXXXXXXX 						Daniel Wong
(613) 954-4949
Attention: XXXXXXXXXX 

November 3, 1998

Dear Sirs:

Re: Foreign Tax Credit

This is in reply to your letter of April 2, 1998, which was addressed to the International Tax Services Office, wherein you requested our opinion with respect to paragraph 126(1) of the Income Tax Act (the “Act”) and paragraph 5 of Article XXIX of the Canada-U.S. Income Tax Convention (1980) (the “Treaty”). You have described the following situations:

Scenario #1.

A, a U.S. citizen, immigrates to Canada in year 1 at a time when A owns a real property situated in the U.S. The U.S. real property is a capital property of A having a capital cost of $100 and a fair market value at that time of $1,000. In a subsequent year, A disposes of the U.S. real property for proceeds of $1,100. A has resided in Canada continuously since the time of immigration. For U.S. tax purposes, A reports a gain in respect of the U.S. real property in the amount of $1,000 and pays U.S. tax of approximately $280 (assuming a U.S. tax rate of 28%). For Canadian tax purposes, A reports a gain of $100 and a taxable capital gain of $75 in respect of the U.S. real property, on the basis that the adjusted cost base of the U.S. real property is $1,000, by virtue of paragraph 128.1(1)(c) of the Act.

In respect of this scenario, you have asked us to confirm whether the tax paid by A to the U.S. government in respect of the capital gain arising from the disposition of the U.S. real property forms part of A’s “non-business-income tax” under paragraph 126(1)(a) and whether the foreign tax credit that is calculated under subsection 126(1) in respect of the aforesaid U.S. tax can be applied by A against Canadian tax otherwise payable on all U.S. source non-business income.

Scenario # 2

B is an individual who is a resident of Canada and a U.S. citizen. B is the sole shareholder of a U.S. S-corporation which carries on an active business in the U.S. During the particular year, the S-corporation has taxable income of $100,000 and it distributes $75,000 to B in that year. B has elected under the appropriate provisions in the Internal Revenue Code to have the income of the S-corporation taxed in B’s hands. Assuming the applicable marginal U.S. tax rate to B is 40%, $40,000 of U.S. tax is paid by B to the U.S. government with respect to the income of the S-corporation. B is seeking to have the rules in paragraph 5 of Article XXIX of the Treaty apply to him.

In respect of this second scenario you have asked us to confirm, on the assumption that paragraph 5 of Article XXIX of the Treaty applies to B, whether B can get a deduction under subsection 91(4) of the Act; whether income of a U.S. S-corporation that is deemed by paragraph 5 of Article XXIX of the Treaty to be Foreign Accrual Property Income (“FAPI”) of B, is foreign source income for the purpose of computing B’s foreign tax credit under subsection 126(1); and whether the U.S. tax paid by B with respect to the income of the S-corporation would form part of B’s “non-business income tax” under paragraph 126(1)(a) of the Act.

COMMENTS

In your letter, you have outlined what appear to be actual fact situations related to transactions and events which have taken place. The review of such situations is generally the responsibility of the local taxation services offices and, as outlined in paragraph 22 of Information Circular 70-6R3, it is not our practice to provide specific opinions on factual situations otherwise than in the context of an advance income tax ruling. In any event, a request for an advance income tax ruling cannot be considered where the transactions are completed or where the issues involved are primarily questions of fact. Furthermore, in order to have the rules under paragraph 5 of Article XXIX of the Treaty apply to a Canadian resident, the Canadian resident must conclude an agreement with the competent authority of Canada, subject to terms and conditions satisfactory to such competent authority. The Income Tax Rulings and Interpretations Directorate is not involved in negotiating such agreements and is not a party to such agreements.

Nevertheless, we are prepared to provide the following comments which we hope will be of assistance to you.

In our view, the U.S. tax paid by A to the U.S. government in respect of the capital gain in scenario #1 is a “non-business-income tax” as defined in subsection 126(7) of the Act. It is not a “business-income tax” as defined in subsection 126(7) and is not deductible under subsections 20(11) or 20(12), as it is not a tax on income from a business or property. It is also not one of the types of tax prescribed in paragraphs (c.1), (d), (e), (f), (g), (h) and (i) of the definition of “non-business-income tax”.

Subsection 126(1) of the Act limits the amount of A’s foreign tax credit for the particular taxation year to the lesser of :(a) the amount of actual non-business-income tax paid by A for the year to the U.S. government, and (b) the portion of the Canadian tax otherwise payable for the year that relates to all of A’s U.S. source non-business income for the year.

Any portion of the U.S. tax paid by A on the gain which is not creditable as a foreign tax credit under subsection 126(1) is not deductible under subsections 20(11) or 20(12), as the U.S. tax on the gain is not tax on income from a property for the purposes of subsection 20(11), or tax on income from a property or business for the purposes of subsection 20(12).

In scenario #2, where paragraph 5 of Article XXIX of the Treaty is applicable, the rules therein, inter alia, will deem the S-corporation to be a controlled foreign affiliate of the Canadian resident taxpayer. Furthermore, the income of the S-corporation will be deemed to be FAPI of the Canadian resident taxpayer, and the income of the S-corporation that is included in the Canadian resident taxpayer’s income will be deemed not to be income from a property for the purpose of subsection 20(11) of the Act.

As the U.S. tax in respect of the income of the S-corporation for a year is paid by B and not by the S-corporation, B is not entitled to a deduction of such U.S. tax under subsection 91(4) of the Act, as it fails to meet the definition of “foreign accrual tax” under subsection 95(1).

B may, however, be entitled to claim a foreign tax credit under subsection 126(1) with respect to such U.S. tax. In our view, for the purposes of computing B’s foreign tax credit under subsection 126(1), the income of the S-corporation that is deemed by paragraph 5 of Article XXIX of the Treaty to be FAPI of B is U.S. source income from a property and is to be included in B’s income under subsection 91(1) of the Act. By virtue of paragraph 5 of Article XXIX of the Treaty, such U.S. tax paid by B, which is included in B’s “non-business-income tax” for the purposes of paragraph 126(1)(a), is deemed for the purposes of subsection 20(11) not to be income from a property and, therefore, paragraph (b) of the definition of “non-business-income tax” in subsection 126(7) will not limit the amount of the credit to 15% of the income of the S-corporation for that year. Any portion of such U.S. tax that is not creditable under subsection 126(1), is deductible in computing B’s income from property for that year under subsection 20(12).

The above comments represent our general views with respect to the subject matter of your letter and are provided in accordance with paragraph 22 of Information Circular 70-6R3.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch