Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Are Ontario taxpayers entitled to a provincial foreign tax credit in respect of tax spared amounts under Article 22 of the Canada-Brazil treaty?
Position: No.
Reasons: Ontario is not a party to the Treaty and has not incorporated the Treaty into the provincial foreign tax credit system.
June 16, 2014
XXXXXXXXXX TSO HEADQUARTERS
XXXXXXXXXX Income Tax Rulings
Directorate
Eli Kae Moore
(613) 957-2104
2014-052596
Tax Spared Amounts under the Canada-Brazil Income Tax Convention and the Taxation Act, 2007
We are writing in response to your memorandum of March 13, 2014, which we received on March 28, 2014, and further to our telephone conversation on April 10, 2014. You have asked us to comment on whether amounts of tax deemed to have been paid ("tax spared amounts") under paragraph 3 of Article 22 of the Canada-Brazil Income Tax Convention ("the Tax Treaty") are eligible for a foreign tax credit (an "ON FTC") under subsection 34(1) of Ontario's Taxation Act, 2007 ("the TA").
In brief, we agree with your reasoned position and it is our view that tax spared amounts under paragraph 3 of Article 22 of the Tax Treaty are not eligible for an ON FTC under subsection 34(1) of the TA because the Province of Ontario is not a party to the Tax Treaty and the province has not incorporated the Tax Treaty into the ON FTC provisions of the TA.
Background
Our understanding of the situation at hand is that in computing its Federal and Ontario income tax liability the taxpayer reported non-business interest income from Brazilian sources. The taxpayer claimed an ON FTC under subsection 34(1) of the TA in respect of the Brazilian source income.
The ON FTC claimed by the taxpayer represents the Ontario portion (based on the provincial income allocation formula) of the excess of the tax spared amounts over the non-business foreign tax credit claimed by the taxpayer for Federal income tax purposes (a "Federal FTC") under subsection 126(1) of the Income Tax Act ( "the Act").
Legislation
The relevant portions of the Act are subsection 126(1) and the definition of "non-business-income tax" in subsection 126(7), which are copied, in part, below (emphasis added):
"126(1) Foreign tax deduction A taxpayer who was resident in Canada at any time in a taxation year may deduct from the tax for the year otherwise payable under this Part by the taxpayer an amount equal to
(a) such part of any non-business-income tax paid by the taxpayer for the year to the government of a country other than Canada
"
"126(7) "non-business-income tax" paid by a taxpayer for a taxation year to the government of a country other than Canada means, subject to subsections (4.1) to (4.2), the portion of any income or profits tax paid by the taxpayer for the year to the government of that country that
(a) was not included in computing the taxpayer's business-income tax for the year in respect of any business carried on by the taxpayer in any country other than Canada,
"
Paragraphs 2 and 3 of Article 22 of the Tax Treaty read as follows:
"2. Unless the provisions of paragraph 4 or 5 apply, where a resident of Canada derives income which, in accordance with the provisions of this Convention, may be taxed in Brazil, Canada shall allow as a deduction from the tax on the income of that person, an amount equal to the income tax paid in Brazil, including business-income tax and non-business-income tax. The deduction shall not, however, exceed that part of the income tax as computed before the deduction is given, which is appropriate to the income which may be taxed in Brazil.
3. For the deduction indicated in paragraph 2, Brazilian tax shall always be considered as having been paid at the rate of 25 per cent of the gross amount of the profits to which paragraph 5(b) of Article 10 applies and at the rate of 20 per cent of the gross amount of the income paid in Brazil in the case of interest to which paragraph 2 of Article 11 applies and royalties to which paragraph 2(b) of Article 12 applies."
ON FTCs are granted under section 34 of the TA, which reads as follows (emphasis added):
34. (1) A corporation that is resident in Canada throughout a taxation year and has foreign investment income for the year may, in computing its tax payable under this Division for the year, deduct a foreign tax credit equal to the lesser of,
(a) the amount calculated under subsection (2) for the year; and
(b) the amount calculated under subsection (3) for the year.
Same
(2) For the purposes of clause (1) (a), the amount is determined by multiplying the corporation's Ontario domestic factor for the taxation year by the amount, if any, by which "A" exceeds "B" where,
"A" is the portion of the non-business-income tax paid for the year by the corporation to the government of a country other than Canada that relates to foreign investment income of the corporation for the year that is not from a share of the capital stock of a foreign affiliate of the corporation, and
"B" is the amount deductible by the corporation in respect of the foreign investment income for the year under subsection 126 (1) of the Federal Act.
Same
(3) For the purposes of clause (1) (b), the amount is calculated using the formula,
C × D × E
Application of Federal Act
(4) Subsection 126 (6) of the Federal Act and the definition of "non-business income tax" in subsection 126 (7) of that Act apply for the purposes of this section.
Definition
(5) In this section,
"foreign investment income" means, in respect of a corporation, income from sources in a country other than Canada in respect of which the corporation paid non-business-income tax to the government of that country.
The TA also contains the following relevant interpretation provisions (emphasis added):
Subsection 1(1):
"federal application rule" means a provision of an Act of Parliament or of the Federal regulations, other than subsection 248 (11) of the Federal Act, that,
(a) affects the application of a provision of the Federal Act or the Federal regulations, or
(b) makes a provision, or the repeal or amendment of a provision, of the Federal Act or Federal regulations apply,
(i) to specified taxation years,
(ii) to specified fiscal periods,
(iii) after a specified time, or
(iv) to transactions or events that occur before or after a specified time or in specified taxation years or specified fiscal periods; ("règle d'application fédérale")
Subsection 1(7):
If a provision of the Federal Act or the Federal regulations (in this subsection referred to as the "Federal provision") is stated in this Act or the regulations to apply for one or more purposes of this Act or the regulations, the Federal provision, as amended from time to time, applies with such modifications as are provided by this Act or the regulations or as the circumstances require as though it had been enacted as a provision of this Act or made as a regulation under this Act and the following rules apply, in addition to those modifications, unless the context indicates otherwise, in applying the Federal provision for those purposes
Subsection 1(8):
Subject to subsection (7), the following rules apply where a provision of the Federal Act or the Federal regulations (in this subsection referred to as the "Federal provision") is stated in this Act or the regulations to apply for one or more purposes of this Act or the regulations:
1. Every federal application rule that applies in respect of the Federal provision applies, with necessary modifications, in the application of the Federal provision for the purposes of this Act or the regulations.
Since the TA incorporates the Federal FTC provisions, it is useful to review the Act and the Tax Treaty first.
In order for a portion of any non-business-income tax paid by the taxpayer for the year to the government of a country other than Canada to be eligible for a Federal FTC under section 126 of the Act, that amount of tax must be "paid by the taxpayer" to the government of the foreign country. This means an actual payment of the tax, unless an applicable provision deems the tax to have been paid. Some tax treaties contain tax sparing provisions which may deem a tax to be paid. A brief discussion on tax sparring provisions within income tax conventions can be found in paragraph 1.73 of Income Tax Folio S5-F2-C1: Foreign Tax Credit.
The tax sparing provision of the Tax Treaty is paragraph 3 of Article 22 which provides that, for the purpose of the deduction indicated in paragraph 2 of Article 22, Brazilian tax (i.e., the tax spared amounts) shall always be considered as having been paid at a rate of 20 per cent of the gross amount of income paid in Brazil in the case of interest to which paragraph 2 of Article 11 of the Tax Treaty applies (we understand that there is no dispute as to whether the payments are interest for the purposes of the Tax Treaty and that paragraph 2 of Article 11 applies). However, it is our position that under the Tax Treaty the tax spared amounts are effective only for the purposes of the Tax Treaty, not for the purposes of section 126 of the Act.
The Department of National Revenue first released a position in respect of the relationship between the provisions of the Act and the tax sparing provision of the Tax Treaty in document 58152 (F) dated October 12, 1989:
« Le paragraphe 20(12) de la loi permet une déduction dans le calcul du revenu d'un contribuable pour une année d'imposition, au titre de l'impôt sur le revenu modifié ne provenant pas d'une entreprise payé pour l'année à un gouvernement étranger.
Nous sommes d'avis que l'impôt brésilien considéré comme ayant été perçu ("tax spared") selon le paragraphe 3 de l'article XXII de la Convention Canada-Brésil est seulement réputé perçu aux fins de la déduction dans le calcul de l'impôt permise en vertu du paragraphe 2 du même article de la Convention Canada Brésil puisque ce paragraphe ne contient pas les mots suivants: "et sans préjudice d'une déduction ou d'un dégrèvement plus important prévu par la législation canadienne." De ce fait aucune déduction en vertu du paragraphe 20(12) de la Loi n'est permise à l'égard de l'impôt brésilien considéré comme ayant été perçu ("tax spared") selon le paragraphe 3 de l'article XXII de la Convention Canada-Brésil. »
Implicit in this position is that Article 22 operates independently from the provisions of the Act in determining the amount of credits or deductions granted under the Tax Treaty.
CRA has also previously examined the relationship between tax spared amounts under the Tax Treaty and section 126 of the Act specifically, for which we came to the following conclusions:
- A claim for a Federal FTC under paragraph 2 of Article 22 of the Tax Treaty is not subject to the provisions of section 126 because paragraph 2 of Article 22 of the Tax Treaty does not contain the phrase "subject to the existing provisions of the laws of Canada regarding the deduction from tax payable in Canada of a tax paid in a territory outside Canada" (the "subject to phrase").
- Based on the plain meaning of the words used in paragraph 2 of Article 22 of the Tax Treaty, the apparent intent of the Canadian negotiators, and pursuant to section 22 of the Canada-Brazil Income Tax Convention Act, 1984 (S.C. 1985, c. 23, Part IV) (the "Convention Act"), where the conditions of that paragraph of the Tax Treaty are met, a Federal FTC can be claimed under that paragraph independent of the provisions of section 126 of the Act.
- The provisions of paragraph 2 of Article 22 of the Tax Treaty provide the basis for computing such a Federal FTC.
- Where the conditions of paragraph 2 of Article 22 the Tax Treaty are met, a taxpayer may claim a Federal FTC under that paragraph of the Tax Treaty, even if one could not be claimed under section 126 of the Act.
- This result is unique to the Tax Treaty.
To qualify as business-income tax or non-business-income tax as defined in subsection 126(7) of the Act, the tax spared amounts would have to have actually been paid or would have to be deemed to have been paid to Brazil for the purpose of computing the Federal FTC in respect of such amounts under section 126 of the Act.
As the subject to phrase is not included in paragraph 2 of Article 22 of the Tax Treaty, the tax spared amounts under paragraph 3 of Article 22 of the Tax Treaty are deemed to be paid only for the purpose of paragraph 2 of Article 22 of the Tax Treaty and not for the purpose of section 126 of the Act.
Therefore, as the tax spared amounts are not a tax actually paid to Brazil, and have not been deemed to have been paid to Brazil by the Tax Treaty for purpose of computing a Federal FTC under section 126 of the Act, the tax spared amounts do not qualify as a business-income tax or non-business-income tax as defined in subsection 126(7) of the Act. The result is that a Federal FTC cannot be claimed for tax spared amounts under section 126 of the Act.
Even though a Federal FTC would not be allowed under section 126 of the Act, as paragraph 2 of Article 22 of the Tax Treaty applies independent of section 126 of the Act, subject to the limit set in that paragraph, a taxpayer can claim a Federal FTC in respect of tax spared amounts under that paragraph of the Tax Treaty. As section 126 of the Act does not apply to such a Federal FTC claim, none of the provisions of section 126 of the Act, including subsections 126(4.1) and (4.2) can be applied to deny such a Federal FTC claim.
To summarize, a taxpayer may choose to claim an applicable Federal FTC under either section 126 of the Act or under Article 22 of the Tax Treaty. Where a taxpayer chooses to avail themselves of a Federal FTC under Article 22 of the Tax Treaty, the Article operates independently of section 126 of the Act in determining the amount of a Federal FTC. Where a taxpayer wishes to claim a Federal FTC in respect of tax spared amounts they must choose to do so under paragraph 3 of Article 22 as it is not available section 126 of the Act.
This now leads us to the issue of whether an ON FTC is available in respect of the tax spared amounts.
Since the Province of Ontario is not a party to the Tax Treaty, the Tax Treaty would, in our view, have no bearing on the availability of an ON FTC unless the province has incorporated the Tax Treaty in a relevant manner. The TA does not directly reference the Tax Treaty or the Convention Act but it does incorporate section 126 of the Act for the purposes of granting an ON FTC. Further, according to subsection 1(8) of the TA, section 126 of the Act would operate as modified by paragraphs 2 and 3 of Article 22 of Tax Treaty for the purposes of the TA if those provisions of the Tax Treaty are "federal application rules" as defined in subsection 1(1) of the TA. The definition of "federal application rule" in subsection 1(1) of the TA includes a provision of an Act of Parliament which affects the application of a provision of the Act.
Consequently, paragraphs 2 and 3 of Article 22 of the Tax Treaty, being Schedule V of the Convention Act would be "federal application rules" if they effected the application of section 126. However, since it is our position, as discussed above, that Article 22 of the Tax Treaty operates independently of the Act and does not affect the application of section 126, it is also our position that paragraphs 2 and 3 of Article 22 of the Tax Treaty are not "federal application rules" for the purposes of granting ON FTCs under section 34(1) of the TA. This means that, in our view, any amount claimed as an ON FTC under subsection 34(1) of the TA must be for an amount paid to the government of a country other than Canada, as required by section 126 of the Act as read without reference to the Tax Treaty. Therefore tax spared amounts are not eligible for an ON FTC under subsection 34(1) of the TA.
In addition, it is our understanding that prior to the CRA's administering Ontario's corporate tax, Ontario's corporate tax legislation at the time would not have allowed for an ON FTC in respect of the tax spared amounts. It is our further understanding that it was not the intent of the Ontario Legislature to expand the availability of the ON FTC when the province updated its tax legislation in 2007. According to the record of debate in Ontario's Standing Committee on Finance and Economic Affairs, when debating Bill 174 (Strengthening Business through a Simpler Tax System Act, 2007, of which the TA was schedule A) an officer of Ontario's Ministry of Finance stated that the new legislation brought "no changes to any tax rates or tax credits."
Conclusion
In conclusion, we agree with your reasoned position and it is our view that tax spared amounts under paragraph 3 of Article 22 of the Tax Treaty are not eligible for an ON FTC under subsection 34(1) of the TA for the following reasons:
- Ontario is not a party to the Tax Treaty;
- Ontario has not incorporated the Tax Treaty into the TA for purposes of granting an ON FTC; and
- Section 126 of the Act (which is incorporated into the TA) operates without modification for the purposes of the TA since Article 22 of the Tax Treaty operates independently of, and does not affect the application of, section 126.
We hope that this adequately addresses your inquiry and allows you to proceed with your file. If you have any questions concerning our response, please contact Eli Kae Moore at (613) 957-2104.
Yours truly,
Lori M. Carruthers CPA, CA
for Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy Regulatory Affairs Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2014
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2014
Email this Content