31 March 2010 External T.I. 2010-0355551E5 - Foreign Tax Credit

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: General comments on claiming foreign tax credits.

Position: General comments.

Reasons: N/A

XXXXXXXXXX 							2010-035555
								S. Leung, CA
Attention:  XXXXXXXXXX 

March 31, 2010

Dear XXXXXXXXXX :

Re: Foreign Tax Credit

We are writing in reply to your letter of January 18, 2010 in which you asked which amount shown in the US 1040 and 1040NR tax returns should be used to claim Canadian foreign tax credits in the two hypothetical situations described in your letter. Both situations involve an individual who is a resident of Canada for the purposes of both the Income Tax Act (the "Act") and the Canada-United States Income Tax Convention (the "Convention"). One situation involves a non-U.S. citizen resident in Canada who realized a capital gain from the disposition of a rental property situated in the U.S. The other situation involves a U.S. citizen resident in Canada who performed part of his employment duties in the U.S. earning U.S. source salary income.

Our Comments

The particular circumstances outlined in your letter appear to relate to factual situations involving specific taxpayers. As explained in Information Circular 70-6R5, Advance Income Tax Rulings, this Directorate does not comment on transactions involving specific taxpayers except by way of an advance income tax ruling in respect of proposed transactions. When a situation involves a specific taxpayer and a completed transaction, the question should be directed to the appropriate Tax Services Office for their views, along with all relevant facts and documentation. However, we are prepared to offer the following general comments.

With respect to a non-U.S. citizen resident in Canada ("Taxpayer1") who realizes a capital gain from the disposition of U.S. rental property that is capital property, the amount of the U.S. tax paid after claiming all the credits (usually the amount shown on line 57 of Form 1040NR (2008)) translated into Canadian currency at the exchange rate in effect on the date the capital gain was realized would, assuming that the capital gain is the only income reported in the U.S. non-resident tax return, be considered to be a "non-business-income tax" within the meaning of subsection 126(7) of the Act for the purposes of claiming foreign tax credits in Canada. In this scenario, provided that the property involved is real property situated in the U.S., the U.S. would maintain its right to tax the capital gain from the disposition of such property under Article XIII of the Convention and Canada is obliged to provide a foreign tax credit under subsection 126(1) of the Act and under Article XXIV of the Convention. The computation of the amount of the foreign tax credit should be performed on Form T2209 and the result be reported on line 405 of Schedule 1 of the T1 General Return.

A situation involving a U.S. citizen resident in Canada ("Taxpayer2") earning part of his salary income in the U.S. is much more complicated. This is so because as set out in paragraph 2 of Article XXIX of the Convention, the U.S. generally reserves its right to tax the income of its citizens regardless of where they are resident. This means that the U.S. tax return of a U.S. citizen will include his or her worldwide income. However, paragraph 3 of Article XXIX states that the provisions of paragraph 2 of that Article shall not affect the obligations undertaken by the U.S. under, among other things, Article XXIV of the Convention.

Paragraph 3 of Article XXIV of the Convention reads as follows:

"3. For the purposes of this Article:

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

(b) profits, income or gains of a resident of a Contracting State which may not be taxed in the other Contracting State in accordance with the Convention (without regard to paragraph 2 of Article XXIX (Miscellaneous Rules)) or to which paragraph 5 of Article XIII (Gains) applies shall be deemed to arise in the first-mentioned State."

Paragraph 4 Article XXIV of the Convention reads as follows:

"4. When a United States citizen is a resident of Canada, the following rules shall apply:

(a) Canada shall allow a deduction from the Canadian tax in respect of income tax paid or accrued to the United States in respect of profits, income or gains which arise (within the meaning of paragraph 3) in the United States, except that such deduction need not exceed the amount of the tax that would be paid to the United States if the resident were not a United States citizen; and

(b) for the purposes of computing the United States tax, the United States shall allow as a credit against United States tax the income tax paid or accrued to Canada after the deduction referred to in subparagraph (a). The credit so allowed shall not reduce that portion of the United States tax that is deductible from Canadian tax in accordance with subparagraph (a).

In accordance with subparagraph 4(a) of Article XXIV of the Convention above, before one can determine the amount of the U.S. tax that is creditable in Canada, a determination must be made of which amounts the U.S. would have been entitled to tax under the Convention, had the Canadian resident not been a U.S. citizen. The provision of the Convention relevant to this determination in the case of Taxpayer2 is Article XV of the Convention. Under that Article, the U.S. is excluded from taxing the salary income of Taxpayer2 if (a) the salary earned in the U.S. does not exceed US$10,000 in the calendar year or (b) Taxpayer2 is present in the U.S. for a period or periods not exceeding 183 days in any 12-month period commencing or ending in the fiscal year concerned and the salary is not paid by or on behalf of a U.S. resident and is not borne by a permanent establishment in the U.S. If the conditions in either subparagraph 2(a) or (b) in Article XV of the Convention are met, the salary income earned by Taxpayer2 in the U.S. would be deemed to be income arising in Canada for the purposes of subparagraph 3(b) of Article XXIV of the Convention, with the result that in accordance with subparagraph 4(a) of Article XXIV of the Convention, Canada would not be required to provide any foreign tax credit in respect of the taxes paid by Taxpayer2 to the U.S. in respect of such salary income. Rather, in order to avoid double taxation, the U.S., in accordance with subparagraph 4(b) of Article XXIV, would provide a tax credit against U.S. taxes payable in respect of the Canadian taxes payable.

Assuming however, that the United States is not restricted from taxing the U.S. source salary income of Taxpayer2 under the provisions of Article XV, then as set out in subparagraph 4(a) of Article XXIV of the Convention, Canada must provide a credit in respect of the amount of the tax that would be paid to the U.S. on the U.S. source salary income if Taxpayer 2 were not a United States citizen. As the U.S. tax return will include Taxpayer2's worldwide income including his salary from sources both within and outside the U.S., it will be necessary to make an allocation of the total U.S. taxes paid to determine the portion reasonably applicable to the salary earned from employment exercised in the U.S. In this regard the eligible U.S. tax paid or accrued for the purposes of claiming Canadian foreign tax credits is the amount of the U.S. tax before the claim for U.S. foreign tax credit for Canadian tax paid but after any other U.S. tax credits (such as the child tax credit or credit for child care expenses). You may refer to Example A of the Technical Explanation of Article XXIV of the Convention for an illustration of the operation of paragraph 4 of that Article in a similar situation.

In view of the above, it is generally not possible to pinpoint any amount shown on the Form 1040 U.S. return as an amount that can be used to claim foreign tax credit in Canada, especially when there is more than one U.S. income source. In the situation of a U.S. citizen resident in Canada, a detailed calculation must be made to determine the amount of U.S. tax that would be paid on each item of income that is deemed to arise in the U.S. in accordance with paragraph 3(a) of Article XXIV of the Convention (i.e. before any foreign tax credit claimed in the U.S. in respect of Canadian taxes paid), and the aggregate amount of all of such amounts of U.S. taxes paid in respect of all the U.S. income sources would be used to compute the amount of the foreign tax credit available in Canada.

As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, the opinions expressed in this letter are not rulings and are consequently not binding on the Canada Revenue Agency.

Yours truly,

Olli Laurikainen, CA
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch