27 February 1998 Internal T.I. 9729076 - FOREIGN TAX CREDIT FOR U.S. CITIZENS

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:

Whether double taxation could occur when a U.S. citizen resident in Canada compute U.S. tax credit in accordance with the worksheet provided in U.S. Publication 514 "foreign Tax Credits for Individuals for use in preparing 1996 returns"

Position:

Yes, in some special situations, double taxation would occur

Reasons:

Because the worksheet does not call for computing U.S. tax credit on an item by item basis. Rather an average treaty rate applies to all items of U.S. source income.

		February 27, 1998

M. Quebec	International Section
	Director	S. Leung
	International Tax Services Office	957-2115
	Attention: France Marengère
	Enquiries and Adjustments Division		972907

Foreign Tax Credit of a U.S. Citizen
Resident in Canada after the Third Protocol

We are writing in response to your round trip memorandum of October 29, 1997 in which you requested our assistance in answering the enquiry of XXXXXXXXXX (the taxpayer).

In his letters of October 23, 1997, the taxpayer enquired about the method of computing foreign tax credits for U.S. income taxes paid by a U.S. citizen resident in Canada on certain items of income (such as interest, dividends and pension payments) in respect of which the U.S. is allowed to tax under the Canada-U.S. Income Tax Convention (the “Convention”) but the U.S. tax so imposed should not exceed certain tax rates provided by the Convention (the “treaty rate(s)”). The taxpayer stated that because different treaty rates are provided for different items of income under the Convention, double taxation could occur when one follows the worksheet provided in U.S. Publication 514 “Foreign Tax Credits for Individuals for use in preparing 1996 returns” (the “Worksheet”) to calculate U.S. tax credits on U.S. source income.

We agree that in certain situations double taxation will occur if one follows the Worksheet to calculate U.S. foreign tax credits. However, such double taxation would only occur in special situations where there are more than one item of income arising in the U.S. taxed at different treaty rates under the Convention and the U.S. Federal income tax otherwise payable before foreign tax credits (the “FITOP”) in respect of those items of income is between the highest and the lowest of the treaty rates on those items of income. In the example provided in the taxpayer’s letter, we do not think that there is any double taxation because it appears that the FITOP of Cdn.$9,271.12 is 16.1881% (not 14.76%) of the total amount of dividend, interest and pension income of Cdn.$52,271.20. This percentage is greater than the highest of the treaty rates (i.e., 15%) of all the items of income in his example. In such a case, the Canadian tax credit in respect of U.S. tax should be as follows:

	On interest income of Cdn.$2,727.20 at 10%		$   272.72
	On dividend income of Cdn.$40,908.00 at 15%		6,136.20
	On pension income of Cdn.$13,636.00 at 15%		2,045.40
	Total foreign tax credit			$8,454.32

This would be equal to the amount in Canadian currency of the U.S. paid after the U.S. tax credit.

Therefore, it should be noted that the U.S. tax used in the computation of Canadian foreign tax credit is FITOP which is the U.S. Federal income tax otherwise payable before the claim of U.S. tax credit for Canadian tax paid, not the net U.S. Federal income tax after U.S. tax credits. This concept is clearly described in our paper titled “Some Aspects of Taxation of U.S. Citizens Resident in Canada”, a copy of which has been sent to you electronically on September 24, 1997. In simple terms, the Canadian tax credit for U.S. regular income taxes is determined prior to the U.S. tax credit for Canadian income taxes.

In special situations described earlier where double taxation will arise, the double taxation is due to the fact that under the Worksheet the U.S. does not compute the tax credit on an item by item basis. Rather, the U.S. adds all the items of income subject to restricted treaty rates together and computes an average treaty tax rate for these items of income. While this method of calculating U.S. tax credits was acceptable prior to the Third Protocol to the Convention, it is, in our view, not an appropriate one after the Third Protocol has entered into force. Before the Third Protocol, paragraph 5 of Article XXIV of the Convention required that Canada provide a tax credit equal to the lesser of the amount of U.S. tax otherwise payable or 15% of the gross amount of each item of income referred to in that paragraph regardless of the rate that such item of income was taxed by the U.S. under the Convention. Therefore, the Worksheet would produce the same result as if the U.S. tax on each item of income were calculated separately. However, after the Third protocol has become effective, such a method of calculation would not produce a correct result if the FITOP is between the highest and the lowest of the treaty rates of all the items of income in question. For instance, if there is a mix of dividend and interest income and the FITOP on each item of income is 13%, the Worksheet would ensure that the total U.S. tax after tax credit is 15% of the dividend income and 10% of the interest income. Canada’s interpretation of paragraph 5 of Article XXIV of the Convention is that the U.S. in such a case would be entitled, after tax credits, to 10% of the interest income and only 13% of the dividend income and those are the amounts for which Canada would provide a tax credit. To the extent that the U.S. tax is greater than 10% of the interest income and 13% of the dividend income, the U.S. would be taxing in excess of the amounts provided by the Convention.

Under paragraph 5 of Article XXIV of the Convention as it read prior to the Third Protocol, Canada would, in such a case, be required to grant a tax credit for all the U.S. tax paid as the overall rate is less than 15%.

It is our view that the Worksheet has not taken into account the Third Protocol and we expect that the U.S. will in due course amend the Worksheet to give effect to paragraph 5 of Article XXIV of the Convention as amended by the Third Protocol. In the mean time if the tax imposed by the U.S. after tax credits on an item of income referred to in paragraph 5 of Article XXIV of the Convention as amended by the Third Protocol exceeds what is allowed under the Convention, you may suggest the taxpayer to seek the assistance of Competent Authority in Canada to resolve the issue. The procedures of requesting Competent Authority’s consideration in Canada are described in Information Circular 71-17R4, a copy of which is herewith enclosed for your reference.

Before closing, we would also like to point out that in the examples provided in the taxpayer’s letter, since the FITOP on each of the interest and dividend is 16.1881% which is greater than 15%, a deduction equivalent to the subsection 20(11) deduction is available and such deduction from income will be equal to 1.1881% of the gross amounts of the interest and the dividend.

We trust you will find the above to be of assistance. If you have any questions, please do not hesitate to contact us.

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