Article 24 - Double Taxation

Cases

Société Générale Valeurs Mobilières Inc. v. Canada, 2017 FCA 3

a Brazilian tax sparing provision did not permit the taxpayer to shelter Canadian-source income

At issue was whether Art. XXII(2) of the Canada-Brazil Treaty contemplated that a Canadian foreign tax credit should be allowed only on the basis of the Canadian taxes otherwise applicable to the Brazilian source income in question as reduced by applicable Canadian expenses. Art. XXII(2) provided:

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.

Paris J.in the Tax Court had stated (at paras. 91, 93):

…The amount of Canadian income tax referred to in the second sentence of Article XXII(2) of the Treaty as being “appropriate to the income which may be taxed in Brazil” is the actual Canadian income tax attributable the income taxed in Brazil, which is computed on the net income arising from Brazil.

…The proper test for determining which amounts of the Canadian resident taxpayer should be included or deducted from the gross interest arising from sources in Brazil is that found in subsection 4(1) of the Income Tax Act.

In upholding this decision, Woods JA stated (at para 12):

…[T]he judge’s interpretation is more consistent with the language of the relevant provision. In particular, the judge is correct that the ordinary meaning of the text takes into account not only the gross income which may be taxed by Brazil, but also the actual Canadian tax as computed under the Income Tax Act, which is based on net income.

See Also

Arsove v. The Queen, 2016 TCC 283 (Informal Procedure)

application of Art. 24 of Canada-U.S. Treaty to IRA distribution to U.S. citizen

A Canadian-resident individual and U.S. citizen was subject to US. income tax of 15% on a distribution to her out of her IRA. However, she filed her U.S. income tax return on the specious basis that the U.S. tax on the distribution was eliminated by a U.S. foreign tax credit based on Art. XXIV, para. 6 of the Canada-U.S. Treaty, and the IRS accepted the return.

Before concluding that that, as no U.S. tax was “ultimately imposed” on the taxpayer, no Canadian foreign tax credit was available, Lamarre ACJ stated (at para. 14), having regard to Art. XXIV of the Canada-U.S. Treaty:

[W]hen a U.S. citizen who is also resident in Canada earns pension income the source of which is in the United States, under the treaty the United States is allowed to tax the first 15% of that income, and the excess is taxable in Canada. This is why, to avoid double taxation, a taxpayer is allowed, in computing the Canadian tax, to claim a foreign tax credit for the 15% tax paid in the United States, and that taxpayer is entitled to a foreign tax credit against his U.S. tax for the tax paid in Canada over and above 15%.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 126 - Subsection 126(1) no credit for U.S. taxes which should have been imposed but were not 373

Société générale valeurs mobilières inc. v. The Queen, 2016 TCC 131, aff'd 2017 FCA 3

Brazilian tax sparing provision did not permit the taxpayer to shelter Canadian-source income
FCA decision summarized above

The Crown brought a motion under Rule 58(1) for determination of questions of law respecting the application of Art. XXII(2) of the Canada-Brazil Treaty to the assumed situation of a Canadian resident taxpayer (who earns income from other sources that is taxable in Canada) earning bond interest arising in Brazil which is taxed in Brazil under Art. XI of the Treaty and with the taxpayer being deemed by Art. XXII(3) to have paid Brazilian tax equal to 20% of the gross bond interest arising in Brazil. The Crown position was that the maximum foreign tax credit available to the taxpayer under Art. XXII(2) was equal to the actual Canadian tax payable on the bond income arising in Brazil, which in its view must take into account applicable expenses incurred by the taxpayer to earn the income. The taxpayer’s position was that such maximum credit equalled the Canadian tax rate multiplied by the gross amount of the interest. Art. XXII(2) provided:

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.

In accepting the Crown’s interpretation, Paris J stated (at paras. 29, 51, 62):

[T]he English word “appropriate”, the French word “correspondant”, and the Portuguese word “correspondante” [in the three versions of Art. XXII(2)] share the common meaning of “correlation between two things”. …

IPL2 stands for the proposition that...gross income from a source in a particular location must be reduced by any deduction that may reasonably be regarded as applicable to that source. Tax is then computed on this net amount... . While the Treaty does not explicitly set out that Canadian tax be computed in this manner for the purposes of Article XXII(2), it is implicit in the phrase “income tax as computed before the deduction is given” which appears in Article XXII(2).

[T]he tax sparing provision was intended to avoid neutralizing any tax incentive offered by Brazil on interest income, a result that was achieved by means of Canada’s agreement to forego any Canadian tax on Brazilian interest income earned by a Canadian resident to which Article XXII(3) applies. It seems unlikely that the tax sparing provision was intended…to operate to shelter not only Brazilian interest income from Canadian tax, but income from other sources unrelated to Brazil as well. …

After noting (at paras. 69-70) that:

Article 23B of the 1977 OECD Model....uses the phrase “that part of the income tax… which is attributable…to the income…which may be taxed in that other state.”

I agree...that “attributable” as used in that phrase is equivalent to “appropriate”... . The French version of Article 23B of the 1977 OECD Model translates “appropriate” as “correspondant”, the same word that is used in the French version of Article XXII(2) of the Treaty.

he stated (at para. 72):

At paragraph 63 of the Commentaries [on the 1977 OECD Model], the limitation on the deduction [in Art. 23B] is stated to be “normally computed as the tax on net income, i.e. on the income from [the State of source] less allowable deductions.”

Paris J went on to state (at para. 88):

The applicable test for determining which expenses are relevant to income from a source in a particular place is found in subsection 4(1) of the Income Tax Act… .

Words and Phrases
appropriate attributable
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 4 - Subsection 4(1) - Paragraph 4(1)(a) foreign source interest reduced by related expenses 390
Tax Topics - Treaties OECD commentaries applied to Brazil (not an OECD member) 209

Anson v. HMRC, [2015] UKSC 44

UK LLC member had a personal (non-proprietary) entitlement to his share of LLC profits as they arose

The taxpayer, who was resident in the UK, paid US income taxes on his share of the profits of an LLC of which he was a member, and also paid UK income taxes on income remitted to the UK including such share of the LLC's profits. He would have been entitled to relief under Art. 23 of the UK-US Double Tax Convention from UK tax on such profits if the UK tax was "computed by reference to the same profits or income by reference to which the United States tax [was] computed."

The First-tier Tribunal ("FTT") found that the combined effect of the Delaware LLC Act and the LLC agreement made between the members was that under the law of Delaware, the members automatically became entitled to their share of the profits generated by the business carried on by the LLC as they arose: prior to, and independently of, any subsequent distribution (para.119), so that Mr Anson was taxed on the same income in both countries, and was entitled to double taxation relief under Art. 23.

This finding was reversed by the Upper Tribunal, whose decision was affirmed by the Court of Appeal, but was restored by the Supreme Court.

The Upper Tribunal construed the FTT's finding, that the profits "belonged" to the members as they arose, as a legally erroneous finding that the profits vested in the members as their property. However, Lord Reed found that when the FTT described the profits as belonging to the members it was referring to a personal right rather than a proprietary right (such as that of the members of a Scottish partnership).

Therefore, contrary to the Commissioners' submissions that the profits generated by the LLC belonged to it and income to Mr Anson arose only as and when profits were distributed, the FTT found that the members of the LLC had an interest in the profits of the LLC as they arose. Accordingly, Mr Anson was entitled to the share of the profits allocated to him, rather than receiving a transfer of profits previously vested (in some sense) in the LLC.

Thus, the "income arising" in the US, being his share of the profits, was income liable to tax under UK law, to the extent that it was remitted to the UK, so that his liability to UK tax was computed by reference to the same income as was taxed in the US, and he was entitled to relief under Art. 23(2)(a) (para. 121)..

Before so concluding, Lord Reed stated (at para. 114):

The words "the same" are ordinary English words. ...]A] degree of pragmatism in their application may be necessary...for example where differences between UK and foreign accounting and tax rules prevent a precise matching of the income by reference to which tax is computed in the two jurisdictions.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Corporation profits of LLC earned directly by members 36
Tax Topics - Treaties - Income Tax Conventions - Article 3 scheme in Treaty article for allocating income between jurisdictions amounted to a definition of "source" 76
Tax Topics - Treaties - Income Tax Conventions - Article 4 pragmatic approach to determining "same" - also appearing in IV,7(b) of Cda-US Treaty 130

HMRC v. Anson, [2013] EWCA Civ 63, rev'd supra

LLC not transparent

The taxpayer, who was resident in the UK, paid US income taxes on his share of the profits of an LLC of which he was a member, and also paid UK income taxes on income remitted to the UK including such share of the LLC's profits. He would have been entitled to relief under Art. 23 of the UK-US Double Tax Convention from UK tax on such profits if the UK tax was "computed by reference to the same profits or income by reference to which the United States tax [was] computed."

In finding that this requirement was not satisfied, given that the distribution of the profits to the taxpayer (so as to attract UK tax) was distinct from the earning of the profits by the LLC in the first place (resulting in the US tax), i.e., the LLC was fiscally transparent for US but not UK purposes, Lady Justice Arden stated (at para. 57):

If profit is earned by an entity, and the source of the profit to the taxpayer as a member of that entity is a contract as between him and other members, then in the usual case it follows that the source of his income must be a different source of income from that of the entity itself. The fact that there is a contract generally suggests that there is a disposition of a right to the profits from one person to another. That result can be avoided if the member had a proprietary right to the profits as they arose. This would as I see it generally be the case where income accrues to a trust under which an income beneficiary has an interest in possession, or to a unit trust or collective investment scheme, if the investors have a beneficial interest in the assets that are subject to the unit trust or scheme.

In the case of the LLC, there was "nothing to suggest that it did not have unqualified ownership of its assets or that its members had any interest in those assets" (para. 77). She further stated (at para. 64):

It would be unusual but not impossible for an entity with a separate legal personality, such as a company, to be tax transparent for English law purposes. One example would be the Scottish partnership where the partnership is a separate legal entity and holds the assets of the business, but the partners have an (indirect) interest in the assets and carry on business in common: this has been held by this court to be tax transparent....

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Corporation LLC not fiscally transparent 422

FLSmidth Ltd. v. The Queen, 2012 DTC 1052 [at 2745], 2012 TCC 3, aff'd 2013 DTC 5118 [at 6147], 2013 FCA 160

In order to finance the acquisition of U.S. companies, the taxpayer set up a "tower structure," a chain of subsidiaries which had different tax treatment in Canada and the U.S.. For U.S. tax purposes, the income the taxpayer received under this structure was interest income arising in the U.S.; for Canadian tax purposes, it realized its income in the form of dividends received by a subsidiary partnership from a subsidiary Nova Scotia unlimited liability company (which, in turn, received dividends from a subsidiary US limited liability company.) Both the dividends paid by the LLC (which came out of its exempt surplus) and the dividends paid by the Nova Scotia ULC and allocated to the taxpayer by the subsidiary partnership (which were eligible for the intercorporate dividend deduction when allocated to the taxpayer) were exempt from Canadian tax.

Paris J. found that the taxpayer could not claim the U.S. tax as a deduction from income under s. 20(12) of the ITA because the tax could be reasonably regarded as having been paid in respect of income from the share of the capital stock of a foreign affiliate (the US LLC). This approach was consistent with Art. XXIV, para. 2(a) of the Canada-US Convention, as the US income taxes were paid on US source income that was not taxed in Canada, so that relief under that paragraph was not available (para. 81). Canada's obligations under Article XXIV did not extend beyond relief from double-taxation, of which there was none here (para. 80).

Meyer v. The Queen, 2004 DTC 2393, 2004 TCC 199 (Informal Procedure)

The taxpayer, who was a U.S. citizen resident in Canada, did not claim treaty benefits when filing his U.S. return, with the result that his U.S.-source pension income was subject to U.S. income tax at graduated rates rather than the treaty-reduced rate of 15%.

Hershfield J., after finding that the overpayment by the taxpayer did not qualify as a tax, indicated (at p. 2398) that paragraph 2 of Article XXIV of the Canada-U.S. Convention did not refer, like paragraph 1 of that Article, to a credit only being provided where the "appropriate amount of income tax" was paid or accrued to the source jurisdiction because "the Canadian drafters of the Treaty would be allowed to rely on jurisprudence or opinions that would confirm that an amount paid gratuitously without basis under the laws of the foreign jurisdiction would not be a 'tax'".

Administrative Policy

13 April 2017 External T.I. 2015-0601781E5 - U.S. tax paid in respect of an LLC's income

Canada's denial of foreign tax credits re undistributed LLC income is consistent with Art. 24 of Canada-US Treaty

A Canadian-resident individual who is a member of a U.S. LLC pays tax in the U.S. on his or her share of profit of the LLC for a particular taxation year but, unless Anson applies, does not have U.S. source income in that taxation year for s. 126(1) purposes. Is the member’s income from the LLC considered to arise as it is earned by the LLC rather than only once it is distributed by the LLC to its members? Can Art. XXIV, para. 2 of the Canada-U.S. Treaty be relied upon to claim a foreign tax credit taxes paid to the U.S. on for the member’s share of of the LLC’s income for the year when there is a distribution in respect of that income from the LLC regardless of whether the distribution takes place in the same taxation year when the income was earned by the LLC?

Notwithstanding Anson, CRA considered that where a Canadian-resident member’s share of LLC income is subject to U.S. tax but the income is not distributed, no Canadian foreign tax credit will be available in the year the income is earned – nor in a subsequent year given that s. 126(1) does not permit the carryforward of the foreign tax.

CRA also considered that this result is consistent with Canada’s Treaty obligations. In particular, after noting that the OECD Commentary on Art. 23B of the Model Convention “expressly contemplates that states may impose timing restrictions on claiming foreign tax credits,” and that where this is so “these countries…would be expected to seek other ways…to relieve the double taxation which might otherwise arise in [such] cases,” CRA stated:

In the case of Canada, such “other ways … to relieve the double taxation” include deductions allowed under subsections 20(11) and 20(12) of the Act. As such, in our view, the limits imposed by subsection 126(1) of the Act on claiming a foreign tax credit are in accordance with the OECD guidelines and do not affect the general principle of Article XXIV of the Treaty.

CRA responded:

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 126 - Subsection 126(1) Post-Anson, no credit for U.S. taxes paid by a Canadian member on undistributed LLC income 193

3 February 2016 External T.I. 2014-0548111E5 - U.S. tax paid in respect of an LLC's income

Treaty sourcing rule does not trench on domestic FTC

Mr. A, Canadian resident and citizen subject to a Canadian marginal rate of tax of 50%, was a member of an LLC carrying on a U.S. active business and which was treated as a partnership for Code purposes. LLC (which was not a controlled foreign affiliate of Mr. A) made a pro rata distribution of all its property in 2014 on a liquidation and dissolution (“L&D”), including a distribution of $2500 to Mr. A, thereby giving rise to a $2,000 capital gain on his LLC shares. After noting that "if Mr. A’s capital gain on the disposition of his LLC shares is a US source capital gain under… S5-F2-C1, subsection 126(1) could apply to allow Mr. A a foreign tax credit of up to $400 in 2014," CRA indicated that the “source” rule in Art. XXIV, 3(b) of the Canada-U.S. Treaty would not preclude the taxable capital gain from being US-source income for purposes of s. 126(1), stating:

[T]he provisions of an income tax treaty are generally not to be applied so as to result in more burdensome Canadian income tax being imposed on a taxpayer resident in Canada than the tax that would otherwise be imposed on the taxpayer under the Act (determined without reference to the treaty).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 88 - Subsection 88(3) - Paragraph 88(3)(d) no deemed dividend 124
Tax Topics - Income Tax Act - Section 126 - Subsection 126(7) - Non-Business-Income Tax LLC tax paid by Cdn member not re business 163
Tax Topics - Income Tax Act - Section 20 - Subsection 20(11) only income was taxable capital gains 131
Tax Topics - Income Tax Act - Section 20 - Subsection 20(12) s. 20(14) deduction for US operating-income taxes imposed on Cdn LLC member even where his only Cdn income from LLC is taxable capital gain 418
Tax Topics - Income Tax Act - Section 126 - Subsection 126(1) FTC for US operating-income taxes imposed on Cdn LLC member even where his only Cdn income from LLC is taxable capital gain 316

[U.K] Revenue and Customs Brief 15 (2015): HMRC response to the Supreme Court decision in George Anson v HMRC (2015) UKSC 44 25 September 2015

Anson specific to its facts

…[T]he [Anson] decision is specific to the facts found in the case. This means that where US LLCs have been treated as companies within a group structure HMRC will continue to treat the US LLCs as companies, and where a US LLC has itself been treated as carrying on a trade or business, HMRC will continue to treat the US LLC as carrying on a trade or business.

HMRC also proposes to continue its existing approach to determining whether a US LLC should be regarded as issuing share capital. Individuals claiming double tax relief and relying on the Anson v HMRC decision will be considered on a case by case basis.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Corporation Anson specific to its facts 104

23 July 2014 Internal T.I. 2014-0525231I7 - Foreign tax credit

s. 40(3) gain had Cdn source

Canco paid Japanese income tax on the capital gain reported on the distribution by it of its shares of a Japanese subsidiary ("Forco") to its non-resident parent as a dividend-in-kind, and claimed a foreign tax credit against the Canadian income tax payable on the taxable portion of the s. 40(3) gain realized as a result of a dividend distribution from Forco earlier in the year. After concluding that Canco would not be entitled to a FTC on the basis inter alia that "a taxable capital gain resulting from a deemed disposition of property is considered to be Canadian-source income, which therefore cannot be included in the foreign non-business income for purposes of claiming a FTC," the Directorate went on to state:

Article 21 [of the Canada-Japan Treaty] deems gains of a resident of Canada, which are taxed in Japan under the Convention, to arise from a source in Japan and requires Canada to provide a credit in respect of such Japanese tax against any Canadian tax payable on such gains. However, Article 21 does not apply… to re-source the deemed gain to Japan because the deemed gain was not taxed in Japan. Moreover, the amount of the subsequent gain on the disposition of Forco shares which was taxed in Japan was nil for the purposes of the Act. Therefore, Article 21…has no bearing… .

See summary under s. 126(1).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 126 - Subsection 126(1) s. 40(3) gain had Cdn source/foreign tax not a "tax" if no refund sought 408
Tax Topics - Income Tax Act - Section 126 - Subsection 126(7) - Non-Business-Income Tax foreign tax not a "tax" if no refund sought 190

16 June 2014 Internal T.I. 2014-0525961I7 - ON Tax and Brazilian Tax Sparing

Brazilian tax-sparing rules operate independently of s. 126

Was tax deemed to have been paid (a "tax spared amounts") under Art. 22, para. 3 of the Canada-Brazil Treaty eligible for a foreign tax credit (an "ON FTC") under s. 34(1) of the Taxation Act, 2007 (Ontario) ("the TA")? The Directorate noted that as the tax spared amounts are not deemed to have been paid to Brazil by the Treaty for purposes of s. 126, they cannot be claimed thereunder, and that as Art. 22, para. 2 applies independently of s. 126, a taxpayer can claim a federal FTC in respect of tax spared amounts under that paragraph of the Tax Treaty, stating:

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.

Locations of other summaries Wordcount
Tax Topics - Other Legislation/Constitution - Ontario - Taxation Act 2007 - Subsection 34(1) Brazilian tax-sparing rules operate independently of s. 126 so that they do not generate an Ontario FTC 217

13 January 2014 External T.I. 2013-0512581E5 - Sale of shares of Brazilian corporation

"income" includes taxable capital gains

The capital gain realized by a resident of Canada ("Canco") on disposing of shares of a Brazilian company was taxed by Brazil in accordance with Art. 13 of the Canada-Brazil Treaty. Art. 22, para. 2 provides:

[W]here 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.

CRA stated:

"[I]ncome" in paragraph 2… includes taxable capital gains. Therefore…Canco can claim a deduction from tax for any income or profits tax paid to the government of Brazil in respect of the Capital Gain. This deduction from tax would be computed independent of the provisions of section 126 of the Act; however ... the deduction from tax will be limited to the amount of Canadian income tax otherwise payable on that Capital Gain.

10 June 2013 STEP CRA Roundtable, 2013-0480301C6 - 2013 STEP CRA Roundtable – Question 4

A U.S. citizen is required to pay U.S. tax on dividends and capital gains at a 20% rate (increased from the previous 15% rate). Does this mean that such citizen if also resident in Canada is only entitled to a deduction under s. 20(11) with respect to the additional 5% tax?

CRA stated that Art. XXIV, para. 5 of the Canada-U.S. Treaty is "a complete code in respect of the deductions and credits available to U.S. citizens resident in Canada for the purposes of eliminating double taxation on dividends, interest, and royalties," and that the deductions thereunder "are available in place of deductions under subsections 20(11) and 20(12), and are typically more advantageous to the taxpayer."

5 November 2012 Internal T.I. 2012-0462151I7 - Foreign Tax Credits

Canco held portfolio investments in shares of U.S. companies in connection with funding its insurance liabilities. The shares were mark-to-market properties to it, and it realized a loss on income account from a deemed dispostion of the shares under s. 142.5(2) immediately before the end of its taxation year. After noting that the income of Canco from the shares was from a business carried on by it entirely in Canada, so that in the absence of Treaty the withholding taxes applicable to the dividends on the shares would not be eligible for a foreign tax credit by virtue of the mid-amble to s. 126(1)(b)(i), CRA went on to find that by virtue of Art. XXIV, para. 2 and 3 of the Canada-U.S. Income Tax Convention,

a portion of the income from Canco’s Canadian XX business must be re-sourced to the U.S. for the purposes of section 126 of the Act. In our view, that portion would be all the income pertaining to the Investments (i.e. the distributions less related expenses and the net mark-to-market loss).

CRA went on to find that, given that gains or losses on the shares were not subject to Canadian income tax by virtue of the Convention, they were deemed by s. 126(6)(c) to be a separate source for purposes of s. 126. Accordingly:

any mark-to-market gains or losses from the deemed dispositions of the Investments would be from a source that produces only tax-exempt income and would not be included in the qualifying income or qualifying losses of Canco by virtue of subparagraph 126(9)(a)(iii) of the Act. Therefore, Canco would compute its...qualifying income and qualifying losses, and its foreign non-business tax credit, without taking into consideration the...net mark-to-market loss on the Investments.

11 May 2012 External T.I. 2011-0428791E5 - Foreign Tax Credit

Respecting a question as to the availability of a foreign tax credit for state franchise tax paid by a Canadian taxpayer (Canco), CRA (after indicating that the tax potentially would qualify for a credit), CRA went on to indicate that Article XXIV of the Canada-US Convention would not provided relief where the foreign tax credit was not available and the franchise tax was imposed notwithstanding the absence by Canco of a permanent establishment in the state (presumably given that the income in question would not be deemed to arise in the US under Art. XXIV, para. 3).

15 March 2004 External T.I. 2003-002265 -

The Mexican assets tax (levied annually at the rate of 1.8% on all business property, commencing after four years of business operations) was not a "tax payable in Mexico on profits, income or gains arising in Mexico" for purposes of Article 22(1) of the Canada-Mexico Convention.

20 February 2003 External T.I. 2002-014360 -

A s. 20(12) deduction may not be taken by a U.S. citizen resident in Canada on the withholding from U.S. source property income that is in excess of a rate of 10% and less than a 15% rate.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 126 - Subsection 126(1) 158

20 February 2003 External T.I. 2002-0143605 -

no 20(12) deduction when Art. XXIV, para. 5 applies

Respecting a U.S. citizen who was resident in Canada and received U.S.-source interest income, the correspondent queried whether the amount of U.S. tax paid on the interest between 10% and 15% would be ineligible for a deduction under s. 20(12). CRA stated that Art. XXIV, para. 5:

requires Canada to give a deduction roughly equivalent to that in subsection 20(11). In particular, paragraph 5(a) of Article XXIV modifies the deduction by requiring that the deduction not be reduced by any credit or deduction for Canadian taxes allowed in computing the U.S. tax on such items. That is, the deduction is based on the taxpayer's gross U.S. tax liability rather than his or her final tax liability. …

Paragraph 5(b) provides that Canada shall allow a deduction from Canadian tax (i.e., a foreign tax credit) on items of income governed by paragraph 5. The foreign tax credit need not exceed the amount of tax that would have been paid to the United States if the resident of Canada were not a citizen of the United States. As a result, the foreign tax credit provided is limited to the lesser of the tax allowed by the Tax Convention and the tax levied by the United States on non-citizens. …

Since paragraph 5 of Article XXIV does not contemplate Canada providing tax relief other than that discussed above, it is our view that a subsection 20(12) deduction cannot be taken where paragraph 5 of Article XXIV applies.

19 October 1998 Memo 8M18146

only U.S. AMT relating to non-Canadian source income eligible for FTC
Summary of Art. XXIV, para. 3 of Canada-U.S. Convention

With respect to the sourcing of an income item, paragraph 3 of Article XXIV of the Convention provides that, for the purposes of that Article, income, profits or gains of a resident of Canada that may be taxed in the U.S. in accordance with the Convention are deemed to arise in the U.S. and those which may not be taxed in the U.S. in accordance with the Convention are deemed to arise in Canada. This sourcing rule applies without regard to the savings clause in paragraph 2 of Article XXIX of the Convention. Therefore, income, profits or gains of a Canadian resident who is a U.S. citizen that would not have been taxed in the U.S. if the resident of Canada were not a U.S. citizen are deemed to arise in Canada (i.e., U.S. source income resourced to Canada). An example of such income is employment income earned by a resident of Canada where the employment was exercised in the U.S. but either the amount of the remuneration did not exceed $10,000 in Canadian currency or the person was present in the U.S. for less than 183 days in a calendar year and the remuneration was not borne by an employer resident in Canada or a permanent establishment of the employer in Canada.

Summary of paras. 4-5

Paragraphs 4 and 5 of Article XXIV of the Convention also require that the U.S. grant a foreign tax credit in respect of certain U.S. source income that is not resourced to Canada pursuant to the sourcing rule described above. In general this income consists of U.S. source pension income, U.S. source income that would not be subject to tax under the Code without regard to the Convention if paid to a resident of Canada who was not a U.S. citizen and U.S. source interest, dividends and royalties to which paragraph 5 of Article XXIV of the Convention applies. Paragraph 6 of Article XXIV provides the U.S. with the authority to resource a certain amount of such U.S. source income to Canada, for the purpose of granting under the Code the credit required by the Convention in respect of Canadian taxes paid on such U.S. source income. The amount of such U.S. source income resourced to Canada would be the amount of such income that would generate an amount of regular U.S. tax equal to the amount of the required credit for Canadian taxes paid on such income. Assume for example that on $100 of U.S. source pension income paragraph 4(b) of Article XXIV requires that the U.S. grant a foreign credit of $25 and the U.S. tax rate is 40%. The amount of such income resourced to Canada would be $62.50.

No FTC for U.S. AMT that relates to (re-sourced) Canadian source income

In the case of income sourced to the U.S. which by virtue of the provisions of the Convention has been resourced to Canada, the U.S. would treat such income for its foreign tax credit purposes as income sourced outside the U.S. and would provide a foreign tax credit for such income. Because of the resourcing rule in the Convention, the taxpayer would have no income arising in the U.S. for purposes of Article XXIV of the Convention and Canada would not be obliged to provide a tax credit for any U.S. tax paid on such income pursuant to paragraph 4(a) of Article XXIV of the Convention. Therefore, the Convention removes the obligation of a Canadian resident to pay U.S. income tax in excess of the amount that would have been paid under the Convention. As discussed above, if as a result of choosing to opt out of the Convention a person pays more regular U.S. tax than he or she would have paid following the provisions of the Convention, it is our position that the excess is a voluntary payment which is not an income or profits tax for the purposes of the Act and is not eligible for a tax credit to reduce Canadian tax. However, if as a result of following the provisions of the Convention AMT arises because of the application of the AMTFTC 90% limitation rule [limiting the foreign tax credit for U.S. alternative minimum tax purposes to 90% of the tentative minimum tax before such credit], such AMT is not a voluntary tax because it is imposed in spite of the Convention. For the purposes of the Act, the AMT is an income or profits tax and the U.S. source income (whether or not resourced for the purposes of the Convention to Canada) is foreign source income. Therefore, the portion of the AMT attributable to such U.S. source income is a non-business-income tax and is creditable for Canadian tax purposes.

3 March 1997 Memorandum 964132

Discussion of the interaction of s. 20(11) and paragraph 5 of Article XXIV of the U.S. Convention.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 20 - Subsection 20(11) 16

1995 Alberta CICA Round Table, Q. 13 (C.T.O. "U.S. Alternative Minimum Tax")

Discussion of double taxation situation where a U.S. citizen who is resident in Canada and earning only Canadian-source income is subject to U.S. alternative minimum tax.

Halifax Round Table, February 1994, Q. 5

As paragraph 1 of Article 24 of the Canada-U.S. Convention is subject to paragraphs 4, 5 and 6, and these paragraphs are not subject to U.S. domestic tax law, the credit to be allowed by the U.S. under the Convention on the Canadian-source investment income earned by a U.S. citizen resident in Canada should not be affected by the 90% limitation on the U.S. foreign tax credit for AMT purposes.

Articles

Manjit Singh, Andrew Spiro, "The Canadian Treatment of Foreign Taxes", 2014 Conference Report, (Canadian Tax Foundation), 22:1-37

Re-sourcing of capital gains and derivative gains (p.7)

A common scenario in which a treaty re-sourcing rule may apply is where a Canadian resident realizes a capital gain from a disposition of foreign-company shares that is taxable in the company's state of residence under a treaty….

Re-sourcing under Canada - U.S. Income Tax Convention (the "U.S. Treaty") may also be relevant in the context of payments by Canadian residents under derivative instruments (which would generally be sourced to Canada under Canadian principles) where such payments are subject to U.S. withholding under the recently enacted "dividend equivalent payment" rules in section 871(m) of the Internal Revenue Code (the "Code"). [fn 48: … OECD Commentary… states that the state of residence should grant a credit in situations where a payment is characterized differently for purposes of an applicable treaty under source state and residence state law. …]

Creditability where domestic Treaty override (p.9)

Where the source state's domestic law expressly provides for taxation in contravention of a treaty, the treaty crediting mechanism would likely not apply (assuming the relevant treaty rule follows the OECD Model, which provides for a credit in respect of tax imposed "in accordance with the treaty"). One could argue that the domestic law credit under section 126 should apply in these circumstances, as a payment of tax in excess of the amount permitted under a treaty should not fail to qualify as a "tax" under general principles where the source state's domestic law imposes the tax under a treaty override. [fn 49: …[S]ee Abraham Leitner and Jon Northup, "The US Inversion Rules and Their Impact on Cross-Border Offerings," 2013 Conference Report… 21: 1-35.] The CRA appears to have accepted this premise in the context of U.S. alternative minimum tax imposed in contravention of the U.S. Treaty, to the extent such tax relates to foreign source income. [fn 50: … 2003-0019751E5… .] Arguably, this analysis could also be applied where foreign tax is imposed in contravention of a treaty under a domestic anti-treaty shopping rule.

Kevyn Nightingale, "The Net Investment Income Tax: How it applies to U.S. Citizens Abroad", International Tax, No. 73, December 2013, p. 9.

What is the NIIT? (p.9)

To help fund "Obamacare", the United States instituted a new tax: the Net Investment Income Tax ("NIIT"). [Note 1: Affordable Care Act. PL 111-152 § 1402, 03/30/2010.]

…The tax is calculated as 3.8% of a U.S. person's net investment income [Note 4: IRC § 1411(a)(1)] to the extent the person's modified adjusted gross income is above the following thresholds [not reproduced]....

Summary of conclusions re NIIT being a social security tax (p.14)

For a U.S. individual living in Canada, the individual should not be subject to the NIIT, provided it is a Social Security tax. The NIIT should be a social security tax for the following reasons:

  • the NIIT supplements existing social security taxes;
  • it is designed to fund an expanded Medicare;
  • Americans abroad are exempt from the individual mandate and the NIIT is designed to fund subsidies for that mandate;
  • it is described as a Medicare tax in the legislation'
  • its location in the Internal Revenue Code is consistent with that status;
  • the tax mechanism dovetails with the increased ordinary Medicare taxes on earned income; and
  • the absence of an FTC [U.S. foreign tax credit] mechanism is consistent with the NIIT being a social security tax and not an income tax.

This position is not without risk because:...SSTAs [the U.S.-Canada Social Security Totalization Agreement] do not explicitly cover the tax;...an individual who is not covered by CPP (by reason of not earning income from employment or self-employment) may be excluded from the Canadian SSTA; and...funds are not earmarked directly for Medicare.

US FTC under Treaty for NIIT if it is an income tax (pp.12-13)

For a U.S. citizen resident in Canada, the Canada-U.S. Income Tax Convention (the "Treaty") allows a FTC for Canadian tax in computing United States tax:…

The fact that the tax arises in a separate section of the Internal Revenue Code is not relevant to this determination:…[Note 34: Treaty Article II(1); … .Note 35: Treaty Article II(3)]… .

Of course the words "subject to the limitations of the law of the United States" could be interpreted to mean that for taxes like the NIIT there is no FTC, because there is no provision for one in the domestic law. The Internal Revenue Service ("IRS") makes a comment in the preamble to the final regulations that where such words are included, a treaty-based FTC would not be allowed.

No Cdn. FTC for NIIT on non-US-source income if it is an income tax (p. 13)

Where the income is non-U.S.-source, Canada will tax the income without regard to U.S. taxation. Canada has no domestic mechanism to provide an FTC in respect of the NIIT in these circumstances because:

  • Qualifying incomes must have a source in one or more countries other than Canada. [Note 37: …subsection 126(7) "non-business income tax".
  • Canada calculates FTCs separately on a country-by-country basis. Income earned in one foreign country (e.g., a non-U.S. country) that is taxed by another foreign country (U.S.) gives rise to no FTC.
  • The NIIT would also not be a creditable tax because it is payable solely by virtue of U.S. citizenship (noting that the tax does not apply to NRAs [non-resident aliens]). [Note 38: ITA subsection 126(7) "non-business income tax" – paragraph (d).]

Under the Treaty, Canada is not obliged to offer a tax credit. The credit required under the Treaty is limited to the amount which would apply if the individual were not a U.S. citizen. [Note 39: Treaty Article XXIV(4)(a).]

No evident intent to override the Treaty (p. 13)

Unlike Canada and most other countries, in the United States a treaty does not automatically supersede domestic law.… .

The IRS, by noting in the preamble to the regulations that (a) a treaty credit may be allowed and (b) residency determined under a treaty will be respected, implicitly acknowledges that this new tax is not intended to be a treaty override.

It is suggested that in light of the working of the Treaty, especially Article II(1), which anticipates the enactment of additional taxes, an FTC should be allowed, notwithstanding the Treasury's comments.

Also no Cdn. FTC for NIIT on US-source income if it is an income tax (p. 13)

…Canada is not required to provide an FTC for U.S. tax in excess of what is properly allowed under the Treaty. Where the Treaty limits the U.S. tax to an amount lower than the ordinary U.S. statutory rate, that Treaty limit forms an upper bound on the creditable tax. [Note 49: Meyer, 2004 DTC 2393 (T.C.C. – Informal Procedure)] Furthermore, where a U.S. citizen is taxable but an NRA would not be on the same type of income, Canada is not required to provide an FTC. [Note 50: Treaty Article XXIV(4)(a)] As noted above, a U.S. NRA is exempt from NIIT. Consequently, Canada would not offer an FTC in respect of this tax.

Where the statutory U.S. calculation results in higher tax than what the Treaty allows, the United States is required under the Treaty to offer a special FTC to reduce its own tax to the Treaty level. [Note 51: Treaty Article XXIV(4)(b)] Provided the Canadian tax is sufficient, this credit should offset the NIIT. Given the fact that Canadian effective tax rates for high-income earners are typically much higher than U.S. rates, this should be the case almost universally.

Filing in light of risk of NIIT being applicable (p. 14)

It is quite possible, of course, that the IRS would view either approach to be incorrect (that the tax is covered by the SSTA or that there is no treaty-based FTC available in a specific jurisdiction). …

For an SSTA exemption, safe tax practice would suggest that filing form 8275 (Disclosure Statement) is a good idea. For a treaty position, it might still be advisable to file the form….

Tremblay, "Foreign Tax Credit Planning", 1993 Corporate Management Tax Conference Report, c. 3.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 126 - Subsection 126(2) 0

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