Foreign Non-Business Income Tax and Foreign Tax Credit Line 405
Income Tax Act s. 20(11), 20(12), s. 126(1), s. 126(9)
Canadian residents who have had withholding taxes deducted from foreign non-business income (FNBI) may claim a foreign tax credit. This should not be confused with the separate calculation for a tax credit for taxes paid on foreign business income (FBI).
The calculation of this non-refundable tax credit may not be automatically done by your tax software, if you have foreign non-business income which is not reported on a T-slip. These amounts may have to be manually typed into a worksheet in the software.
If an individual has anything more than withholding taxes from foreign dividends, the foreign tax credit can be a complex calculation. It becomes more complex when the individual wants to deduct a portion of the foreign tax from income as well as using the foreign tax credit, because the portion deducted from income must be excluded from the foreign taxes in the tax credit calculation. A detailed description of the foreign tax credit calculation was found in the Canada Revenue Agency (CRA) bulletin IT-270, Foreign Tax Credit. As of March 27, 2013, this bulletin is not available. CRA has published income tax folio S5-F2-C1: Foreign Tax Credit, replacing the IT bulletin.
The foreign non-business tax credit is calculated separately for each foreign country. However, if the total foreign taxes are less than $200, CRA will usually allow a single calculation. When the tax credit has to be calculated separately for more than one country, the tax return is no longer eligible for NetFile.
The calculation for the tax credit uses the total foreign non-business income, such as pension income, employment income, director's fees, commissions, interest, dividends, and some taxable capital gains in excess of allowable capital losses. Capital gains and losses on publicly traded securities are generally considered foreign income if the securities were traded on a foreign stock exchange. However, if any of the foreign income is exempt from income or profits tax in the foreign country due to a tax treaty with that country, then it is not included in the calculation of the foreign tax credit. Foreign non-business income is not reduced by net capital losses carried forward from a previous year.
When Canadians trade securities on US stock exchanges, the capital gains are exempt from tax in the US due to the tax treaty, so there should be no withholding tax deducted from proceeds of sale, and the gains from these sales should not be included in the foreign tax credit calculation. If the account is actually held with a brokerage in the US, an IRS W-8Ben form must be filed with them to ensure there are no withholding taxes on sales proceeds. If your trade confirmation for US securities shows a small amount titled "US tax", usually for a fraction of 1%, this amount is actual a securities exchange fee, not withholding tax.
When foreign property income (other than from real property, or from a trust) has had withholding tax in excess of 15% deducted, the excess can be deducted from income on line 232 of the personal tax return, "Other deductions", as a s. 20(11) deduction. Only the 15% tax amount is included in calculating the foreign tax credit, and the excess reduces the amount of foreign non-business income. If your foreign income is reported on a T3, then it is from a trust (such as a mutual fund or ETF), so this deduction does not apply. Income tax software will automatically provide this deduction for income reported on a T5, and will ignore any excess tax paid on a T3, as it should.
If the federal foreign tax credit is less than the foreign tax you paid, you may also be able to claim a provincial or territorial tax credit. For territories, and provinces other than Quebec, form T2036 Provincial Foreign Tax Credit is used.
The foreign taxes are often not completely recovered by the foreign tax credits. Non-business foreign taxes which are not recovered as a tax credit may be deducted from income on line 232 of the personal tax return, "Other deductions", as a s. 20(12) deduction (again, foreign taxes reported on a T3 are not eligible). This deduction is not usually done automatically by income tax software. You would enter this amount in the software on the foreign tax credits worksheet. When this is done, the foreign tax credit calculation is automatically revised, by reducing both foreign non-business income and foreign tax paid by the amount of foreign tax deducted on line 232. This is what is called a "circular calculation", so may have to be done a few times before final amounts are determined.
Foreign Taxes From a Trust - Reported on a T3
The following is from paragraph 11 of IT-506, Foreign Income Taxes:
Forms on Which the Foreign Tax Credit is Calculated:
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