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Foreign Tax Credit

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Filing Your Return -> Foreign Non-Business Income Tax / Foreign Tax Credit

Foreign Non-Business Income Tax and Foreign Tax Credit  (FTC) 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 three countries, 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.  However, see the note below regarding the limitation re tax in excess of the treaty rate.  The excess foreign tax over 15% deducted under s. 20(11) reduces the amount of foreign non-business income which is used in the foreign tax credit calculation.  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.  Personal income tax software will automatically provide the s. 20(11) deduction for income and foreign taxes 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 sometimes not completely recovered by the federal and provincial 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 will have to enter this on the Foreign Tax Credits Worksheet.  As you can see, both the s. 20(11) and s. 20(12) deductions are both claimed on line 232 of the tax return.

Foreign Tax Credit and s. 20(12) Deduction Calculation

Assume, for an Ontario taxpayer:

    - FNBI = Foreign non-business income of 10,000
    - Other income of 15,000
    - Single person with only basic personal amount tax credit
    - FIT = Foreign income tax withheld 2,000 (20%) - see limitation re tax in excess of treaty rate, below
    - E = Excess for s. 20(11) deduction = 2,000 - (15% x 10,000) = 500
    - Net foreign non-business income (FNBI) after s. 20(11) deduction = 10,000 - 500 - 9,500
    - Taxable Income before FTC = 15,000 + 10,000 - 500 = 24,500

Calculation of Foreign Tax Credit (FTC) with above assumptions   1st Iteration 2nd iteration 3rd iteration 7th iteration
s. 20(12) deduction 20(12) $nil $458.65 $524.60 535.56
Net foreign non-business income for FTC = 9,500 - 20(12) FNBI 9,500.00 9,041.35 8,975.40 8,964.44
Taxable Income = 24,500 - 20(12) TI 24,500 24,041.35 23,975.40 23,964.44
Basic federal tax on TI (see note on T2209 - link below) FTax 1,953.90 1,885.10 1,875.21 1,873.57
Federal FTC = FNBI / TI x FTax FFTC 757.63 708.94 702.00 700.85
Net federal tax FedTax 1,196.27 1,176.16 1,173.21 1,172.72
Foreign tax not recovered after s. 20(11) and FTC = 2,000 - 500 - FFTC   742.37 791.06 798.00 799.15
Ontario tax otherwise payable before calculating provincial FTC ONTax1 731.69 708.53 705.20 704.64
Ontario FTC = FNBI / TI x ONTax1 ONFTC 283.72 266.46 264.00 263.59
Ontario tax before Ontario Health Premium A 447.97 442.07 441.20 441.05
Add Health Premium B 270.99 242.48 238.52 237.87
Total Ontario tax = A + B ONTax 717.97 684.55 679.72 678.92
Total federal + Ontario tax = FedTax + ONTax   1,914.24 1,860.71 1,852.93 1,851.64
Foreign tax not recovered = 2,000 - 500 - FFTC - ONFTC: for s. 20(12) Line 232   458.65 524.60 534.00 535.56

In the 1st iteration, you would enter the 458.65 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.  You would then have to recalculate the foreign tax not recovered and change the amount on the FTC worksheet again.  This is what is called a "circular calculation", so may have to be done a few times before final amounts are determined.  As you can see, there was very little change in the total tax payable after the 3rd iteration above.

We did the same calculation as above, but with "other income" of $100,000.  In that case, the federal foreign tax credit was more than the foreign taxes paid, so there was no s. 20(12) deduction.  With other income of $70,000, there was a small amount for a s. 20(12) deduction, but it only made a $3.09 reduction in the total taxes payable, after 6 iterations.

The Detailed Canadian Income Tax and RRSP Savings Calculator does not currently calculate the foreign tax credit.

Foreign Taxes From a Trust - Reported on a T3

The following is from paragraph 11 of IT-506, Foreign Income Taxes:

11.  Subsection 104(22) provides the rules for the allocation of foreign source income and foreign taxes of a trust between the trust and its beneficiaries (see IT-201R).  Since the rules in subsection 104(22) apply only to that subsection and to section 126, a beneficiary may not utilize the provisions of subsection 20(11) or (12) in respect of foreign taxes allocated to it under subsection 104(22).

What this means:  The foreign income from a trust (reported on a T3) is included in FNBI above, and the foreign taxes from a trust are included in the calculation of the foreign tax credit.  However, any excess over 15% is not included in the s. 20(11) deduction, and no s. 20(12) deduction is available for the foreign taxes shown on a T3.

Limitation re Tax in Excess of Treaty Rate

On the T2209 Federal Foreign tax Credit worksheet, it indicates "Any amount of tax you paid to a foreign government in excess of the amount you had to pay according to a tax treaty is considered a voluntary contribution and does not qualify as foreign taxes paid.”   This means that the excess amounts are not eligible for the s. 20(11) or 20(12) deductions.

The above position of CRA was confirmed by the Tax Court in Meyer v. The Queen, 2004 TCC 199.  In this case, the judge initially felt that Meyer's position was correct, based on the Income Tax Act, but was subsequently convinced that CRA's position was correct, based on definitions of what constitutes a tax, and the fact that the amount withheld must be legally enforceable in order to be considered a tax.

If you have significant amounts of foreign non-business income tax paid, in excess of a treaty amount, you should be seeking advice from a qualified tax professional (CPA) with expertise in this area.  You may be able to recover taxes from the foreign government.

See Tax Treaties on the CRA website.

Forms on Which the Foreign Tax Credit is Calculated:

    - T2209 Foreign Tax Credit

    - T2036 Provincial Foreign Tax Credit

CRA Resources:

    - Line 405 Federal Foreign Tax Credit

    - S5-F2-C1: Foreign Tax Credit and Deductions - this folio has a great deal of detail on the foreign tax credits for both business and non-business income.

    - IT-506 - Foreign Income Taxes as a Deduction from Income (Archived)- see paragraph 11 re the unavailability of s. 20(11) or (12) deduction for trust beneficiaries.

    - IT-201R - Foreign Tax Credit - Trust and Beneficiaries (Archived)

Tax Tips:
   - If you don't understand this, you are not alone!
   - If your foreign taxes involve more than withholding taxes on dividends, get your tax return done (or at least reviewed) by a professional.

Revised: May 31, 2018

 

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