ARCHIVED - Foreign Income Taxes as a Deduction From Income

What the "Archived Content" notice means for interpretation bulletins

INTERPRETATION BULLETIN

REFERENCE:
Subsections 20(11) and (12) (also subsections 104(22), 126(1) and (7) and 138(5.1))

Proposals contained in the Notice of Ways and Means Motion of October 31, 1986 are not considered in this release.

1. A tax credit for foreign income or profits taxes paid by a resident of Canada is permitted by virtue of section 126 as a deduction from Canadian tax otherwise payable on that foreign income (see IT-270R). This bulletin discusses subsections 20(11) and (12) which provide for the deduction of certain foreign taxes in the computation of a taxpayer's income from a business or property.

2. Although both subsections 20(11) and (12) refer to taxes which have been paid, the deductions discussed hereunder may only be claimed in respect of the taxation year for which the taxes were paid. It is irrelevant whether the taxes were paid before, during or after the year the foreign source income arose.

3. An individual (including a trust) who in a taxation year earns income that is

(a) not included in income from a business carried on in a foreign country, and

(b) from a particular property outside Canada that is not real property

may deal with any income or profits tax paid thereon for the year to a foreign country in the following manner:

(c) deduct under subsection 20(11) the portion, if any, of the foreign tax that exceeds 15% of the gross income for the year from the particular property; and

(d) as to the amount not deductible under subsection 20(11),

(i) deduct part or all of it under subsection 20(12) (see 5 below), and

(ii) include the part not deducted under subsection 20(12) in computing the individual's non-business-income tax for the purpose of claiming a foreign tax credit for the year under section 126.

4. In calculating the deduction under subsection 20(11), the actual foreign income or profits taxes paid with respect to the income described in 3 above should be used where possible. On the other hand, depending on the circumstances, it may be necessary to make a determination of the foreign income or profits taxes paid which may be attributable to such property. Where it is necessary to make such a determination all the relevant facts must be taken into consideration. For example, if the foreign tax of a country is determined on gross property income, then a reasonable portion of the foreign tax relating to income from property other than real property in that country would be the proportion that the gross income from such property in that country is of the gross income from all property in that country. Conversely, if the foreign tax is calculated on the net foreign-source income in that country, the net income figures would be used in the calculation.

5. In computing income for a taxation year a taxpayer (not limited to an individual as in 3 above) may claim a deduction under subsection 20(12) in respect of modified non-business-income tax paid for the year to a foreign government, but not including any such tax paid by a corporation in respect of income from a share of a foreign affiliate.

6. For the purposes of subsection 20(12), modified non-business-income tax has the meaning of "non-business-income tax" as defined in paragraph 126(7)(c), modified by the deletion of its subparagraphs (iii) and (v), and includes any foreign income or profits tax except

(a) a business-income tax in respect of any business carried on in any country other than Canada,

(b) a tax deductible under subsection 20(11),

(c) for 1980 and subsequent taxation years, a tax or the portion of a tax imposed solely on the basis of citizenship and that cannot reasonably be attributable to an income source outside Canada,

(d) for 1984 and subsequent taxation years, any tax that can reasonably be attributable to the amount of income for which an overseas employment tax credit is available, and

(e) for 1985 and subsequent taxation years, any tax attributable to a taxable capital gain or a portion thereof in respect of which the taxpayer has claimed a deduction under section 110.6.

For taxation years commencing after November 12, 1981, a foreign tax repaid or repayable by a foreign government to any other person or partnership is excluded from non-business-income tax for purposes of paragraph 126(7)(c), but not for purposes of subsection 20(12).

7. For taxation years ending after November 12, 1981, subsection 138(5.1) denies a life insurer resident in Canada a deduction under subsection 20(12) for foreign tax relating to its insurance business. (For taxation years commencing before April, 1983, however, this rule only applied in respect of an insurance business carried on outside Canada.)

8. Non-business-income tax that has been deducted by virtue of subsection 20(12) is excluded from non-business-income tax for purposes of paragraph 126(7)(c). That is, a deduction under subsection 20(12) requires an equivalent reduction in respect of the relevant foreign country of the non-business-income tax eligible for a foreign tax credit, the foreign non-business-income amount which is used in calculating the amount of foreign tax credit which may be claimed, and the amount of net income used in that calculation. The subsection 20(12) deduction results in tax relief at the effective tax rates, while the section 126 relief is usually available on a dollar-for-dollar basis.

9. Non-business-income taxes paid in respect of employment income are not deductible under subsection 20(12) since subsection 8(2) restricts employment income deductions to those allowed under section 8. However, a non-business-income tax paid by a taxpayer resident in Canada on self-employment income (e.g., United States Social Security Tax - see IT-122R) may be deducted under subsection 20(12) to the extent that it relates to business income.

10. The fact that a foreign income or profits tax is levied on business income does not necessarily mean that the tax is a "business-income tax" as defined in paragraph 126(7)(a). Where business income to which the tax relates is considered not to have a foreign source or not to be from a business carried on in a foreign country, the tax would fail to qualify as business-income tax and would come within the category of non-business-income tax. However, the income to which it relates would remain "business income".

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).