Case Summary – Foreign Tax Credits for Canadian Residents

written on behalf of Feigenbaum Law

In a decision released late last year, the Tax Court of Canada confirmed that foreign tax credits may only be deducted for amounts that were actually paid to foreign governments.

The Canada-US tax treaty and foreign tax credits

The Canada-US tax treaty is intended to prevent double taxation when someone files tax returns in both countries. When a US citizen earns pension income from a US-based source, the treaty allows the US federal government to withhold tax on the first 15% of that income. The balance of the income is taxed in Canada.

Therefore, a taxpayer may claim a foreign tax credit in Canada for the 15% withheld by the US federal government. They may also claim a foreign tax credit in the United States for any amount they paid to the Canadian government in excess of that 15%.

Arsove v The Queen

This case was an appeal from a reassessment disallowing the appellant, Arsove, from claiming a foreign tax credit on her 2013 Canadian return. Arsove was a Canadian resident and US citizen.

Arsove had earned the bulk of her income in Canada, except for an IRA distribution in the United States. The applicable US federal tax had been withheld upon distribution, and Arsove sought to claim a Canadian foreign tax credit for this amount on her 2013 return.

Arsove paid Canadian taxes on her Canadian earnings, which made up the bulk of her income for the year. In her 2013 US return, her US taxes were offset completely following deduction of her Canadian foreign tax credit. The US federal taxes that had initially been withheld from the IRA distribution were refunded to her on this basis.

Clarification of foreign tax credits applied to US-source pension income

The judge found that Arsove had incorrectly interpreted the treaty, and how it treats US pension income paid to Canadian residents. She had filed her US return as if the total amount of the distribution was taxed in Canada, when in fact the first 15% had been taxed in the United States.

The amount of tax paid to a foreign jurisdiction for the purposes of calculating the foreign tax credit is equal to the amount ultimately paid to the government of another country. Since Arsove had been refunded the amount that was initially withheld, she had paid nothing to the US federal government, and was not subject to double taxation.

Foreign tax credit and tax planning advice for Canadians and US citizens

Feigenbaum Tax Law provides tax advice and planning for Canadians and Americans with cross-border income or assets. Our tax experts offer custom service, building comprehensive solutions to meet your personal tax planning needs.

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