Canco, and its wholly-owned subsidiary, Cansubco, are the 99.9% and 0.1% partners of USLP, which is a partnership for Canadian purposes and has elected to be a corporation for U.S. tax purposes. USLP holds all the shares of USLLC, which has elected to be disregarded entity for US tax purposes. USLLC earns active business income. USLLC has not distributed any dividends to USLP. For US tax purposes, USLP declares the active business income earned by USLLC. Would Canco be entitled to a s. 20(12) deduction where the US tax paid by USLP on business income is not in respect of the income that Canco would potentially receive as dividend income from USLLC shares held by USLP? After noting that since the taxes paid by USLP "are in respect of business income, they would not meet the definition of 'non-business income taxes'," CRA stated:
The phrase "in respect of that source" found in subsection 20(12) requires that the foreign taxes paid must be paid in respect of the particular business or property to which the tax relates. In other words, for the purposes of claiming the deduction in subsection 20(12), the computation of income from a business or property should be on a business-by-business and/or property-by-property basis. Therefore…in computing the income of Canco and Cansubco from the shares of USLLC (as partners of USLP), USLP cannot deduct, under subsection 20(12), the foreign taxes paid by it on income from business, computed under US tax law, because USLP would generally only receive income from property under Canadian tax law.
CRA went on to note that the prohibition against recognizing tax paid by a corporation respecting income from foreign affiliate shares also applied in light of s. 93.1(1).