16 January 1990 Income Tax Severed Letter ACC8922 - Calculation of Foreign Tax Credit

HBW 6593-7 (WP6)

David R. Senecal (613) 957-2074

19(1)

January 16, 1990

Dear 19(1)

Re: Calculation of Foreign Tax Credit

This is in reply to your letter of December 21, 1989, requesting clarification of the calculation of the foreign tax credit for Canadian tax purposes.

Foreign tax credits are calculated somewhat differently depending on whether or not the foreign tax is paid in respect of a business carried on in a foreign country. In the case of dividends from foreign corporations, only foreign taxes paid in respect of dividends on portfolio investments (essentially, shares in non-resident corporations in which the shareholder's ownership is less than 10%) are eligible for the foreign tax credit because of the special rules for foreign affiliates. Double taxation of dividends from foreign affiliates (essentially, those non-resident corporations in which the shareholder's ownership is greater than 10%) is avoided by allowing the recipient a series of deductions in computing taxable income.

In order to determine the foreign tax credit available for a particular taxation year, foreign taxes must be segregated between those paid on foreign business-income ("business-income tax") and on all other forms of income ("non-business-income tax"), since the foreign tax credit is determined separately for each category.

Unused foreign business-income tax credits may be carried back three years and forward seven years. However, only foreign business-income taxes paid in a year which are not creditable in that year qualify to be carried over as unused foreign tax credits. To the extent that the business-income tax could have been credited in the year paid but was not, it will not be available for credit in any other taxation year. Unused foreign non-business-income tax may not be carried forward or back; it may be deducted in computing income for the particular taxation year.

In calculating the amount of a foreign tax credit, one of the limitations is the Canadian tax that would otherwise be payable on the foreign source income. Also, the foreign tax credit must be calculated separately for the taxes paid to each foreign country.

It is therefore necessary to analyze foreign source income and the foreign tax paid thereon on a country-by-country basis. In addition, Canada's tax treaties should be consulted to determine if they modify the formula for computing the foreign tax credit prescribed in its domestic legislation.

Foreign Business-Income Tax

We have assumed that the example given in your letter refers to the calculation of the foreign tax credit as it relates to foreign-business income.

The foreign business-income tax credit allowed to corporations resident in Canada at any time in a taxation year is the least of:

     (a)  foreign business-income tax paid to a particular
          country or political subdivision for the year plus
          unused foreign business-income tax carried over from
          any of the seven preceding and the three following
          taxation years.

(b) the amount arrived at using the following formula:

          net foreign business income of the (A)
          particular country X tax otherwise payable (C)
          --------------------------
          net income from all sources minus certain amounts (B)

     (c)  tax otherwise payable minus amounts deducted as
          non-business-income tax credits

As the example provided in your letter does not indicate the total income of the company for each of the years in question, we are unable to calculate the actual business-income tax credit for each of the years. If, for example, the corporation had losses from other sources, the tax otherwise payable may be reduced or eliminated resulting in the reduction or loss of the foreign tax credit for that year. As to how foreign income is computed for Canadian foreign tax credit purposes, we wish to confirm that the income must be computed in accordance with the Canadian Income Tax Act and without regard to the method used in the foreign country.

We would also like to take this opportunity to correct a
misunderstanding by     19(1)     of Canada's position with
respect to the attribution of income to permanent establishments. 
When dealing with intra group services, Canada is of the view
that, generally, there should not be any profit element in shared
costs charged to Canadian branches and the arm's length approach
is not used as     19(1)     was led to believe from interpreting
our responses to his original questionnaire.

Yours sincerely,

C. Savage A/Director Provincial and International Relations Division

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