Principal Issues: Whether a Canadian taxpayer can claim a foreign tax credit in respect of an amount of foreign taxes withheld in excess of the limit established under the applicable treaty?
Position: No.
Reasons: Application of the ITA and previous positions.
FINANCIAL STRATEGIES AND INSTRUMENTS ROUNDTABLE 5 OCTOBER 2012
2012 APFF CONFERENCE
Question 10 - Excess withholding taxes and characterization as foreign tax
Residents of Canada are required to report, in their Canadian income tax return, their gross foreign dividend on foreign equities (before withholding tax) and to pay tax at their marginal tax rate, as well as for interest. To minimize double taxation, investors can claim a foreign tax credit in their Canadian income tax return for foreign withholding tax paid.
The maximum Canadian foreign tax credit allowed for dividends on foreign-source portfolio investments is limited to 15% by virtue of paragraph (b) of the definition of "non-business-income-tax" in subsection 126(7), and subsection 20(11). The portion of foreign tax paid in excess of the tax credit may be deducted in computing income by virtue of subsection 20(11).
Furthermore, the withholding tax actually levied may be in excess of the maximums provided in Canada's tax conventions with other countries, because of the complexities of cross-border financial instruments and the difficulty of accessing relevant information.
For example, the tax deducted on income from certificates representing foreign shares (footnote 1) (ADR Advanced [sic] depositary receipts) is systematically levied above the maximums provided for in the conventions. Until now, this tax could not be used either as a credit or as a deduction because it did not fall within the definition of a "foreign tax" because the tax convention sets a maximum for applicable foreign taxes. This excess was viewed more as an administrative expense rather than a tax.
Recently, in Technical Interpretation 2011-0398741I7 (footnote 2), the CRA overturned its longstanding position that a 10% penalty for early withdrawal from an IRA scheme is not a foreign tax. It states that this previous position is not supportable in law and that the conditions to qualify as a foreign tax penalty are satisfied.
In Lawson (footnote 3), the Supreme Court of Canada provided the following definition of a tax:
A tax is a levy, enforceable by law imposed under the authority of a legislature, imposed by a public body and levied for a public purpose.
A similar argument could be made regarding the excess tax levied on income from ADRs.
Question to the CRA
Can the withholding taxes levied by a foreign government on certificates representing foreign shares or other foreign investments be considered foreign taxes in their entirety, and not only up to the maximums provided for in the convention?
CRA Response
The question submitted does not tell us the source country of the property income. It is therefore not possible for us to identify the applicable international convention to which Canada is a party. In the same way, we cannot comment on the application of the provisions defining the powers of each of the Contracting States with respect to the taxation of income and the procedures for eliminating international double taxation.
In that context, and assuming that the amount of tax withheld at source and remitted to the tax authority of a foreign country exceeds what is agreed under an applicable international convention to which Canada is a party, it appears to us that the excess amount unduly paid could generally be recovered from the foreign tax authority. From a Canadian point of view, this excess amount would be considered as a "voluntary tax". As such, we are of the view that this amount would not qualify as an "income or profit tax". No foreign tax credit could be granted in respect of the excess amount. For more details on this subject, we invite you to consult paragraph 11 of Interpretation Bulletin IT-270R3 - Foreign Tax Credit.
Furthermore, we are of the view that the excess amount could not be considered as an outlay or expense made or incurred by the taxpayer to earn income from property. In addition, it would not be deductible under subsection 20(11).
Yannick Roulier
(613) 957-2134
2012-045125
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 Certificates representing foreign shares are tradable certificates that typically represent publicly traded equity securities or debt securities of a foreign corporation.
2 CRA, Technical Interpretation 2011-0398741I7 of 19 April 2011.
3 [1931] S.C.C. 357