Principal Issues: Whether a foreign tax credit is available for the U.S. estate tax paid in the hypothetical situations.
Position: The U.S. estate tax paid is not eligible for a foreign tax credit under subsection 126(1) of the Act because an estate tax is not an “income or profits tax”. However, paragraph 6 of Article XXIX-B of the Canada-U.S. Tax Treaty would apply to grant a Canadian tax credit in respect of the estate tax paid in the U.S.
Reasons: The conditions specified in subparagraph 6(a) of Article XXIX-B of the Canada-U.S. Tax Treaty are met.
2024 STEP CRA Roundtable – June 4, 2024
Question 11. Foreign Tax Credit for U.S. Estate Tax
Paragraph (6)(a) of Article XXIX-B (“Article XXIX-B(6)(a)”) of the Canada-U.S. Tax Treaty (“Treaty”) allows a deduction in the terminal return of an individual who immediately before death was a resident of Canada of the amount of any U.S. Federal or state estate or inheritance taxes paid in respect of property situated within the U.S. Articles XXIX-B(6)(a)(i) and (a)(ii) provide that the deduction may be applied to reduce the amount of Canadian tax otherwise payable on the total of the following income earned by the individual in the taxation year in which the individual died:
(a)(i): any income, profits or gains arising in the U.S. within the meaning of Article XXIV(3) of the Treaty, and
(a)(ii): where, at the time of death, the individual’s entire gross estate (wherever situated) exceeded U.S. $1.2 million, any income, profits or gains of the individual from property situated in the U.S. at that time.
The post-amble of Article XXIX-B(6) further states that for purposes of that determination, property is situated within the U.S. if it is so treated for U.S. estate tax purposes.
A Canadian resident who is not a U.S. citizen dies while holding real property situated in the U.S. (“U.S. Realty”) and shares of a U.S. public corporation (“U.S. Shares”). The U.S. Shares did not form part of the deceased's Registered Retirement Savings Plan and they are not classified as a “U.S. real property interest” for the purpose of subparagraph 3(a) of Article XIII of the Treaty. The U.S. Realty and the U.S. Shares are both subject to U.S. estate tax under the Internal Revenue Code on the basis that they are U.S. situs property. As a result of the disposition deemed to occur on death under subsection 70(5) of the Income Tax Act (the “Act”), a capital gain is realized on the U.S. Realty and on the U.S. Shares. Will the executor be permitted to claim a credit in Canada in respect of the U.S. estate tax paid where:
(a) the value of the deceased’s entire gross estate is equal to, or lower than, U.S. $1.2 million,
or
(b) the value of the deceased’s entire gross estate exceeds U.S. $1.2 million?
CRA Response
In order to qualify for a foreign tax credit under subsection 126(1) of the Act, an amount paid to a foreign jurisdiction must be an “income or profits tax”. The U.S. estate tax paid is not eligible for a foreign tax credit under subsection 126(1) of the Act because an estate tax is not an “income or profits tax”.
However, paragraph 6 of Article XXIX-B of the Treaty provides that a Canadian tax credit shall be allowed in respect of estate taxes paid in the U.S. where the conditions specified in that paragraph are met. Where the estate tax is imposed upon an individual’s death, the credit that Canada shall allow is limited to the Canadian federal tax otherwise payable calculated in accordance with Article XXIX-B(6)(a).
In the present case, where the value of the deceased’s entire gross estate is equal to, or lower than, U.S.$1.2 million, subparagraph 6(a)(i) of Article XXIX-B (“Article XXIX-B(6)(a)(i)”) of the Treaty would apply to allow a Canadian tax credit, which would be limited to the Canadian federal tax otherwise payable on income, profits or gains arising in the U.S.
Pursuant to the combined operation of Article XIII and paragraph 3 of Article XXIV of the Treaty, the gain resulting from the deemed disposition of the U.S. Realty under subsection 70(5) of the Act is deemed to arise in the U.S., while the gain from the U.S. Shares is deemed to arise in Canada. Accordingly, the gain from the deemed disposition of the U.S. Shares will not be included in calculating the credit allowed under Article XXIX-B(6)(a)(i). This is a corollary of the U.S. Shares being carved out of the U.S. estate tax base by Article XXIX-B(8). As a result, the executor may claim a tax credit in accordance with Article XXIX-B(6)(a)(i) of the Treaty for the U.S. estate tax paid on the U.S. Realty against the Canadian federal tax otherwise payable on the gain from the deemed disposition of the U.S. Realty plus other U.S. source income as defined under the Treaty.
U.S. income taxes payable for the year of death are also creditable and are included in calculating the aggregate foreign tax credit allowable in Canada. The post-amble of Article XXIX-B(6) provides an ordering rule, such that Canadian federal tax otherwise payable is reduced by the foreign tax credit allowed under Article XXIV before the calculation of the additional foreign tax credit allowed under Article XXIX-B(6).
On the other hand, where the value of the deceased’s entire gross estate exceeds U.S.$1.2 million, subparagraph 6(a)(ii) of Article XXIX-B (“Article XXIX-B(6)(a)(ii)”) would apply to permit the calculation of the Canadian federal tax otherwise payable to also include the tax levied on income, profits, or gains from property situated in the U.S. In these circumstances, it includes the gain from the deemed disposition of the U.S. Shares as they are property situated in the U.S. Therefore, in this case, the executor may claim a tax credit in accordance with Article XXIX-B(6)(a)(ii) for the U.S. estate tax paid against the Canadian federal tax otherwise payable on the gains from the deemed disposition of the U.S. Realty and the U.S. Shares plus other U.S. source income as defined under the Treaty. The ordering rule in the post-amble of Article XXIX-B(6) also applies in this case.
As outlined in Document 2010-0379381E5, U.S. estate taxes are eligible for a provincial foreign tax credit only if allowed under provincial income tax legislation. Article XXIX-B(6) does not have the force of law in the Provinces and Territories of Canada.
Vicky Liu
2024-100349