Principal Issues: Whether, for the purposes of the calculation of a “non-eligible refundable dividend tax on hand” (“NERDTOH”) under subparagraph (a)(i) of the definition of NERDTOH in subsection 129(4), the foreign tax paid on non-business income deducted from Part I tax pursuant to subsection 126(1) by a CCPC that earns investment income is reduced by the amount corresponding to 8% of its foreign investment income for the year under element B of the formula “A-B” in subparagraph (a)(i) of the definition of NERDTOH, whether or not the CCPC has paid foreign tax on the foreign investment income, such as a capital gain from foreign source.
Position: Yes. The amount corresponding to 8% of the foreign income reduces the amount of the foreign tax deduction for non-business income pursuant to subsection 126(1) under element B of the formula “A-B” in subparagraph (a)(i) of the definition of NERDTOH in subsection 129(4).
Reasons: Wording of the Act.
FINANCIAL STRATEGIES AND FINANCIAL INSTRUMENTS ROUNDTABLE, 10 OCTOBER 2024
2024 APFF CONFERENCE
Q.8 Foreign property disposition and computing non-eligible refundable dividend tax on hand ("NERDTOH")
The ERDTOH (footnote 1) concept was introduced to comply with the principle of tax integration. That concept provides in particular that the amount identified for this purpose as the refundable portion of Part I tax (the “Refundable Portion”) under the Income Tax Act, which is the lesser of the amounts determined in subparagraphs (a)(i) to (iii) of the definition of NERDTOH in subsection 129(4) (footnote 2), is included in the NERDTOH.
Pursuant to subparagraph (a)(i) of the definition of NERDTOH, the Refundable Portion corresponding to the amount determined by the formula “A – B”, where element A corresponds to 30 2/3% of the corporation’s aggregate investment income for the year (“AII”), which may be included in the NERDTOH of a corporation that is a Canadian-controlled private corporation (“CCPC”) throughout the year. This generally results in that amount being refunded to the corporation when it pays taxable dividends to its shareholders.
The AII on which the Refundable Portion is calculated in subparagraph (a)(i) of the definition of NERDTOH includes certain investment income from Canadian and foreign sources. In particular, it includes the eligible portion of taxable capital gains realized on the disposition of foreign property. In its Income Tax Folio S5-F2-C1, (footnote 3) at para. 1.65 and following, the CRA specifies that in the case of a disposition of securities resulting in a capital gain, the gain will have a foreign-source where the stock exchange on which the sale of shares takes place is located outside Canada.
Where the CCPC claims a foreign tax deduction under subsection 126(1) ("FTD"), a reduction is provided for in the description of B of the formula “A – B” in subparagraph (a)(i) of the definition of NERDTOH. More specifically, the reduction is equal to the amount by which the CCPC's deduction for the year under subsection 126(1) (the “FTD”) in respect of its foreign non-business income (clause (A) of element B of the “A – B” formula) exceeds 8% of the foreign investment income ("FII") (clause (B) of element B of the “A – B” formula).
Consequently, on the sale of shares of a foreign public company listed on a foreign stock exchange resulting in a capital gain, we understand that the amount to be deducted under subparagraph (a)(i) of the definition of NERDTOH in subsection 129(4) is insensitive to whether or not tax is withheld by the foreign country on that gain. Furthermore, the definition of “tax-exempt income” in subsection 126(7) does not apply to the calculations in subsection 129(4).
Questions
Can the CRA confirm the tax treatment that is applicable on the disposition of foreign property?
Specifically, does the amount to be deducted in computing the Refundable Portion in respect of foreign investment income always correspond to the FTD otherwise claimed by the corporation in respect of its foreign non-business income, reduced by 8% of the FII, regardless of whether or not tax is withheld by the foreign country on such investment income?
CRA Response
Under subparagraph (a)(i) of the definition of NERDTOH in subsection 129(4), a corporation that is a CCPC throughout the year includes in its NERDTOH calculation an amount equal to 30 2/3% of its AII (element A of the "A - B" formula). If the corporation deducts, for the year, an amount under subsection 126(1) (the FTD), element B of the "A - B" formula provides a reduction for the excess of the amount deducted by the corporation, for the year, under subsection 126(1) (clause (A) of element B of the "A - B" formula), over the amount corresponding to 8% of its FII (footnote 4) (clause (B) of element B of the formula "A - B"). Depending on the situation, the theoretical reduction of the amount equal to 8% of the FII could have no impact on the result of the "A - B" formula.
This notional calculation of 8% of FII in clause (B) of element B of the “A – B” formula applies regardless of whether a foreign country has levied a tax on foreign source income.
Nathalie Aubin
2024-102359
10 October 2024
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 Refundable dividend tax on hand (“RDTOH”) was previously defined in subsection 129(3). Legislative changes to the RDTOH concept were made for taxation years beginning after 2018. RDTOH is now separated into two accounts: “eligible refundable dividend tax on hand” (“ERDTOH”) and “Non-eligible refundable dividend tax on hand” (“NERDTOH”), which are now defined in subsection 129(4).
2 R.S.C. 1985, c. 1 (5th Supp.) (the “Act”).
3 CANADA REVENUE AGENCY, Income Tax Folio S5-F2-C1, “Foreign Tax Credit’” December 1, 2015.
4 CANADA, Department of Finance, Explanatory Notes Relating to the Income Tax Act, December 2015. Based on the Department of Finance's Explanatory Notes to subsection 129(3) I.T.A., we understand that foreign investment income (“FII”) may be included in computing a corporation's NERDTOH at the rate of 30 2/3% unless a foreign tax deduction (“FTD”) had the effect of reducing its effective federal tax rate on such income to a rate less than 30 2/3%. For this purpose, subparagraph 129(4)(a)(i) of the definition of NERDTOH is based on an implicit federal tax rate of 38 2/3% applicable to the FII, without taking into account the FTD. Generally, this implicit federal tax rate corresponds to the sum of the 28% federal corporate tax rate applicable to the CCPC's AII and the 10 2/3% rate applicable to such income as provided for in section 123.3. In order to limit the amount included in a corporation's NERDTOH in respect of its tax under Part I, an amount equal to the corporation's FTD for its foreign non-business income reduced by 8% (38 2/3% - 30 2/3%) of its FII is subtracted from element B of the formula in subparagraph 129(4)(a)(i). Clause (B) of element B in the formula in subparagraph 129(4)(a)(i) ensures that the amount to be deducted in respect of FII is equal to the corporation's FTD for its foreign non-business income, reduced by 8% (38 2/3% - 30 2/3%) of its FII. The 8% percentage represents the difference between a deemed tax rate of 38 2/3% on the CCPC's FII and the refundable amount at the rate of 30 2/3%.