TaxTips.ca - Foreign Tax Credit (2024)

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Note: Before tax year 2019, line 40500 was line 405.

Income Tax Act s. 20(11), 20(12), s. 126(1), s.126(9)

Canadian residents who have had withholding taxesdeducted from foreign non-business income (FNBI) mayclaim a foreign tax credit. This should not beconfused with the separate calculation for a taxcredit for taxes paid on foreign business income (FBI).

The calculation of this non-refundabletax credit may not be automatically done by your tax software, if you have foreignnon-business income which is notreported on a T-slip. These amounts may haveto be manually typed into a worksheet in the software.

If an individual has anything more than withholding taxesfrom foreign dividends, theforeign tax credit can be a complex calculation.It becomes more complex when the individual wants to deducta portion of the foreign tax from income as well as usingthe foreign tax credit, because the portion deductedfrom income must be excluded from the foreign taxes in thetax credit calculation. A detailed description of theforeign tax credit calculation was found in the Canada Revenue Agency (CRA)bulletin IT-270,Foreign Tax Credit. As of March 27, 2013, this bulletin is notavailable. CRA has published income tax folio S5-F2-C1:Foreign Tax Credit, replacing the IT bulletin.

The foreign non-business tax credit iscalculated separately for each foreigncountry. However, if the total foreign taxes are lessthan $200, CRA will usually allow a single calculation.When thetax credit is being calculated for more than three countries,the tax return is no longer eligible for NetFile.

The calculation for the tax credit uses the total foreignnon-business income, such as pension income, employment income, director'sfees, commissions, interest, dividends, and some taxable capitalgains in excess of allowable capital losses. Capital gains andlosses on publicly traded securities are generally considered foreignincome if the securities were traded on a foreign stockexchange. However, ifany of the foreign income is exempt from income or profits tax in the foreigncountry due to a tax treaty with that country, then it is notincluded in the calculation of the foreign tax credit. Foreign non-business income is not reducedby net capital losses carried forward from a previous year.

When Canadians trade securities on US stock exchanges, thecapital gains are exempt from tax in the US due to the tax treaty, so thereshould be no withholding tax deducted from proceeds of sale, and the gains fromthese sales should not be included in the foreign tax credit calculation.If the account is actually held with a brokerage in the US, an IRS W-8Ben formmust be filed with them to ensure there are no withholding taxes on salesproceeds. If your trade confirmation for US securities shows a smallamount titled "US tax", usually for a fraction of 1%, this amount isactual a securities exchange fee, not withholding tax.

When foreign property income (other than from real property,or from a trust) has had withholding tax in excess of 15% deducted,the excess can be deducted from income on line 23200 (line 232 prior to 2019) of thepersonal taxreturn, "Other deductions", as a s. 20(11) deduction. However,see the note below regarding the limitationre tax in excess of the treaty rate. The excessforeign tax over 15% deducted under s. 20(11) reducesthe amount of foreign non-business income which is used in the foreign taxcredit calculation. If your foreign income isreported on a T3, then it is from a trust (such as a mutual fund or ETF), so this deduction does notapply. Personal income tax software will automatically provide the s.20(11) deduction forincome and foreign taxes reported on a T5, and will ignore any excess tax paid on a T3, as itshould.

If the federal foreign taxcredit is less than the foreign tax you paid, you may alsobe able to claim a provincial or territorial taxcredit. For territories, and provinces other thanQuebec, form T2036Provincial Foreign Tax Credit is used.

The foreign taxes are sometimes notcompletely recovered by the federal and provincial foreign tax credits.Non-business foreign taxes which are not recovered as a taxcredit may be deducted from income on line 23200 of thepersonal taxreturn, "Other deductions", as a s. 20(12) deduction(again, foreign taxes reported on a T3 are not eligible).This deduction is not usually done automatically by income tax software.You will have to enter this on the Foreign Tax Credits Worksheet. As youcan see, both the s. 20(11) and s. 20(12) deductions are both claimed on line23200 of the tax return.

ForeignTax Credit and s. 20(12) Deduction Calculation

Assume, for an Ontario taxpayer for 2019:

	FNBI = Foreign non-business income of10,000
	Other income of 15,000
	Single person with only basic personal amount tax credit
	FIT = Foreign income tax withheld 2,000 (20%) - seelimitation re tax in excess of treaty rate, below
	E = Excess for s. 20(11) deduction = 2,000 - (15% x 10,000)= 500
	Net foreign non-business income (FNBI) after s. 20(11)deduction = 10,000 - 500 - 9,500
	Taxable Income before FTC = 15,000 + 10,000 - 500 = 24,500

Note: This ignores the Climate Action Incentive.

In the 1st iteration, you would enter the $504.43 amount in the software on theForeign Tax Credits Worksheet. When this isdone, the foreign tax credit calculation is automatically revised, byreducing both foreign non-business income and foreign taxpaid by the amount of foreign tax deducted on line 23200. You would thenhave to recalculate the foreign tax not recovered and change the amount on theFTC worksheet again. This is what iscalled a "circular calculation", so may have to be done a few timesbefore final amounts are determined. As you can see, there was very littlechange in the Total Federal + Ontario tax payable after the 2nd or 3rd iteration above.

We did the same calculation as above, but with "otherincome" of $100,000. In that case, the federal foreign tax credit wasmore than the foreign taxes paid, so there was no s. 20(12) deduction.With other income of $70,000, there was a small amount for a s. 20(12)deduction, but it only made a $3.09 reduction in the total taxes payable, after6 iterations.

The DetailedCanadian Income Tax and RRSP Savings Calculator does not calculate the foreign tax credit.

Foreign Taxes From a Trust - Reported on aT3

The following is from paragraph 11 of IT-506, Foreign IncomeTaxes:

11. Subsection 104(22) provides the rules for the allocation of foreign source income and foreign taxes of a trust between the trust and its beneficiaries (see IT-201R). Since the rules in subsection 104(22) apply only to that subsection and to section 126, a beneficiary may not utilize the provisions of subsection 20(11) or (12) in respect of foreign taxes allocated to it under subsection 104(22).

What this means: The foreign income from a trust(reported on a T3) is included in FNBI above, and the foreign taxes from a trustare included in the calculation of the foreign tax credit. However, anyexcess over 15% is not included in the s. 20(11) deduction, and no s. 20(12)deduction is available for the foreign taxes shown on a T3.

Limitationre Tax in Excess of Treaty Rate

On the T2209 Federal Foreign tax Credit worksheet, itindicates "Any amount of tax you paid to a foreign government in excess of the amount you had to pay according to a tax treaty is considered a voluntary contribution and does not qualify as foreign taxes paid.”This means that the excess amounts are not eligible for the s. 20(11) or 20(12)deductions.

The above position of CRA was confirmed by the Tax Court in Meyerv. The Queen, 2004 TCC 199. In this case, the judge initially feltthat Meyer's position was correct, based on the Income Tax Act, but wassubsequently convinced that CRA's position was correct, based on definitions ofwhat constitutes a tax, and the fact that the amount withheld must be legallyenforceable in order to be considered a tax.

If you have significant amounts of foreign non-business income tax paid, inexcess of a treaty amount, you should be seeking advice from a qualified taxprofessional (CPA) with expertise in this area. You may be able to recovertaxes from the foreign government.

See TaxTreaties on the CRA website.

Forms on Which the Foreign Tax Credit isCalculated:

T2036Provincial Foreign Tax Credit

Canada Revenue Agency (CRA) Resources

S5-F2-C1: Foreign Tax Credit and Deductions - this folio has a great deal of detail on the foreign tax credits for both business and non-business income.

IT-506 - Foreign Income Taxes as a Deduction from Income (Archived)- see paragraph 11 re the unavailability of s. 20(11) or (12) deduction for trust beneficiaries.

IT-201R - Foreign Tax Credit - Trust and Beneficiaries (Archived)

Tax Tips:

If you don't understand this, you arenot alone!

If yourforeign taxes involve more than withholding taxes ondividends, get your tax return done (or at least reviewed) by a professional.