As discussed in previous articles, the combination of Canadian income tax consequences that arise on death in respect of foreign real property and foreign taxes that may apply in respect of that same property may result in double-taxation. Also as discussed in a previous article, one way that such double-taxation may be mitigated or eliminated is by the application of a tax treaty. Another way that such double-taxation may be mitigated or eliminated is through the foreign tax credit.
The Income Tax Act provides a foreign tax credit to residents of Canada. This foreign tax credit allows for a deduction from a Canadian resident’s income tax where that Canadian resident has paid income tax to a foreign country.
The mechanics of calculating the foreign tax credit can be complicated; however, generally speaking, the foreign tax credit is calculated separately for business income and non-business income, and separately for each foreign jurisdiction. The maximum amount of foreign tax credit that is available is the lesser of:
- The applicable foreign tax paid for the year; and
- The amount of Canadian tax that would otherwise be payable for the year that relates to the applicable foreign income.
In other words, the foreign tax credit may be used to reduce the taxes payable in Canada by either the amount a Canadian resident is required to pay to the foreign jurisdiction in respect of that source of income (i.e. business or non-business) or by the amount the Canadian resident is required to pay to Canada in respect of that same source of income, whichever is the least.
The result of the foreign tax credit is that the maximum amount of taxes that a Canadian resident will pay in respect of foreign source income is the higher of the foreign tax or the Canadian tax. This provides relief from double-taxation.
With respect to the disposition of foreign real estate, if a capital gain is realized, the profits are considered to be non-business income. If tax is payable to both the foreign jurisdiction and to Canada in respect of that capital gain, a foreign tax credit will be available. The maximum amount of the foreign tax credit will be the lesser of the tax paid to the particular foreign jurisdiction in respect of non-business income and the tax otherwise payable to Canada in respect of non-business income. If the foreign tax credit is claimed, then the most tax a Canadian resident will be required to pay will be the higher of the tax imposed under the foreign jurisdiction and the tax imposed in Canada.
The availability of the foreign tax credit can be affected by the presence of a tax treaty between Canada and the foreign jurisdiction, so it is always important to consider whether there is a treaty in place with the foreign jurisdiction and, if so, how it affects the foreign tax credit.