2018-0748811C6 STEP 2018 - Q12 - US Transition Tax

Principal Issues: Is the US transition tax, a "non-business-income tax" under subsection 126(7)?

Position: Yes but a foreign tax credit would likely not be available.

Reasons: In the example provided, the tax that is paid by the individual should qualify as a "non-business-income tax" under subsection 126(7) since it is substantially similar to the one under the Income Tax Act and it can reasonably be regarded as being attributable to income from a source outside of Canada. However, Subpart F income is not deemed to be income under Canadian domestic law and if the taxpayer does not have any non-business income that is US sourced income, a foreign tax credit under subsection 126(1) would not be available.

Author: Grondin, Yves
Section: 20(12); 126(1); and 126(7) "non-business-income tax"

2018 STEP CRA Roundtable - May 29, 2018

Question 12. US Transition Tax

Recently implemented US tax reform has introduced a one-time so-called “transition tax” that applies to US persons who own interests in certain non-US corporations. Consider the situation of a US citizen resident in Canada who holds a controlling interest in a UK company. The US imposes its one time transition tax on the “earnings and profits” of the UK company held at certain dates in 2017. Would Canada view such US transition tax as an “income or profits tax” as referred to under subsection 126(7) of the Income Tax Act (“Act”) when applying the foreign tax credit (“FTC”) rules in the computation of the US citizen / Canadian resident individual?

CRA Response

Our understanding of section 965 of the Internal Revenue Code (“IRC”) is that the accumulated deferred foreign income (calculated at certain dates in 2017) of a specified foreign corporation will be included in the US “Subpart F income” of that corporation for its last taxable year that begins before January 1, 2018. US shareholders of the specified foreign corporation that are subject to this rule must then include (under section 951 of the IRC) their pro rata share of the foreign corporation’s US Subpart F income in their income. A US shareholder may elect to pay the net tax liability resulting from the application of section 965 of the IRC (the “transition tax”) in eight annual installments.

Assuming that the UK company has a calendar year end, we understand that the rules described above would result in the individual, in this example, having to include in the individual’s US income, in 2017, the pro rata share of the UK company’s US Subpart F income. Furthermore, the individual would likely pay the US income tax on this income over several annual installments.

As indicated in Folio S5-F2-C1, “Foreign Tax Credit”, (the “Folio”), in order to determine if a foreign tax is an income or profit tax, the basic scheme of application of the foreign tax is compared with the scheme of application of the income and profits taxes imposed under the Act. Generally, if the basis of taxation is substantially similar to the ones in Canada, in the sense that it is also levied on net income or profits (but not necessarily as would be computed for Canadian tax purposes), the foreign tax will be considered as an income or profit tax for purposes of the Canadian FTC rules. We understand that the US Subpart F income rules resemble our Foreign Accrual Property Income (“FAPI”) rules and that the US tax that is paid by the individual on the individual’s share of the US Subpart F income, in this example, is an income tax that is similar to the one that is levied under the Act, and, as such, we are of the view that it should qualify as an income tax for purposes of the Canadian FTC rules. We have assumed for the purpose of the example that the US transition tax is entirely attributable to income from a source outside of Canada and therefore this tax should not be disqualified from being a “non-business-income tax” under paragraph d) of the definition under subsection 126(7) of the Act.

However, this does not fully resolve the issue as to whether a FTC should be available in this case. As indicated in the Folio, a separate FTC calculation is required for each foreign country and the maximum amount of FTC that the taxpayer may claim with respect to the foreign non-business-income tax is essentially equal to the lesser of two amounts: the applicable foreign income tax paid to the government of a country for the year; and the amount of Canadian tax otherwise payable for the year that pertains to the applicable foreign income from sources in that country (“non-business income”).

In the example, the FTC would thus be calculated based on a formula which takes into account the amount of US-sourced income and it is not clear in this case if any income is sourced to the US. US Subpart F income is not deemed to be income under Canadian domestic law and would thus not be considered as US-sourced income for the FTC calculations.

To the extent that the individual doesn’t have any non-business income that is US-sourced, it is our view that a FTC would not be available in this example. Note that our answer would be the same if the UK company had paid an actual dividend to the individual in 2017 since this dividend income would be sourced to the UK and not to the US. Furthermore, as indicated in the Folio, before an amount of FTC can be claimed under subsection 126(1) of the Act, it must be paid for the year (2017, in the example), whether it is paid before, during or after the year in question. We understand that the transition tax in the example would be paid for the year 2017 and that a Canadian FTC would thus not be available in any other year after 2017 even if the tax were to be paid over several annual installments.

Yves A. Grondin / Nicolas Bilodeau
2018-074881

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