Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: In the specified fact pattern, whether a foreign tax credit may be claimed by a Canadian resident individual in respect of tax paid to Australia on a capital gain arising from a disposition of the shares of a UK corporation by the Canadian resident individual.
Position: Yes, subject to the computational rules in subsection 126(1) of the Act.
Reasons: Articles 22(2) and 23(2)(a) of the Canada-Australia Treaty operate in conjunction with subsection 126(1) of the Income Tax Act to provide a foreign tax credit.
Author: Patel, Komal
Section: 126(1); 126(7) "non-business-income tax"; Canada-UK Treaty, Canada-Australia Treaty
2020 STEP CRA Roundtable – November 26, 2020
Question 4 - Foreign Tax Credit
Under the Income Tax Act (the “Act”), the Canadian tax base extends to tax a non-resident on the capital gain realized on a disposition of taxable Canadian property (“TCP”). For this purpose, TCP includes shares of a foreign corporation where the shares derive their value primarily from Canadian real estate (or certain other Canadian property as noted in the definition of TCP).
Other countries have similar rules, for example Australia and India.
Assume that an individual resident in Canada (the “Taxpayer”) owns all the shares of a corporation resident in the UK, and the UK corporation owns all the shares of a corporation resident in Australia. The value of the UK corporation’s shares is wholly derived from real property in Australia. The Canadian resident individual sells the shares of the UK corporation and realizes a capital gain under both Australian and Canadian income tax laws. The capital gain is subject to income tax in Australia which the Taxpayer pays. The capital gain is not subject to income tax in the UK.
In these circumstances, in computing its Canadian taxes payable can the Taxpayer obtain a foreign tax credit for the income tax paid to Australia on the capital gain? In particular, is the gain considered to be from a source in Australia for purposes of computing the foreign tax credit?
Generally, subsection 126(1) of the Act permits a Canadian resident taxpayer to deduct from the tax otherwise payable for a taxation year, a foreign tax credit in respect of “non-business income tax” (as defined in subsection 126(7) of the Act) paid by the taxpayer for the taxation year. Where a taxpayer has income for a taxation year that is sourced to more than one country, pursuant to paragraph 126(6)(b) of the Act and as stated in paragraph 1.91 of Income Tax Folio S5-F2-C1, Foreign Tax Credit (referred to herein as the “Folio”), separate foreign tax credit calculations under subsection 126(1) must be made for each country. In the example above and pursuant to paragraph 126(1)(b) of the Act, the tax paid to Australia may only be credited against Canadian taxes otherwise payable in respect of non-business income from sources in Australia.
Generally, when determining the source of a capital gain from the disposition of shares for foreign tax credit purposes under section 126 of the Act, certain factors as outlined in paragraph 1.65 of the Folio would be taken into consideration. However, where Canada has entered into a tax treaty with the country to whom taxes are paid, consideration must be given as to whether the provisions of the treaty may affect and modify the general sourcing rules. Paragraph 4 of Article 13 (Capital Gains) in the Canada-Australia Treaty (the “Treaty”) provides that gains from the disposition of shares of a company, where the value of the assets of such company is derived principally (whether directly or indirectly) from real property situated in a Contracting State, may be taxed in that Contracting State.
As the facts provide that the value of the UK corporation’s shares is wholly derived from real property in Australia, pursuant to paragraph 4 of Article 13 of the Treaty, the gain realized by the Taxpayer on the disposition of the shares of the UK corporation may be taxed in Australia.
Paragraph 2 of Article 22 (Source of Income) of the Treaty provides that for the purposes of Article 23 (Elimination of Double Taxation) and the law of Canada, profits, income or gains of a resident of Canada which are taxed in Australia in accordance with Article 13 of the Treaty shall be deemed to be income from sources in Australia. This paragraph would therefore apply to deem the capital gain realized by the Taxpayer on the disposition of the shares of the UK corporation to be income from sources in Australia for purposes of Article 23 and the Act.
In general terms, pursuant to subparagraph 2(a) of Article 23 of the Treaty, Canada shall provide a foreign tax credit for taxes payable in Australia on profits, income or gains from sources in Australia, subject to the existing provisions of the law of Canada. Therefore, in our view, in this particular hypothetical situation the Taxpayer would be eligible to claim a foreign tax credit for the income tax paid to Australia in accordance with subsection 126(1) of the Act and subparagraph 2(a) of Article 23 of the Treaty. The actual amount of the foreign tax credit would be determined based on the computational rules of section 126 of the Act.
John Meek / Komal Patel
November 26, 2020
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