2020-0842981E5 Ontario foreign tax credit

Principal Issues: Whether the total “amount deductible … under subsection 126(1) of the Federal Act” in element B of subsection 34(2) of the TAO in respect of NBIT paid in more than one foreign country should be limited to the Canadian.

Position: Yes.

Reasons: Based on the textual, contextual and purposive interpretation of the relevant legislative provisions, on the facts at issue, the "amount deductible...under subsection 126(1) of the Federal Act" in element B of subsection 34(2) of the TAO in respect of each foreign country should be considered to be a proportionate share of the FTOP.

Author: Eroff, Ina
Section: 126(1), 126(6)(b), 126(7) of the ITA, 34 of the TAO

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                                                                                        2020-084298
                                                                                        Ina Eroff, B.C.L./LL.B.

August 17, 2021

Dear XXXXXXXXXX:

Re: Ontario Foreign Tax Credit

This is in reply to your letter of March 4, 2020, where you requested our view on the interpretation of subsection 126(1) of the Income Tax Act, R.S.C. 1985 (5th Supp.), c.1, as amended, (the “ITA”) and section 34 of the Taxation Act, 2007 (Ontario), SO 2007, c 11, Sched A, as amended (the “TAO”) in the context of the hypothetical scenario set out in your letter, involving a corporation resident in Canada earning non-business income in more than one foreign jurisdiction and where the total foreign-source non-business income exceeds the Canadian taxable income of the corporation.

Hypothetical facts:

You have asked us to assume the following hypothetical facts:

* Canco is a corporation resident in Canada;
* Country A and Country B are countries other than Canada;
* Canco earns $100 of investment income in Country A and $100 of investment income in Country B;
* Canco incurs a Canadian source loss of $100, so that Canco’s net income and taxable income under the ITA is $100 and its Canadian federal income tax otherwise payable (“FTOP”) at 15% federal tax rate is $15;
* The “non-business-income tax” (“NBIT”) paid to Country A on the investment income earned in Country A is $10, and the NBIT paid to Country B on the investment income earned in Country B is $10;
* Canco’s Ontario domestic factor and Ontario allocation factor are both 1.
* The Ontario corporate tax rate is 11.5%.

Query:

You have asked us to confirm that the total “amount deductible … under subsection 126(1) of the Federal Act” in element B of subsection 34(2) of the TAO in respect of both Country A and Country B cannot exceed the maximum amount that could be deducted under subsection 126(1) of the ITA, in this case being the FTOP on the taxable income of Canco under the ITA for the year.

Section 34 of the TAO provides a provincial foreign tax credit (“FTC”) for NBIT (as defined in subsection 126(7) of the ITA) paid to a jurisdiction outside Canada. Specifically, subsection 34(1) of the TAO allows a corporation to deduct, in computing the corporation’s tax payable under Division B of Part III of the TAO for the year, a provincial FTC equal to the lesser of two amounts calculated under subsections 34(2) and (3) of the TAO.

The amount in subsection 34(2) of the TAO is determined by multiplying the corporation’s Ontario domestic factor for the taxation year by the amount, if any, by which “A” exceeds “B” where,

“A” is, with certain exceptions, the portion of the NBIT paid for the year by the corporation to the government of a country other than Canada that relates to foreign investment income of the corporation for the year, and

“B” is the amount deductible by the corporation in respect of the foreign investment income for the year under subsection 126(1) of the ITA.

The amount calculated under subsection 34(3) of the TAO is calculated using the formula C × D × E, in which:

“C” is the portion of the corporation’s foreign investment income for the year described in the definition of “A” in subsection 34(2),

“D” is the Ontario corporate tax rate, and

“E” is the corporation’s Ontario allocation factor for the year.

The amount calculated under subsection 34(3) of the TAO in respect of each of Country A and Country B is $11.5.

It is element B in subsection 34(2) of the TAO that is at issue in this technical interpretation.

Subsection 126(1) of the ITA sets out the rules for claiming a federal FTC in respect of foreign NBIT against Canadian FTOP. With certain exceptions, paragraph 126(1)(a) of the ITA provides that a taxpayer may deduct from the tax for the year otherwise payable under Part I of the ITA by the taxpayer an amount equal to such part of any NBIT paid by the taxpayer for the year to the government of a country other than Canada as the taxpayer may claim. Under paragraph 126(1)(b) of the ITA, such deduction is limited, in general terms, to the amount of the FTOP on the taxpayer’s non-business income from that country determined by reference to the ratio of such foreign-source income to total income of the taxpayer for the year computed taking into account certain adjustments provided for in that paragraph.

Where a taxpayer’s income for a taxation year is derived from sources in more than one foreign country, both subsection 126(1) of the ITA and section 34 of the TAO are to be read as providing for separate deductions in respect of each foreign country. This is mandated by paragraph 126(6)(b) of the ITA, which is incorporated by reference in section 34 of the TAO. In your view, applying subsection 126(1) of the ITA and section 34 of the TAO to Canco in respect of each of Country A and Country B in isolation would lead to the anomalous result that no Ontario FTC could be claimed under the TAO. The reasoning leading to that conclusion is described below:

* The amount determined under paragraph 126(1)(a) of the ITA in respect of Country A is the NBIT on the investment income earned in that country ($10);

* The limit under paragraph 126(1)(b) of the ITA determined in respect of Country A is the proportion of the FTOP on Canco’s taxable income under the ITA ($15) that the $100 income from Country A is of the total taxable income of Canco ($100), hence $15.

* If the reference to “the amount deductible” by Canco “in respect of the foreign investment income for the year under subsection 126(1)” of the ITA in element B in subsection 34(2) of the TAO is interpreted as referring to the amount deductible under paragraphs 126(1)(a) or (b) in respect of Country A, the amount determined under subsection 34(2) of the TAO in respect of Country A would be nil (that is, the Ontario domestic factor of 1 multiplied by NBIT of $10 minus the amount deductible in respect of Country A under paragraph 126(1)(a) of the ITA ($10)).

* Since the amount determined under subsection 34(1) of the TAO is the lesser of the amounts determined under subsections 34(2) ($0) and 34(3) of the TAO, Canco could not claim any Ontario FTC in respect of Country A.

* Interpreting subsection 126(1) of the ITA and section 34 of the TAO to Canco in respect of Country B in the same manner would yield the same result.

Under the above interpretation of the relevant provisions, no Ontario FTC could be claimed in the case scenario at issue due to the fact that the total foreign-source non-business income of Canco ($200) exceeds its taxable income under the ITA ($100) as a result of the deduction for the Canadian source loss. The formula in paragraph 126(1)(b) of the ITA fails to prorate the deduction computed under subsection 126(1) of the ITA in respect of each of the relevant foreign countries in this case. Had all of Canco’s foreign-source income originated from a single foreign country, Canco would have been entitled to a deduction under section 34 of the TAO of $5.

In your view, concluding that no Ontario FTC can be claimed by Canco is inconsistent with the legislative intent of section 34 of the TAO. You suggest that in light of the preamble of subsection 126(1) of the ITA, a textual, contextual and purposive interpretation of subsection 126(1) and paragraph 126(6)(b) of the ITA and section 34 of the TAO would suggest that the amount deductible under subsection 126(1) of the ITA for purposes of subsection 34(2) of the TAO should be limited to the FTOP on Canco’s taxable income under the ITA ($15) in respect of both Country A and Country B and not in respect of each of Country A and Country B separately.

Our comments:

To be included in element B in subsection 34(2) of the TAO, the “amount deductible” under subsection 126(1) of the ITA has to be “in respect of the foreign investment income for the year.” Subsection 34(5) of the TAO defines “foreign investment income” as income from sources in a country other than Canada in respect of which the corporation paid non-business-income tax to the government of that country. Where the total of all amounts computed under paragraphs 126(1)(a) or (b) in respect of all foreign countries exceeds the amount of the corporation’s FTOP on its taxable income under the ITA, in our view, the wording of element B in subsection 34(2) of the TAO and the definition of “foreign investment income” in subsection 34(5) of the TAO require that the FTOP be apportioned among the countries in order to determine, for purposes of element B in subsection 34(2) of the TAO, “the amount deductible by the corporation in respect of the foreign investment income for the year under subsection 126(1)” on a country-by-country basis.

The relevant legislative provisions do not provide specific guidance about the method that should be used to achieve that allocation. One possible method would be allocating the FTOP to a foreign country using the ratio that the amount calculated under paragraphs 126(1)(a) and (b) in respect of that foreign country is of the aggregate amount calculated under paragraphs 126(1)(a) and (b) in respect of all relevant foreign countries .

On the hypothetical facts at issue, since the amount calculated in respect of each of Country A and Country B under paragraph 126(1)(a) is $10, that method would allocate half of the $15 maximum amount deductible by Canco under subsection 126(1) of the ITA to each of Country A and Country B and the “amount deductible by [Canco] in respect of the foreign investment income for the year under subsection 126(1)” in respect of each of Country A and Country B would be $7.50.

On that basis, the amount calculated under subsection 34(2) of the TAO in respect of Country A would be $2.50 (being the Ontario domestic factor of 1, multiplied by the excess of $10 of the NBIT paid to Country A over $7.50) and not nil. The amount determined under subsection 34(1) of the TAO in respect of Country A would also be $2.50 (being the lesser of the amounts calculated under subsections 34(2) and (3) of the TAO in this specific case scenario). The same result would be obtained when applying section 34 of the TAO to Country B.

We note that, consistent with the fact that the aggregate amount deductible under subsection 126(1) of the ITA in a year cannot exceed the FTOP from which it is being deducted, subsection 34(1) of the TAO limits the amount of the total Ontario FTCs to the taxpayer’s “tax payable under this Division for the year” (being $11.50 in the hypothetical case scenario).

In our view, the phrase “the amount deductible … under subsection 126(1) of the Federal Act” in subsection 34(2) of the TAO can be read as supporting the country-by-country allocation as described above in the circumstances.

That interpretation provides for a consistent application of section 34 whether foreign-source income is earned in one or in multiple foreign jurisdictions. It also allows Canco to deduct FTC from its Ontario corporate income tax on account of NBIT paid to Country A and Country B in excess of the maximum deduction under subsection 126(1) of the ITA. In our view, that interpretation is consistent with the context and purpose of section 34 of the TAO.

This technical interpretation provides general comments about the provisions of the ITA and TAO. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R11, Advance Income Tax Rulings and Technical Interpretations.

We hope this information is of assistance to you.

Yours truly,

John Meek
Acting Section Chief
For Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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