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Income Tax Interpretation Bulletin
Foreign Tax Credit - Foreign-Source Capital Gains and Losses
NO: IT-395R2
DATE: August 21, 2002
SUBJECT: INCOME TAX ACT
Foreign Tax Credit - Foreign-Source Capital Gains and Losses
REFERENCE: Subsection 126(1) (also sections 3 and 39, subsection 126(2.21), the definitions of "non-business-income tax" and "tax-exempt income" in subsection 126(7), and paragraphs 111(1)(b) and 128.1(4)(b))
Notice -- Bulletins do not have the force of law
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Foreign Tax Credit - Foreign-Source Capital Gains and Losses
This version is only available electronically.
Contents
- Application
- Summary
- Discussion and Interpretation
- Foreign Tax Credit Formula (¶s 1-2)
- Location of a Capital Gain or Capital Loss (¶s 3-4)
- Basic Treatment of Foreign-Source Capital Gains and Losses (¶s 5-6)
- Application of Allowable Capital Losses (¶s 7-8)
- Tax-Exempt Income (¶ 9)
- Explanation of Changes
Application
This bulletin cancels and replaces Interpretation Bulletin IT-395R dated July 31, 1991.
Summary
Section 126 permits a taxpayer resident in Canada at any time in a taxation year to claim, against Canadian tax otherwise payable for the year, a foreign tax credit in respect of income or profits taxes paid for the year to a foreign country. The taxpayer must make separate foreign tax credit calculations for foreign "business-income tax" and "non-business-income tax".
Subsection 126(1) sets out the rules for claiming a "non-business-income tax" foreign tax credit. This credit is basically the lesser of the actual non-business-income taxes paid to the foreign country and the portion of Canadian tax otherwise payable that relates to the non-business income from sources in that country.
Foreign-source taxable capital gains and allowable capital losses are taken into account in calculating a "non-business-income tax" foreign tax credit. Where more than one foreign country is involved, a separate foreign tax credit must be calculated for each country. Therefore, the taxpayer must determine the particular country to which each capital gain or capital loss should be allocated.
Also, the allocation of allowable capital losses among countries is limited by the amount of such losses that are deductible in calculating section 3 income.
Discussion and Interpretation
Foreign Tax Credit Formula
¶ 1. Where a resident of Canada has non-business income from a source or sources in a foreign country and pays income tax on that income to that country for a particular taxation year, subsection 126(1) permits the taxpayer to claim, against Canadian tax otherwise payable for that year, a foreign tax credit in respect of the non-business-income tax so paid to the foreign country. Subsection 126(1) requires that a separate foreign tax credit be calculated for each foreign country to which non-business-income tax is paid and, in general terms, limits the amount of each credit for a particular taxation year to the lesser of
(a) the amount of actual non-business-income tax paid for the year to the particular foreign country, and
(b) the portion of Canadian tax otherwise payable for the year that relates to the non-business income for the year from sources in that country, which is determined as follows:
( FNBI ÷ WI ) × CTOP
The variables in the above formula are as follows:
| Variable | Definition | |
|---|---|---|
|
FNBI |
is the numerator in the above fraction. FNBI is the total of the taxpayer's foreign non-business income for the year from sources in that country, as calculated in accordance with subparagraph 126(1)(b)(i). |
|
|
WI |
is the denominator in the above fraction. It essentially represents the taxpayer's worldwide income for the year, subject to the adjustments contained in subparagraph 126(1)(b)(ii). |
|
|
CTOP |
is the Canadian tax otherwise payable for the year as calculated under paragraph (a) of the subsection 126(7) definition of the term "tax for the year otherwise payable under this Part". |
|
Example
A resident of Canada has world income for the year of $50,000. Of that total, $30,000 is the foreign non-business income for a particular foreign country and the taxpayer pays $6,500 non-business-income tax to that country. The taxpayer's Canadian tax otherwise payable of $10,000 (in the calculation of which the full $50,000 of world income is taken into account) is reduced to $4,000 by a foreign tax credit of $6,000, being the lesser of
- the $6,500 non-business-income tax paid to the foreign country, and
- the amount determined by the formula
( FNBI ÷ WI ) × CTOP = $30,000 ÷ $50,000 × $10,000 = $6,000
¶ 2. For a more complete discussion of the subsection 126(1) foreign tax credit and the variables which are used in its calculation, reference should be made to the current version of IT-270, Foreign Tax Credit. It should be noted from that bulletin that the subsection 126(1) foreign tax credit in respect of non-business-income tax paid to a foreign country is entirely separate from the subsection 126(2) foreign tax credit in respect of business-income tax paid to a foreign country. Since taxable capital gains are not considered to be business income for Canadian taxation purposes, foreign-source taxable capital gains and allowable capital losses will affect the calculation of the subsection 126(1) (non-business-income tax) foreign tax credit, as discussed in the following paragraphs.
Location of a Capital Gain or Capital Loss
¶ 3. In determining the country to which a taxpayer's capital gain or capital loss on a disposition of real property (land and buildings) should be allocated, the major factor to be considered is the geographic location of the property. In the case of capital property other than real property, the country to which the capital gain or capital loss should be allocated is usually based on the geographic location at which the sale or disposition took place (see ¶ 4, for example, in the case of stocks and bonds).
If there has been a deemed disposition of property, any resulting capital gain or capital loss is allocated to Canada rather than to a foreign country, regardless of the geographic location of the property at the time of the deemed disposition. For example, where a taxpayer has ceased to be resident in Canada, a taxable capital gain resulting from a deemed disposition of property under paragraph 128.1(4)(b) is considered to be Canadian-source income, which therefore cannot be included in the numerator FNBI in ¶ 1(b) for purposes of a foreign tax credit under subsection 126(1). (The resulting "pre-departure" Canadian taxes may, however, be reduced by a foreign tax credit, under subsection 126(2.21), for a portion of any "post-departure" foreign taxes resulting from a subsequent actual disposition of the property.)
A different result for a deemed disposition can sometimes occur, however, by means of a tax treaty:
Example
Ms. X emigrated on January 31, 2001 from Canada to the United States. Because of the operation of paragraph 128.1(4)(b) of Canada's Income Tax Act (the "Act"), Ms. X had a capital gain from a deemed disposition, at fair market value on January 31, 2001, of land she owned in the United States. Using paragraph 7 (in conjunction with paragraph 1) of Article XIII of the Canada-United States Income Tax Convention (1980) (the "treaty"), Ms. X elected to be taxed in 2001 by the United States (in accordance with the U.S. Internal Revenue Code) on the capital gain accruing on the land up to January 31, 2001. Under paragraph 3(a) of Article XXIV of the treaty, the capital gain so taxed by the United States became a U.S.-source capital gain for purposes of subparagraph 2(a)(i) of Article XXIV. As a result, Ms. X included the taxable capital gain that occurred under the Canadian Act in the numerator FNBI for 2001. This allowed Ms. X to claim a subsection 126(1) foreign tax credit against her Canadian tax otherwise payable for the 2001 taxation year. (On December 15, 2002, Ms. X, at that time a non-resident of Canada, sold the land and paid tax to the United States as a result of the capital gain accruing from February 1, 2001 to December 15, 2002. This "post-departure" foreign tax did not qualify for a foreign tax credit under subsection 126(2.21) of the Canadian Act as no part of the gain accrued while she was resident in Canada.)
¶ 4. Generally, the place where a stock or bond is sold is the securities or stock exchange in which it is sold, regardless of the location of the issuer's transfer office. Where a sale is not made through a securities or stock exchange, other factors, such as the location or place of business of the issuer, the issuer's transfer office, the owner of the security or the owner's selling agent, should be considered in establishing where the sale is made.
Basic Treatment of Foreign-Source Capital Gains and Losses
¶ 5. The taxpayer should include all foreign-source taxable capital gains in the calculation of both the numerator, FNBI, and the denominator, WI, in ¶ 1(b). The taxpayer should also subtract, for purposes of calculating these variables, all foreign-source allowable capital losses to the extent that such losses are deductible in calculating the taxpayer's income under section 3 of the Act (see ¶s 7 and 8 for specific applications of this rule). This Canadian tax treatment would not be affected by a different treatment under the tax law of the particular foreign jurisdiction to which the capital gain or loss is allocated by the taxpayer, e.g., where the capital gain or loss so allocated, whether or not from the disposition of a capital property used in the business of the taxpayer at the time of its disposition, is considered by the foreign jurisdiction to be a gain or loss of a business nature.
The above comments are subject to the comments in ¶ 9.
Also, any tax in the nature of an income, gains or profits tax that is paid for the year to a foreign jurisdiction in respect of a capital gain should be included in the non-business-income tax paid to that jurisdiction (see ¶ 1(a)).
¶ 6. Net capital losses claimed under paragraph 111(1)(b) in computing the taxpayer's taxable income do not reduce the numerator, FNBI, in ¶ 1(b), but are deducted in calculating the denominator, WI, in ¶ 1(b).
Application of Allowable Capital Losses
¶ 7. As indicated in ¶ 1, a separate foreign tax credit calculation under subsection 126(1) must be made for each country to which non-business-income tax is paid. Accordingly, in a situation where a taxpayer has a taxable capital gain allocated to one foreign country and an allowable capital loss allocated to another foreign country, the taxable capital gain is included in computing FNBI (the numerator in ¶ 1(b)) for the first country and the allowable capital loss is subtracted in computing FNBI for the second country to the extent that such allowable capital loss is deductible in computing the taxpayer's income for the year under section 3.
Example
Assume the following income details for Corporation A:
| Foreign Country B | Foreign Country C | Canada | Total | |
|---|---|---|---|---|
|
Taxable capital gains |
$ 10,000 |
$ NIL |
$ 2,000 |
$ 12,000 |
|
Allowable capital losses |
NIL |
(15,000) |
NIL |
(15,000) |
|
Other non-business income |
28,000 |
21,500 |
NIL |
49,500 |
|
Business income |
21,000 |
22,000 |
23,000 |
66,000 |
The calculation of Corporation A's FNBI for each foreign country is as follows:
| Foreign Country B | Foreign Country C | |
|---|---|---|
|
Taxable capital gains |
$ 10,000 |
$ NIL |
|
Allowable capital losses |
N/A |
(12,000)* |
|
Other non-business income |
28,000 |
21,500 |
|
FNBI |
$ 38,000 |
$ 9,500 |
The calculation of Corporation A's WI (which is used in its foreign tax credit calculations for both foreign countries) is as follows:
|
Taxable capital gains |
$ 12,000 |
|---|---|
|
Allowable capital losses |
(12,000)* |
|
Other non-business income |
49,500 |
|
Business income |
66,000 |
|
WI |
$115,500 |
* The amount of allowable capital losses that is subtracted in calculating the above variables under subsection 126(1) is limited to $12,000. This is because only $12,000 of the $15,000 allowable capital losses incurred in the year by Corporation A is deductible in computing its income for the year under section 3 of the Act. That is, the amount of the taxpayer's allowable capital losses for the year deductible under subparagraph 3(b)(ii) cannot exceed the taxpayer's $12,000 taxable capital gains for the year included under subparagraph 3(b)(i), because the net amount calculated under paragraph 3(b) cannot be less than nil.
The above comments are subject to the comments in ¶ 9.
¶ 8. The taxpayer may have allowable capital losses for more than one foreign country. In such a situation, where the total allowable capital losses for all countries (including Canada) exceeds the amount of such losses that is deductible in computing the taxpayer's income under section 3, the taxpayer may allocate the foreign-source portion of the deductible losses among the foreign countries, for purposes of calculating FNBI for each respective country, in such a way that:
(a) the amount of allowable capital losses allocated to any particular foreign country does not exceed the allowable capital losses actually incurred in that country, and
(b) the aggregate of the Canadian portion (if any) of the allowable capital losses and the various amounts allocated to the foreign countries is equal to the total amount of allowable capital losses that is deductible in calculating the taxpayer's income under section 3 of the Act.
Example
Assume the following income details for Corporation D:
|
Foreign |
Foreign |
Foreign |
Foreign |
|
|
|
|---|---|---|---|---|---|---|
|
Taxable capital gains |
$ 3,000 |
$ 1,000 |
$ 2,000 |
$ 6,000 |
$ 3,500 |
$ 9,500 |
|
Allowable capital losses |
(5,000) |
(1,500) |
(1,000) |
(7,500) |
(7,000) |
(14,500) |
|
Other non-business income |
3,500 |
NIL |
4,200 |
7,700 |
NIL |
7,700 |
|
Business income |
1,200 |
2,400 |
1,600 |
5,200 |
1,800 |
7,000 |
Corporation D calculates FNBI for each foreign country as follows:
|
Foreign |
Foreign |
Foreign |
|
|---|---|---|---|
|
Taxable capital gains |
$ 3,000 |
$ 1,000 |
$ 2,000 |
|
Allowable capital losses, as allocated by taxpayer* |
(4,000)* |
(1,000)* |
(1,000)* |
|
Other non-business income |
3,500 |
NIL |
4,200 |
|
FNBI |
$ 2,500 |
$ NIL |
$ 5,200 |
The calculation of Corporation D's WI (which is used in its foreign tax credit calculations for all foreign countries) is as follows:
|
Taxable capital gains |
$ 9,500 |
|---|---|
|
Allowable capital losses |
(9,500)* |
|
Other non-business income |
7,700 |
|
Business income |
7,000 |
|
WI |
$ 14,700 |
* Of the $14,500 allowable capital losses incurred by Corporation D for the year, only $9,500 is deductible under subparagraph 3(b)(ii) for purposes of computing income for the year under section 3 of the Act, because taxable capital gains included under subparagraph 3(b)(i) are only $9,500. For purposes of subsection 126(1), the $9,500 deductible allowable capital losses are deducted in calculating Corporation D's WI. The Canadian-source portion of the $9,500 deductible losses is $3,500 (even though the actual Canadian-source allowable capital losses are $7,000), because the Canadian-source taxable capital gains included under subparagraph 3(b)(i) are only $3,500. Therefore, the foreign-source portion of the $9,500 deductible allowable capital losses is $6,000, which is allocated among the three foreign countries. The amount allocated to each country is subtracted in calculating Corporation D's FNBI for that country. Corporation D can allocate the $6,000 among the three foreign countries in the manner it chooses, as long as the rules given in (a) and (b) above are met.
The above comments are subject to the comments in ¶ 9.
Tax-Exempt Income
¶ 9. If a foreign-source taxable capital gain is tax-exempt income, it is not included in the numerator, FNBI. Similarly, if a disposition resulting in a foreign-source allowable capital loss had instead resulted in a foreign-source taxable capital gain that was tax-exempt income, the allowable capital loss is not subtracted when calculating FNBI.
For this purpose, "tax-exempt income" is defined in subsection 126(7). It is income from a source in a country if two conditions are fulfilled in respect of that income:
(a) the taxpayer is entitled to an exemption, because of a tax treaty into which that country has entered, from all income or profits taxes, imposed in that country, to which the treaty applies; and
(b) no income or profits tax to which the treaty does not apply is imposed in any country other than Canada.
Example
Mr. A, who is a resident of Canada, has a taxable capital gain from the sale of shares. The sale occurred on a stock exchange in a foreign country and the taxable capital gain is considered to have its source in that country. However, under the terms of the tax treaty between that country and Canada, the gain is exempt from income or profits taxes by that country. Furthermore, the gain is not subject to an income or profits tax by a political subdivision of that country or by any other foreign jurisdiction. Therefore, Mr. A's taxable capital gain is tax-exempt income and he cannot include it in the numerator, FNBI, for that country for purposes of a foreign tax credit.
Explanation of Changes
Introduction
The purpose of the Explanation of Changes is to give the reasons for the revisions to an interpretation bulletin. It outlines revisions that we have made as a result of changes to the law, as well as changes reflecting new or revised interpretations of the CCRA.
Reasons for the Revision
We have revised this bulletin to reflect the relevant provisions of the Income Tax Act as they read at the time of publication of the revised bulletin.
Legislative and Other Changes
In ¶ 3, the previous bulletin's reference to subsection 48(1) has been replaced by a reference to paragraph 128.1(4)(b). This reflects the repeal of section 48 and replacement of rules therein by the rules in section 128.1.
Also in ¶ 3, a reference is now made to the foreign tax credit allowed under subsection 126(2.21), which was added to the Act since the issuance of the previous bulletin. The previous bulletin's reference to the foreign tax credit allowed under subsection 126(2.2) has been discontinued, because that subsection was amended to phase out its application.
¶ 5 no longer indicates that the Canadian tax treatment given in that paragraph would apply even where the capital gain or loss was exempt from income or profits tax in the applicable foreign jurisdiction by virtue of a treaty between Canada and that jurisdiction. This change is consequential on the rules discussed in new ¶ 9 (see explanation below).
The rewording of ¶ 6 is for clarification purposes only.
¶s 9 and 10 of the previous bulletin explained the effect of claiming a section 110.6 capital gains deduction on a foreign-source taxable capital gain. These paragraphs (and the reference to them at the end of ¶ 5) in the previous bulletin have not been continued in the new bulletin because a capital gains deduction can now be claimed only on a taxable capital gain resulting from the disposition of a "qualified small business corporation share" or of "qualified farm property". A taxable capital gain on the disposition of either of these types of property essentially represents Canadian-source income that cannot be included in subparagraph 126(1)(b)(i) (the numerator, FNBI, in ¶ 1).
¶ 9 is now a new paragraph. It discusses the effect of the rules for "tax-exempt income" on foreign-source taxable capital gains and allowable capital losses. These rules were added to the Act since the issuance of the previous bulletin.
Any other changes throughout the bulletin were made only for purposes of clarification or readability.
Notice -- Bulletins do not have the force of law
At the Canada Customs and Revenue Agency (CCRA), we issue income tax interpretation bulletins (ITs) in order to provide technical interpretations and positions regarding certain provisions contained in income tax law. Due to their technical nature, ITs are used primarily by our staff, tax specialists, and other individuals who have an interest in tax matters. For those readers who prefer a less technical explanation of the law, we offer other publications, such as tax guides and pamphlets.
While the comments in a particular paragraph in an IT may relate to provisions of the law in force at the time they were made, such comments are not a substitute for the law. The reader should, therefore, consider such comments in light of the relevant provisions of the law in force for the particular taxation year being considered, taking into account the effect of any relevant amendments to those provisions or relevant court decisions occurring after the date on which the comments were made.
Subject to the above, an interpretation or position contained in an IT generally applies as of the date on which it was published, unless otherwise specified. If there is a subsequent change in that interpretation or position and the change is beneficial to taxpayers, it is usually effective for future assessments and reassessments. If, on the other hand, the change is not favourable to taxpayers, it will normally be effective for the current and subsequent taxation years or for transactions entered into after the date on which the change is published.
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