Misalignment of Federal and Provincial Tax Credits

Canada has tax treaties with almost 100 countries that help prevent the double taxation of foreign income. Tax treaties do not automatically have the force of law in the provinces, which can create situations where a taxpayer can claim a federal foreign tax credit but not a provincial foreign tax credit. Two such situations involve (1) US federal and state estate taxes of Ontario and BC taxpayers, and (2) tax-sparing provisions in treaties with developing countries.

For years, the US estate taxes have been an issue for Canadian residents holding US property, and many Canadians are not aware that their current US-situs holdings may be subject to US estate tax at death. If a Canadian resident has US-situs assets greater than US $60,000 and a worldwide estate greater than US $11.4 million (in 2019), he or she will be subject to US estate tax. The taxpayer's US-situs assets, which are subject to the estate tax, will be reduced by the exclusion amount set out below:

US-situs assets  × US$11.4 million = Exclusion amount.
Worldwide assets

Pursuant to subsection 126(7), only the foreign income or profits tax paid is eligible for a non-business-income tax credit. Generally, taxes on resource royalties, sales taxes, inheritance taxes, property taxes, customs or import duties, excise taxes, gift taxes, capital or wealth taxes, and documentary or stamp taxes are not considered income or profits tax, and thus will not qualify for the non-business-income tax credit unless a treaty specifically allows for a reduction in Canadian taxes. Because US federal and state estate taxes are an inheritance tax and not a tax on account of income or profits, they are eligible for a foreign tax credit only because of article XXIX B(6) of the Canada-US tax treaty.

The treaty benefits apply only to the federal foreign tax credit; they do not apply to the provincial foreign tax credit unless the province specifically allows a tax credit for US estate taxes. The majority of provinces have enacted legislation that aligns the federal and provincial foreign tax credits on US estate taxes. However, there is no specific provision in either the Ontario or British Columbia income tax act that allow for a provincial tax credit on US estate taxes (see CRA document no. 2010-0379381E5, September 14, 2010), which creates a misalignment between the federal and provincial foreign tax credits available and, correspondingly, double taxation.

Another mismatch situation can arise with respect to calculating the business-income and non-business-income tax credits when a Canadian tax treaty provides for tax sparing with a foreign country (such as Bangladesh, India, Brazil, Jamaica, Pakistan, and Nigeria). Tax sparing is a method of encouraging investment in the foreign country by providing a foreign tax credit for more than the foreign tax actually paid. The relevant treaty will provide an exemption from the developing country's income and profits taxes but, for the purposes of double tax relief, the spared taxes are deemed to be included in the income and profits taxes paid for the calculation of the Canadian foreign tax credit. The CRA indicated in a technical interpretation (2016-0632711I7, April 13, 2016) that Ontario taxpayers are not entitled to a provincial foreign tax credit on amounts spared under the Canada-Brazil tax treaty, but the CRA has not provided commentary on the tax implications in regard to other provinces and/or other tax treaties. This issue is more likely to arise with respect to non-business-income tax since the provinces do not have business-income tax credits for corporations (see "The Missing Provincial Tax Credit for Foreign Business-Income Tax," Canadian Tax Focus, May 2016).

Kailey McLeod and Nadia Pulla
Fuller Landau LLP, Toronto

Canadian Tax Focus
Volume 9, Number 4, November 2019
©2019, Canadian Tax Foundation