56 How are foreign tax credits treated when calculating the tax payable of a corporation? Why does this treatment exist?

According to ITA 126, any income tax paid to a foreign country’s government by a corporation or individual (that was a resident in Canada anytime during the year) on business and non-business income, can be used to determine the amount to be claimed as a Foreign Tax Credit against income tax to be paid in Canada.

This treatment exists as a result of Canada having tax treaties with other countries to avoid double taxation and prevent tax evasion. If this treatment did not exist, the taxpayer would have to pay full tax to both Canada and the other country. For example, a corporation that has a residence in Canada but also paid income tax in the USA will avoid being double-taxed when they claim this credit on their Canadian tax return. The foreign tax credits are calculated as follows:

Foreign Non-Business Income Tax Credit

Is the lesser of :

• Foreign non-business income tax paid (on foreign non-business income);  and
• (Foreign non-business income/Adjusted Division B Income) X tax otherwise payable.
  • The 2nd calculation is estimating the amount of tax you would pay in Canada on the foreign income.

Foreign Business Income Tax credit

Is the least of:

• Foreign business income tax paid (on foreign business income) ; or
• (Foreign business income/Adjusted Division B Income) X tax otherwise payable (basic corporate amount less general rate reduction) ; or
• Tax otherwise payable (above) less foreign non-business income tax credit taken.

Example: Foreign Non-Business Income Tax Credit Calculation

In the year 2020, Singh International Corp. has Net Income for Tax Purposes of $120,000 of which $84,000 is foreign non-business income. The corporation paid the US government $26,000 in taxes. The corporation’s Canadian tax otherwise payable is $35,000.

The amount for the Foreign Tax Credit would be the lesser of:

1. (Foreign Non-Business Income/Adjusted Division B Income) x Tax Otherwise Payable.= ($84,000 / $120,000) x $35,000 = $24,500

Or

2. Foreign Non-Business Income Tax Paid (on Foreign Non-Business Income) = $26,000

The Foreign Non-Business Income Tax Credit would be the lesser of $24,500 and $26,000. Therefore, the Foreign Non-Business Income Tax Credit would be $24,500.

Interactive content (Author: Prab Badyal, January 2020)

Interactive content (Author: Bal Nijjer, January 2020)

References and Resources:

• IT Folio S5-F2-C1
• ITA 126(1),126(2)
• Article – “Foreign Tax Credit” (Author: Government of Canada)
• Article – “Canada’s Foreign Income Tax Credit” (Author: Turbo Tax Canada)
• Article – “Tax treaties” (Author: Government of Canada)
• Article – “Income Tax Folio S5-F2-C1, Foreign Tax Credit” (Author: Government of Canada)

January 2020