CRA denies foreign tax credit, pushing taxpayer to take CRA to court

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Claiming a overseas tax credit score is the first means Canadian residents can keep away from paying double tax on overseas earnings, however the potential to assert a overseas tax credit score just isn’t all the time easy because it depends upon what is definitely thought of to be a overseas tax.

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This got here up most lately in a case involving a Canadian resident working for the Spanish authorities on the Embassy of Spain in Ottawa. However earlier than delving into the case particulars, let’s evaluation the aim of the overseas tax credit score.

As Canadian residents, we’re taxable on our worldwide earnings. Which means even earnings earned overseas, whether or not it’s overseas employment earnings or overseas funding earnings, is topic to Canadian tax at marginal tax charges. However this overseas earnings, typically, can be topic to overseas tax in that overseas jurisdiction. To keep away from paying double tax on the identical earnings, it’s possible you’ll be entitled to assert a overseas tax credit score in your Canadian return for overseas taxes paid on that overseas earnings.

For many of us, our solely expertise with claiming a overseas tax credit score possible happens if we earn overseas curiosity or dividends in a non-registered funding account. For instance, if I personal Pfizer Inc. shares in my non-registered buying and selling account, the dividend earnings can be topic to a 15-per-cent non-resident withholding tax in america. I’d then pay Canadian tax on that U.S. dividend earnings at my regular marginal charges after I file my Canadian return, however be entitled to assert a overseas tax credit score for the non-resident tax withheld, thus avoiding double tax.

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The taxpayer within the latest case claimed a overseas tax credit score of $842 in 2016, $2,527 in 2017 and $2,545 in 2018, consisting of necessary contributions to a nationally run pension plan in Spain. The Canada Revenue Agency denied the taxpayer’s overseas tax credit and the taxpayer finally took the matter to Tax Court.

In courtroom, the taxpayer argued that the quantities at situation had been withheld by the federal government in Spain, and will be handled as tax paid to a overseas jurisdiction. The CRA’s view was that these quantities weren’t a tax. The seminal situation, subsequently, was whether or not the quantities withheld by Spain may very well be akin to a tax.

To reply this query, the choose started with a evaluation of the 4 traits of a “tax,” as decided by a 1930 decision of the Supreme Court of Canada: enforceable by legislation, imposed below the authority of the legislature, imposed by a public physique and made for a public goal.

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Regardless of a scarcity of proof at trial, together with “little or no description” of the mechanics of gathering these funds, the authority below which it was accomplished, and whether or not the deductions had been subtracted from the gross earnings of the taxpayer as a part of his tax filings in Canada, the choose concluded that the primary three elements of the Supreme Court docket check had been met. In different phrases, the quantities being claimed had been possible withheld by the Spanish authorities due to Spanish laws that makes such funds obligatory.

The issue, the choose went on to clarify, lies with the ultimate part of the Supreme Court docket’s check. The taxpayer testified that the quantities at situation had been deducted by Spain to be able to contribute to the Spanish nationwide pension plan. The taxpayer was unsure as to what advantages he’ll finally obtain from the plan, however acknowledged he would possible obtain some funds sooner or later.

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The choose, subsequently, concluded that the quantities collected by the Spanish authorities did “not meet the definition of a tax, in that they weren’t collected for a public curiosity … The pension deductions had been made by the Spanish authorities for the long run advantage of the contributor … These funds weren’t made to be able to generate earnings for the state.” Consequently, these quantities didn’t qualify for overseas tax credit.

This result’s in line with prior case legislation. For instance, in a 2001 tax case, contributions a Canadian taxpayer paid to a nationwide insurance coverage plan in the UK had been additionally discovered to not be eligible for the overseas tax credit score. An identical conclusion was reached once more by the Tax Court docket in a 2019 determination, which held that contributions to a overseas insurance coverage plan are usually not a tax for public functions, partly as a result of the contributor receives “a direct private and monetary profit sooner or later for his or her contributions.”

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One remaining warning relating to claiming overseas tax credit. As famous above, a overseas tax credit score for withholding tax on funding earnings is simply out there when these investments are held in a non-registered account. However what should you maintain your overseas investments inside a registered plan, similar to a registered retirement financial savings plan (RRSP), registered retirement earnings fund (RRIF), tax-free financial savings account (TFSA) or registered training financial savings plan (RESP)?

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That’s the place issues can get a bit tough. If, for instance, you maintain overseas shares in your registered account and dividends are paid on these shares, they are going to possible be topic to a 15-per-cent non-resident withholding tax by the payor nation earlier than hitting your registered plan. You must take into account this a sunk price, as a result of there is no such thing as a potential to assert a overseas tax credit score for withholding tax paid by a registered account.

The one exception to the above is for U.S. shares held in an RRSP or RRIF. Due to a singular provision within the Canada-U.S. tax treaty, there may be an exemption from withholding tax that’s mechanically utilized when U.S. dividends are paid to an RRSP or RRIF. Be aware that this identical break doesn’t apply to U.S. dividends paid to a TFSA or RESP. That’s as a result of these accounts are usually not “operated completely to manage or present pension, retirement or worker advantages,” which is the requirement below the Canada-U.S. treaty to be exempt from withholding tax.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is the managing director, Tax & Property Planning with CIBC Personal Wealth in Toronto. [email protected]

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