Foreign Tax Credits: Problems with Timing of Income Recognition

Two of the factors limiting the foreign tax credit (business or non-business) for a year are the foreign tax paid for the year and the estimated Canadian tax on the foreign income for the year. In certain situations, however, the foreign tax in this calculation appears in a different year than the Canadian tax on the foreign income. For taxpayers for whom foreign income does not occur every year, this timing difference can play havoc with the normal relief from double taxation.

Suppose that, for cross-border employee stock options, the employment income is recognized in Canada in the year in which the options are exercised (year 1) but is not recognized in the foreign country until the subsequent disposition of the shares (year 2). If this is the taxpayer's only foreign income in the two years, there is a problem: in the year in which the foreign tax is paid (year 2), no foreign income is recognized in Canada; in the year in which foreign income is recognized in Canada (year 1), no foreign tax is paid. Thus, the foreign tax credits for both years are zero. Can this problem be avoided by paying the foreign tax in year 1, as a prepayment? The CRA is of the view that the reference to "year" in "tax paid by the taxpayer for the year" refers to the year for which the foreign tax is paid, not the year in which the foreign tax is paid (Interpretation Bulletin IT-270R3, "Foreign Tax Credit," November 25, 2004, paragraph 11). Thus, a prepayment is of no help.

A related question arises when the foreign tax year does not coincide with the Canadian tax year, but overlaps to some degree. In that situation, the CRA says that the foreign tax for the Canadian tax year should be calculated as a proration (presumably daily or monthly) of the tax paid for the two foreign tax years that overlap the Canadian tax year ("Revenue Canada Round Table," 1989 Conference Report, question 4). This tends to work to the detriment of the taxpayer who has foreign income in only one year. Suppose, for example, that a Canadian taxpayer earns employment income in the United Kingdom from May to December 2012 and then ceases her employment there. The UK tax year for individuals ends in early April (say March 31, for simplicity). In this example, 9/12 of the UK tax will be eligible for the foreign tax credit in 2012, and 3/12 of the UK tax will be eligible in 2013. However, since the taxpayer has only foreign income in 2012, she will lose part of the potential foreign tax credit.

This timing issue applies to both individual and corporate taxpayers. In CRA document no. 2000-0029575, the CRA considered a similar situation involving a corporation (Canco) that owned an interest in a partnership that had different year-ends for Canadian and foreign tax purposes. Canco earned both foreign business income and non-recurring foreign non-business income (capital gains on the sale of real property). Again, the CRA indicated that its administrative policy would be to accept apportioned amounts of foreign income and taxes paid on the basis of the portion of income earned during the calendar year. If the taxpayer had no non-business income in a preceding or subsequent Canadian tax year, part of the foreign tax credit associated with the foreign non-business income tax paid would be lost. (For a further discussion of these issues, see Ken Snider, "The Foreign Tax Credit Rules," in the 2001 Conference Report.)

Wynn Vo
KPMG LLP, Vancouver
[email protected]

Canadian Tax Focus
Volume 2, Number 3, August 2012
©2012, Canadian Tax Foundation