Canadian Tax Court Case Provides Important Warning

The Tax Court of Canada has issued a decision having important consequences for Canadian residents with certain Canada/US cross border transactions.

Canadian residents, (including those who are US citizens), cannot claim a foreign tax credit on their Canadian income tax return for tax paid to the United States that exceeds the foreign tax credit allowed under the Canada /US tax treaty, even if the actual tax paid to the US is greater, and apparently even if a greater foreign tax credit would have been allowed for tax paid to countries other than the US.

For example, if the "normal" US withholding tax of 30% is deducted from US dividends paid to you, or a US pension paid to you, you cannot take a foreign tax credit on the Canadian income tax return for the amount of US tax exceeding the 15% allowed under the treaty, even if you do not claim a refund from the US.

The rule probably has more subtle results for US citizens resident in Canada. For example, if such an individual computes his/her US tax liability based solely on US domestic tax law, pays that amount of US tax, and then claims a foreign tax credit in Canada for that amount, Canada will disallow a foreign tax credit claim for the portion of the US tax that exceeds the maximum amount credit specified under the treaty. If this is discovered after the "period of limitations" has expired in the US (generally three years) it may be too late to apply for the appropriate tax refund in the US.

The treaty contains an ameliorating provision for US citizens in Article XXIV of the treaty. It provides the potential for a United States foreign tax credit for Canadian tax that exceeds 15% on certain US source income. (Meyer 2004 TCC 199, Informal Procedure Decision).