Questions About Claiming Foreign Tax Credits

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nielkfj
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Questions About Claiming Foreign Tax Credits

Post by nielkfj » Fri May 22, 2020 12:28 pm

I have some questions about claiming foreign tax credits on Canadian and U.S. tax returns:

1) If U.S. tax is paid for capital gains and dividends on a TFSA account (which I understand is taxable in the U.S.), can that tax be used as a foreign tax credit to offset Canadian tax on capital gains and dividends from a different account?

2) If U.S. taxes paid on capital gains and dividends are higher in a given year than the Canadian taxes on the same account, can the additional U.S. tax be used as a foreign tax credit on the Canadian return?

3) In what sequence should the U.S. and Canadian returns be done to allow for foreign tax credits to be claimed? For example should the return that has the higher taxes owing in a given year be filed first, then wait for it to be processed, then file the other return claiming foreign tax credits from the first?

nelsona
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Re: Questions About Claiming Foreign Tax Credits

Post by nelsona » Fri May 22, 2020 3:31 pm

1. Yes. You use the taxes paid in canada for PASSIVE income, against the US tax owed for PASSIVE income.
2. No, for two reasons. 1) you can't claim foreign tax credit on on your Cdn return for Cdn-sourced income. 2) You are only paying US tax because you are a US tax person (if you were Cdn you would not be paying any US tax on this income) and the treaty specifically allows Canada to deny such tax credit.
3. You prepare BOTH returns at same time without foreign tax credit. Then you calculate the tax rate for each type of income on each return, and then you apply the foreign tax against the foreign income. No "iterations" are required. Just rememebr that you cannot claim any credit on income from that country on that country's tax retunrn, and you cannot claim any US tax on your Cdn return for US income that would not have been taxed if you were not a US taxpayer (interest, cap gains, wages under US$10K, etc).
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nielkfj
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Joined: Fri Apr 17, 2020 2:01 pm

Re: Questions About Claiming Foreign Tax Credits

Post by nielkfj » Fri May 22, 2020 10:24 pm

nelsona wrote:
> 1. Yes. You use the taxes paid in canada for PASSIVE income, against the US
> tax owed for PASSIVE income.

Actually I was asking about using taxes paid in the US on TFSA income against Canadian tax owed. But you answered this in your answer 2 below.

Anyhow, I imagine that since tax rates in Canada are lower than in the USA (for long-term cap gains at least) and my TFSA is relatively small, I should be able to zero out U.S. tax owed on the TFSA with a passive income FTC.

> 2. No, for two reasons. 1) you can't claim foreign tax credit on on your
> Cdn return for Cdn-sourced income.

OK, so the FTC is only available for taxes paid on FOREIGN sourced income.
And, cap gains are foreign sourced because the treaty says the source is the country of residence of the tax filer. Correct?

> 2) You are only paying US tax because
> you are a US tax person (if you were Cdn you would not be paying any US tax
> on this income) and the treaty specifically allows Canada to deny such tax
> credit.

So I take it this is a special rule that has to do with the USA taxing based on citizenship, not residency. In my situation I am a US citizen (dual-citizen actually) resident in Canada, so this rule applies. Whereas in the converse situation, if I were a Canadian citizen resident the the U.S. the rule would not apply because Canada would not tax me based on my residency. Correct?

> 3. You prepare BOTH returns at same time without foreign tax credit. Then
> you calculate the tax rate for each type of income on each return,

There is one key aspect to this that I am not clear on:

When calculating the tax rate for each type of income (in other words allocating the taxes to each type of income) on country A’s return do all amounts need to be converted to the currency of country B (using the exchange rate on the specific date that each amount was incurred) prior to allocating country A’s taxes to that income?

In other words would I need to do a Canadian tax return with all amounts in USD, including the basic personal amount for example, in order to figure out the allocation of Canadian taxes to the income?

nelsona
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Re: Questions About Claiming Foreign Tax Credits

Post by nelsona » Sun May 24, 2020 7:59 am

I think you can figure this out.
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nielkfj
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Re: Questions About Claiming Foreign Tax Credits

Post by nielkfj » Sun May 24, 2020 8:49 pm

nelsona wrote:
> I think you can figure this out.

Thanks for the vote of confidence, but I was trying to save a few brain cells by not having to. I already expended several million so far (haha).

Anyhow, from what I got out of the instructions for form 1116 and Publication 514, it appears that basically I need to do this:

1) Convert all amounts entered on the Canadian return - income, deductions, tax credit amounts (including the basic personal amount), federal tax and provincial tax - to USD, using either the exchange rate on the date the amount was incurred or an average rate, whichever is more appropriate.

2) Sort the income amounts into the form 1116 categories, and also the deductions, non-refundable tax credit amounts, federal tax, provincial tax etc. that are definitely related to one of the categories of income.

3) For each category of income go through the steps on the Canadian tax return AND provincial tax return, along the way “prorating” the deductions, non-refundable tax credit amounts, federal tax, provincial tax etc. that are NOT definitely related to one of the categories of income. The calculated “total payable” amounts (line 435 of the T1) are the allocations of Canadian tax to each category of income.

Is this correct?

I imagine that U.S. tax software will not do this for me.

nelsona
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Re: Questions About Claiming Foreign Tax Credits

Post by nelsona » Mon May 25, 2020 7:49 am

I have brain cells to think about, too.
Sorry.
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nielkfj
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Re: Questions About Claiming Foreign Tax Credits

Post by nielkfj » Tue May 26, 2020 7:02 pm

nelsona wrote:
> I have brain cells to think about, too.
> Sorry.

OK, thanks anyway.
I'm pretty sure that the steps I described in my previous comment are correct.

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