15% Foreign Interest Credit limit

otto · Post by **otto** » Sun Jan 11, 2009 4:37 pm

Hi,

I was looking through the Canadian Tax Software and I ran across a statement that Canada only credits 15% of foreign interest income.

I am a US citizen who is now a perm resident. I generate substantial interest income from the US. Would I get a tax credit from the US even though the income is coming from the US because I have now moved to Canada? Would I get taxed twice?

Could you please clarify.

Thanks again.

nelsona · Post by **nelsona** » Mon Jan 12, 2009 5:31 am

I presume you mean that canada only gives credit fpr 15% TAX on foreign interest. This is true.

Its worse for US however, as canada gives NO credit for US tax paid on US-sourced interest, by treaty, since, yo uwould not be paying any US tax on that interst if you were not a US citizen. Now, I'm talikng about regular arm's length interest here (ie. bank interest), not interst earned in the conduct of a business in US. Non-US citizens do not pay US tax on bank interest, so canada does not give you a tax credit on any US tax on that interest.

The remedy is, as you suspected, elsewhere. First canada lets you take a deduction for the US tax that it denies as a foreign tax credit. Then, you use the "resourced by treaty" category pf the US foreign tax credit to get back what US taxed.

But, from your question, I sense that you are misunderstanding how to determine the US tax on the interest you made. Remember that if you made $100K of which $1K was interest, the US tax attributable to that interest in only 1% of your total US tax bill, not what the extra $1000 added to your taxbill on the top. It is your effective taxrate, not your marginal rate.

So, unless you EFFECTIVE tax rate is 15%, there is no way you had 15% tax on interest.

Regardless, for US-sourced interst (non-business interest), you can't claim ANY credit.

nelsona · Post by **nelsona** » Mon Jan 12, 2009 5:39 am

CRA's IT-506 discusses this aspect. You would take the deduction at line 256.

nelsona · Post by **nelsona** » Mon Jan 12, 2009 5:41 am

If all this IS busiess interest, you need to look at the Foreign tax credit IT-270.

cfn2007 · Post by **cfn2007** » Sun Jan 18, 2009 1:46 pm

"The remedy is, as you suspected, elsewhere. First canada lets you take a deduction for the US tax that it denies as a foreign tax credit. Then, you use the "resourced by treaty" category pf the US foreign tax credit to get back what US taxed."

This is the first I have heard about deducting the US tax on the Cdn return. Are you supposed to use both of these remedies or just one? I thought that you could simply eliminate all the double tax using the "resourced by treaty" category on the US return? (So the effective US tax after FTC is $0.)

nelsona · Post by **nelsona** » Sun Jan 18, 2009 3:57 pm

Both.

The technical explanation to the treaty (the older one) goes into detail about this. I won't repeat it here.

But, in a nutshell. Any US tax that you cannot use on your Cdn return because of the clause that disallows any tax paid to US which arose strictly because you are a US citizen is treated first as a deduction on your CDn return, and then sufficient US income is resourced on 1116 to use up the rest of the US tax.

cfn2007 · Post by **cfn2007** » Sun Jan 25, 2009 5:50 pm

How do you figure out how much US tax to deduct on your Cdn return? Your average tax rate before your apply the re-source tax credit on 1040 is higher than after taking the FTC, right? Seems to me that the process gets iterative?

I assume this rule would also apply to US-sourced capital gains since US taxes are only owed by virtue of US citizenship? (So in this respect CGs and interest are treated the same in that US taxes are first deducted on line 256.)

Thanks.

nelsona · Post by **nelsona** » Sun Jan 25, 2009 6:53 pm

The treaty (and its technical explanation) describe how to do this. In essence you do your Cdn and US returns once without regard for FTC,

Then you apply all foreign tax credits and limits on your Cdn return, and then you do your US return with FTCs and re-sourcing.

You are correct about US taxes on CGs (non-realestate) and interest yeilding no FTC on the Cdn return, and are thus put on line 256 (in the second pass of Cdn return).

cfn2007 · Post by **cfn2007** » Mon Mar 23, 2009 9:57 pm

I have been trying to figure this out by reading these various bulletins, cruising the CRA site, and playing with Ufile.

Are you sure that US taxes on US bank interest (for a US citizen) get deducted on line 256? From my readings, the CRA says, "Enter on line 256, the amount of your foreign income that is non-taxable in Canada because of a tax treaty with a foreign country." On the contrary, this interest is fully taxable in Canada! If I do need to deduct this on line 256, where in Ufile does this get entered?

As an aside, my research suggested that line 232 was perhaps the correct place to deduct the US tax on US interest??? I don't suppose we are talking about subsection 20(11) or 20(12) deductions, are we? (I'm not really sure if/when those get used.)

Thank you.

nelsona · Post by **nelsona** » Tue Mar 24, 2009 5:25 am

The deduction that you would take on 256 is the US TAX that you are restricted from using as foreign tax credit, not the income from which the tax arises.

cfn2007 · Post by **cfn2007** » Tue Mar 24, 2009 6:32 am

Thanks for confirming that line 256 is indeed the correct place to deduct the US tax (and not line 232).

Yes, I understand that the deduction is on US TAX and not on the US Interest Income. What I can't figure out is the right way to get this into UFile. When I enter the US tax due based on my first pass of my 1040 (~18%), it automatically shows up as a tax credit on my T2202 up to 10%. But from what you have said, this is incorrect. US interest is not creditable in Canada! That's why I asked whether the tax was considered a "deduction under section 20(11) or 20(12)".

Sorry to be a bit slow. I'm really struggling to figure out how to get this to work in practice. Thanks for your patience!

nelsona · Post by **nelsona** » Tue Mar 24, 2009 8:39 am

Yes it is a deduction under those sections.

But, are you sure your US tax is 10%? My effective taxrate is nowhere near that.

cfn2007 · Post by **cfn2007** » Tue Mar 24, 2009 10:02 am

Maybe I'm doing something wrong??? My US average tax rate is coming out at ~15.8% before applying any FTCs. This is ~65k US in Cdn-sourced wages along with ~10k of interest/dividends. I am single and do not itemize.

Do you think this sounds wildly off? Do you think my US tax rate (before FTCs) should be higher/lower for that income level?

nelsona · Post by **nelsona** » Tue Mar 24, 2009 1:58 pm

That's not including FICA, right? FICA only counts against your wages.

And to be clear, only interest/dividend income is limited in its foreign tax credit, not other types of income.

cfn2007 · Post by **cfn2007** » Tue Mar 24, 2009 3:00 pm

No FICA included. I work in live/work in Canada so that's not an issue.

I get these numbers by calculating US federal tax as if all my income was all US-sourced. I understood this was the way to do this since I don't apply any FTCs on the first pass???