claiming treaty credit treatment

[kal2]

Hello. Can someone suggest a resource for figuring out how a US citizen living in Canada can treat US-source interest income as foreign source income for foreign tax credit purposes? This operates outside form 1116, right? Or has it been integrated into that form? I find all the publications on this issue to be amazingly unclear on this process, and the worksheet to be very confusing.

[nelsona]

http://www.irs.gov/pub/irs-trty/canatech.pdf

You use 1116, but the category is "re-sourced by treaty".

First you need to determine how much tax your US interest is being taxed in both countries. Remember it is the EFFECTIVE taxrate of all your income that determines this. So, you first need to prep your US and Cdn tax returns, without foreign tax credits.

Normally, you would then simply take the US tax attributable to the US income and use this as a credit on your Cdn return. However, since canada -- by treaty -- will not give you any credit for US tax on interest (since you would not owe any tax if you were not a US citizen). you follow this process:

say the amount of Cdn tax on the interest (say $100) was $10, and the amount of US tax on the interst was $4 (remember -- EFFECTIVE tax rate, not marginal).

Since you cannot use the $4 as a credit, canada first allows you to deduct the $4 on line 256. that's all for canada.

US then allows you to resouced enough US interest to create a $4 credit on your 1116 for re-sourced income.

The result is that you pay $10 in canada, 0 in US and you get a little deduction in canada extra.

[triunbad]

Is it possible at this point, if I am filing three years of US returns, to send in the US returns, pay tax in the US, and then file amended tax returns in Canada applying for the foreign tax credit on the Canadian return?

[nelsona]

Yes. But you really should not have any Us tax liability, and b, you can't get any creit for US tax paid on Cdn income.

[dw]

In order to take the deduction on the Canadian return, wouldn't one have to have actually paid the tax to the US? If I am understanding this correctly, by re-sourcing the interest income on the form 1116, the tax is reduced to zero. This makes me think the Canadian deduction wouldn't be allowed.

[nelsona]

The deduction is a special treatment reserved for US citizens becuae of not being allowed a credit. It is spelled out in the treaty.

[lanman2000]

[quote="nelsona"]http://www.irs.gov/pub/irs-trty/canatech.pdf

US then allows you to resouced enough US interest to create a $4 credit on your 1116 for re-sourced income.

[/quote]

How do you calculate the amount of US interest to resource that would result in creating that $4 credit? That's the part I'm struggling with.

[nelsona]

The simplest wy is by plugging in a value in your re-source 1116 unti lyou get $4.

Surely you are using software to do these forms.

[dw]

Is it a requirement that you limit the amount of tax paid in Canada to just the amount owed? Why not carry over the unused credit in case you need it in a future year? Is this not allowed? Thanks in advance.

[nelsona]

We are talking about a special provison here Dw, not run-of-the-mill FTC.

In this case IRS is given a foreign tax credit on THEIR TAX on US income, thus special rules must be followed.

[lanman2000]

hypothetical question... if your effective tax rate in the US was the same as in Canada you would have to re-source ALL of the interest right? Same if your US effective tax rate was higher than your canadian one.

[nelsona]

Sure, but it won't be.

[lanman2000]

they were pretty close to being the same effective rate for me because I had a large RRSP deduction and employment expenses that I was able to deduct on my canadian return that I was not able to deduct on my US return.

[nelsona]

like I said....