Claiming a Foreign Tax Credit on Form 1116 for third-country income

[komensky]

Dual Canadian/US citizen, resident of Canada. Only income is from earned income in Canada (below the FEIE limit), plus US and Czech bank interest (above the US standard deduction).

The Canadian-Czech tax treaty (Article 11) says that interest income is “deemed to arise” in the country of residency (thus in Canada), but the Czechs are allowed to impose a 10% tax, for which I take a FTC on the Canadian return on form T2209.

My question is how to take a Foreign Tax Credit on form 1116 for the Czech and Canadian taxes paid on the Czech bank interest.

My thinking is that since the treaty re-sources the Czech interest to Canada, I should just list this income as Canadian-sourced on form 1116 (passive), calculating the tax rate before taking the FTC on the Canadian return for the Czech tax. And of course a second 1116 (re-sourced by treaty) to account for the US bank interest.

Is this the correct approach, or should I list this Czech interest income twice under Canada and the Czech Republic in columns A and B on form 1116, and then somehow split the tax between them? I don’t see any guidance anywhere on how one would do this sort of calculation, so I’m thinking this can’t be the right approach.

(US and Czech bank interest is otherwise listed normally on Schedule B, and FBAR, 8938 and T1135 are filed.)

[nelsona]

Did you notice that form 1116 has three columns, for three different countries?
You would report the Czech income separate from the Cdn income. You would need to check the czech-US treaty to see what relief you are entitled to on form 1116.

[nelsona]

you would not include the czeck income under Canada. Your relief for any Cdn tax would be on your CDn return.

[komensky]

Thank you for your response.

I don't believe that the US-Czech treaty applies, because not a resident of either country. For what it's worth, though, this treaty has a similar sourcing provision for interest, but doesn't allow the Czechs to impose the 10% tax.

[komensky]

So just to be clear, what you're saying is that even if income from a third country is re-sourced by treaty to Canada, the IRS will not recognize it as Canadian-sourced income for the purposes of avoiding double taxation through a FTC. Correct?

[nelsona]

Resourced by treaty means that a specific clause in a treaty allows, for the purposes of tax credit to re-source the income. Simply "deeming it to arise" in my opinion does not make the income eligible for "re-sourced by treaty treatment" especially since that is not part of the treaty between US and Czech.

So, Canada will give you credit for the czech tax you paid.

US will give you credit for for the Czech tax you paid, on 1116 passive as czech income. Canada has nothing to do with this income with respect to foreign tax credit. No need to re-source since it is foreign income, eligible for FTC by IRS rules, without need of a treaty.

This should satisfy you as you are getting to take credit for the same interest twice.

Just so you understand what re-sourced by treat applies, it applies in your case to US INTEREST, That interest should be put on a re-sourced 1116, and should reduce your US tax to zero on that interest.

Resourced by treaty in US terms means US-sourced income (not Cdn, not Czech) is "re-sourced' to canada, so that foreign tax credit can be given by the IRS.

This of course means that you are not allowed to claim any tax credit on your Cdn return for any US tax that arises from the US interest, as Canada i not required nor will they grant credit for any US tax that is only being taxed because of your citizenship. This the "re-sourced" provision that US allows to prevent double taxation.

[komensky]

OK, I think I understand now. Thank you for taking the time to write out this clear and detailed explanation. I appreciate it.

Taking the FTC on 1116 (passive) for the 10% Czech tax does mostly eliminate the US tax liability for this income, at least at my current income level.

So just to sum up, in case it could be useful to others: as a general rule, it's only possible to take a FTC credit on the US return for income tax paid in the foreign country where the income originated, not for income tax paid on that income in another country (in this case, Canada).

And just as a hypothetical, if the Canada-Czech treaty did not allow the Czechs to impose a 10% tax on this income, then I would simply have to pay tax on this income on both my Canadian and US tax returns, with no possibility of a FTC on either of them.

Please correct me if this is inaccurate, and thank you again for your help.