Canadian resident taxpayers are subject to income tax on their world-wide income. As a result, the individual is required to report foreign source income such as foreign employment income, foreign investment income, foreign pension income, etc. on their income tax return each year.
The income is required to be converted to Canadian dollars before reporting, and foreign tax credit could be claimed for any foreign taxes paid. This may sound simple but taxpayers need to use the appropriate conversion rates, and be sure that the foreign taxes paid qualifies for any foreign tax credit.
As the 2017 Canada Tax Season approaches, the following should provide you some insight into the taxation of foreign income in Canada and the appropriate conversion rates to use.
Conversion of Foreign Income Amount to Canadian Amount
Generally, the foreign income is earned in the currency of the foreign country, which needs to be converted to Canadian dollars, before being reported on the Canadian income tax return.
The foreign currency amount is converted to Canadian dollars based on either the foreign exchange rate prevailing on that particular transaction date, or as per the average exchange rate in effect for the period the income was earned. For example, if the taxpayer earned employment income for the period January 1 to March 31, the average rate for these three months should be used. The Canada Revenue Agency uses specific rates published by the Bank of Canada for that period.
NOTE: Canadian taxpayers should, however, be aware that effective March 1, 2017, the Bank of Canada will be changing how it publishes foreign exchange rate data to a single rate reflecting the daily average exchange rate each day at 4:30 PM ET.
At times, the foreign employer or payer may convert the income or expense amount to Canadian dollars before giving it to the Canadian individual. In this case, the Canadian person should report the amount as it is, with no conversion required.
Seeking professional help with the conversion of the foreign currency, and determining whether the income is foreign-sourced or Canada-sourced is advisable to avoid any tax consequences.
Claiming The Canada Foreign Tax Credit (FTC)
The Canadian foreign tax credit (FTC) allows the taxpayer to deduct a certain amount of the taxes paid in a foreign country with regards to the foreign income earned through employment, business, or investments from their Canadian tax otherwise payable on that income during a particular tax year.
The maximum tax credit that can be claimed will be equal to either the full foreign tax amount paid or the Canadian tax payable on the foreign income, whichever is lower.
There are certain important points to keep in mind regarding Canadian foreign tax credit:
- The credit for tax paid on income from property such as interest and dividends may not exceed 15%.
- Certain foreign non-business taxes may be claimed as a deduction from income, as a foreign tax credit or combination of both.
- The calculation of foreign tax credit for foreign business income varies from the calculation of FTC for non-business income.
- It should be ensured that the foreign tax credit for foreign non-business income taxes are deducted before the business foreign tax credit. This is done because unused business foreign taxes are allowed to be carried forward while non-business taxes are not, thus, allowing taxpayers to maximize FTC claims over the years.
- A separate foreign tax credit calculation is required for each foreign country a taxpayer has paid an income, profit, or capital gains tax.
- The foreign tax credit calculation may vary if the FTC is related to authorized foreign bank or resource companies.
- Canadian FTC cannot be claimed for foreign taxes paid as real estate taxes, inheritance tax, etc.
- If a tax-treaty exists between Canada and the foreign country and the income is not subject to taxes in the foreign country, then that income cannot be included to arrive at the foreign tax credit amount. For example, a resident of Canada receives income from sources in another country which has been subject to withholding tax at a rate in excess of the rate specified in a treaty between Canada and that country, such excess is not considered to be foreign tax paid for the year for purposes of the foreign tax credit. The maximum credit allowed will be determined on the basis of the treaty rate and the taxpayer should seek a refund of the excess withholding tax from the foreign revenue authorities.
- Furthermore, the Canadian foreign tax credit (FTC) has to be manually calculated and added to the Form T1, Canada Personal Income Tax Return.
Given the above mentioned conditions, it is highly recommended that the taxpayer consults an international cross border tax expert to calculate the correct FTC amount, since an incorrect claim could lead to severe tax penalties and complicate the tax situation.
Canadians Tax Forms for Reporting Foreign Income
In order to claim foreign tax credits, the Canadian taxpayer would need to comply with the filing of the following tax forms:
Schedule T2209, Federal Foreign Tax Credit
The federal foreign tax credit is calculated on Schedule T2209, and at least a portion of it should reduce your taxes payable.
Schedule T2036, Provincial Foreign Tax Credit
The provincial or territorial foreign tax credit is calculated on Schedule T2036. If the federal foreign tax credit is less than the foreign tax you paid, you may also be able to claim a provincial or territorial tax credit. For territories, and provinces other than Quebec, form T2036 Provincial Foreign Tax Credit is used.
Form T1135, Foreign Income Verification Statement
Qualifying Canadian taxpayers with foreign property, assets, or accounts with a cost equal to or more than CAD $100,000 during the year need to file Form T1135, Foreign Income Verification Statement. The taxpayer can be an individual, a trust, or a corporation as long as they are ‘Canadian resident’ taxpayers.
Foreign Tax Credits prove to be very useful when a taxpayer is subject to tax reporting in two or more countries specially to avoid double taxation. However, claiming the correct FTC amount, deciding between the credit or deduction and being tax compliant with all the tax authorities involved can be quite challenging and time-consuming.
If you are a Canadian taxpayer with U.S. or other foreign income or a U.S. resident or citizen taxpayer with Canadian or other foreign income, it is best practice to consult a cross-border tax specialist. U.S. taxpayers may also consider professional help in choosing between FTC and Foreign Earned Income Exclusion, or how to divide their incomes between the two tax benefits to maximize their tax savings.
AG TAX LLP CAN HELP
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of US and Canadian tax laws as well as cross-border compliance.
Furthermore, as a full service accounting firm, AG Tax assures complete assistance with even your most complex tax needs.
We can assist with:
- Canadian Personal and corporate tax returns
- Cross Border Taxation and Business Planning
- US Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
To obtain a quote or to arrange for a tax consultation to discuss your queries, please contact us at:
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Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.
