Claiming the Foreign Tax Credit in Canada

The Canadian Foreign Tax Credit (FTC) prevents double taxation for Canadian residents who earn income from other countries and pay foreign taxes on it. The credit’s function is to prevent the same income from being taxed by both a foreign country and Canada. It is a non-refundable credit, meaning it can reduce a taxpayer’s Canadian income tax liability to zero but will not generate a refund on its own.

Eligibility for the Foreign Tax Credit

To qualify for the Foreign Tax Credit, a taxpayer must be a resident of Canada for tax purposes during the year the foreign income was earned. The individual or corporation must have also paid income tax to a foreign government. This same income must be reported on the taxpayer’s Canadian income tax return for that year.

Taxes paid on income or profits, such as foreign employment income tax or tax on investment earnings, qualify for the credit. However, not all payments to foreign governments are considered eligible income taxes. For instance, the following do not qualify for the Foreign Tax Credit because they are not considered taxes on income:

• Foreign sales taxes
• Value-added taxes (VAT)
• Property taxes
• Customs duties

Information and Forms Required to Claim the Credit

To claim the credit, a taxpayer must gather proof of the foreign income earned, such as foreign pay stubs, a U.S. W-2 form, or investment statements. Proof of the foreign income tax paid is also required. This can include an official notice of assessment from the foreign tax authority, receipts, or statements showing the amount of tax withheld at the source.

All financial amounts from a foreign currency must be converted to Canadian dollars. The Canada Revenue Agency (CRA) requires using the Bank of Canada’s exchange rate from the day of the transaction. If income was received over a period, an average exchange rate for that period can be used.

The primary form for this credit is Form T2209, Federal Foreign Tax Credit, which is used to calculate the credit for both non-business and business foreign income. When completing the form, you must enter the country where the income was earned, the total foreign income, and the foreign tax paid. If you have income from multiple countries, a separate calculation is required for each one.

Calculating the Foreign Tax Credit

The calculation of the Foreign Tax Credit is based on a key principle: the credit is limited to the lesser of two amounts. The first is the actual foreign income tax you paid. The second is the amount of Canadian tax that is payable on your net foreign income. You cannot claim a credit that exceeds the Canadian tax attributable to that same income.

To determine the Canadian tax payable on foreign income, you multiply your basic federal tax by a fraction. The numerator is your net income from the specific foreign country, and the denominator is your total net income from all sources. For example, if your basic federal tax is $10,000, net foreign income is $20,000, and total net income is $100,000, the Canadian tax payable on your foreign income is $2,000. If you paid $2,500 in foreign tax, your credit would be limited to this $2,000 amount.

The calculations for foreign business income and foreign non-business income must be done separately, as different rules and limitations apply to each. For instance, the credit for non-business income from property may be limited to 15% of the net income from that property.

Foreign Tax Credit Carryover Provisions

If the foreign tax paid in a year is higher than the maximum credit you can claim, special rules apply. This can happen when the foreign tax rate is higher than the Canadian rate on the same income. For foreign non-business income, this excess tax cannot be carried to other years as a credit, but the unused portion may be claimed as a deduction against that same foreign income.

The situation is different for unused foreign tax credits related to business income. If the foreign tax paid on business income exceeds the allowable credit for the year, these excess credits can be carried over. The rules permit these unused business credits to be carried back three years and carried forward for ten years. This allows a business to apply the unused credit to reduce Canadian taxes on foreign business income in years where the Canadian tax might be higher.

To apply these unused credits, a taxpayer must request an adjustment to a prior year’s tax return for a carryback or claim the amount on a future tax return for a carryforward. This process allows businesses to eventually get relief for the foreign taxes they have paid, even if they cannot use the full amount in the year the tax was incurred.