How to Claim the Canada Foreign Tax Credit

The Canada Foreign Tax Credit (FTC) is a non-refundable tax credit designed to prevent double taxation. For Canadian residents who earn income from sources outside of Canada, that income may be taxed by the foreign country where it was earned and then again by Canada. The FTC provides relief by allowing these individuals to reduce their Canadian income tax payable by the amount of foreign taxes they have already paid on that same income. The credit directly offsets Canadian tax liability, providing a dollar-for-dollar reduction up to a certain limit.

Eligibility for the Foreign Tax Credit

To claim the Foreign Tax Credit, an individual must first be a resident of Canada for tax purposes at some point during the year. The credit is available to individuals, corporations, and trusts that meet the necessary conditions, though the rules discussed here focus primarily on individuals.

The second condition is that the individual must have earned income from a foreign country and paid an income or profits tax to that country on the earnings. It is not enough to have simply earned foreign income; proof of foreign tax paid is necessary. The income must be reported on the Canadian tax return.

Qualifying Foreign Income and Taxes

Qualifying income is separated into two categories: non-business and business income. Non-business income includes earnings from foreign investments like dividends, interest, capital gains, foreign pension payments, and employment income earned abroad. Business income refers to profits from operating a business in a foreign country.

Only “income or profits taxes” paid to a foreign government qualify for the credit. This includes foreign withholding tax on dividends, interest payments, and income taxes on foreign employment earnings. Contributions to foreign public pension plans, like U.S. FICA taxes, can also be considered a non-business income tax.

Foreign taxes that are not eligible for the credit include:

• Value-added taxes (VAT)
• Sales taxes
• Property taxes
• User fees paid to a foreign government

Any foreign tax paid that exceeds a tax treaty limit is considered a voluntary contribution and does not qualify.

Calculating the Federal Foreign Tax Credit

The Federal Foreign Tax Credit is the lesser of two amounts: the foreign income tax you paid, and the Canadian tax otherwise payable on your net foreign income. This limitation ensures the credit only offsets the Canadian tax that would have been paid on that specific foreign income. All calculations must use Canadian dollars.

The Canadian tax payable on foreign income is determined by the formula: (Net Foreign Income / Total Net Income) x Canadian Federal Tax Payable. For non-business income, this calculation is done separately for each country, while for business income, income from all foreign sources can be pooled.

For example, assume your total net income is $80,000, including $8,000 in U.S. dividends, and your Canadian federal tax is $12,000. You paid $1,200 in U.S. withholding tax. The Canadian tax on your foreign income is ($8,000 / $80,000) x $12,000, which equals $1,200.

Since the foreign tax paid ($1,200) is not more than the Canadian tax payable on that income ($1,200), the allowable credit is $1,200. If the foreign tax paid had been $1,500, the credit would be capped at $1,200. For income from foreign property, excluding real property, the creditable tax cannot exceed 15% of the net income from that property.

How to Claim the Credit on Your Tax Return

To claim the credit, you must complete Form T2209, Federal Foreign Tax Credits. On this form, you report the results of your calculations, including net foreign income and foreign taxes paid for each country. A separate form, such as Form T2036, is used to claim the corresponding provincial or territorial foreign tax credit.

If you use certified tax software, the program will guide you through the foreign income section and automatically generate Form T2209. The completed form is then transmitted electronically to the CRA with your T1 income tax return.

For those who file a paper return, a physical copy of Form T2209 must be completed and attached to the T1 return. Whether filing electronically or by paper, you must keep all supporting documents, such as foreign tax statements or pay stubs, on file in case the CRA requests to see them.

Handling Unused Foreign Tax Credits

If the foreign income tax you paid exceeds your allowable credit for the year, you may have an unused foreign tax credit. The rules for this excess amount differ for business and non-business income.

For foreign business income, unused credits can be carried back three years and forward for 10 years to offset Canadian tax on foreign business income in other years.

For foreign non-business income, there is no carryforward or carryback provision. However, the portion of the foreign tax not claimed as a credit may be claimed as a deduction from your income.