According to Moodys Gartner, the transition tax on businesses, introduced by the US Tax Cuts and Jobs Act 2017, may cause some Canadian-resident US individuals with a substantial unexpected US tax liability. They will have to pay the tax without being able to claim it as a tax credit against their Canadian income, unless the Ottawa government decides to allow them relief from this double taxation.
- The Transition Tax applies to the shareholder even if the Canadian corporation has not actually declared a dividend meaning that there is no “source” of income against which to credit the Transition Tax.
- Under Canadian law, dividends received by a shareholder from a Canadian corporation are classified as Canadian source income and therefore the resulting Canadian tax liability is not eligible to be credited for the US tax paid. The general Canadian principle is that US taxes will be creditable only if the income received is US sourced.
At the 2018 Society of Trust and Estate Practitioners (STEP) conference held in Toronto, the Canada Revenue Agency (CRA) confirmed that a Canadian resident shareholder’s Canadian tax liability would not be eligible for a credit to offset the Transition Tax paid (see question #12 of the CRA Roundtable Questions & Answers here). Accordingly, this can lead to double taxation for these unfortunate Canadian residents.
The allowance of a domestic tax credit for foreign tax paid on domestic income is specifically found in the Article XXIV of the Canadian/US Tax Treaty which provides relief by deeming the source of some types of income to be foreign, thereby enabling the use of FTCs to offset the Canadian or US. tax otherwise payable.
Another possible solution would have been for CanadaCo to pay out an immediate dividend of the same amount in 2017, as the income would be included on the personal returns in both countries in 2017.
This problem may also be faced by US citizens living in other countries besides Canada, since most other industrialized countries will not consider this transition tax nor other types of accrued Subpart F income, as taxable in their country:
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The 965 deemed distribution is taxable in the U.S. in 2017, but there is no taxable event in the country of residence and therefore no tax paid in the country of “tax residence”.
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There is no credit allowed for the U.S. tax paid on the individual’s 2017 foreign tax return where he/she actually lives.
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When the amount of the 2017 IRC §965 inclusion is later distributed to the US shareholder, that distribution is taxed in the foreign jurisdiction a second time.
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Therefore, unless the US/Country of Residents tax treaty provides a solution, the §965 inclusion amount will be taxed twice, first by the United States in 2017 and then by the country of residence upon distribution in years after 2017.
Marini & Associates, P.A.
Sources:
Moodys Gartner
Forbes
Read more at: Tax Times blog
