Taxpayer double taxed here and abroad wins in court against CRA

In some cases, the CRA is requesting copies of foreign tax returns, showing that foreign tax was, indeed, owing and paid. Photo by BRUNSWICK NEWS/Postmedia

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Nobody wants to pay more than their fair share of tax. So, imagine if you had to pay double tax. In other words, what if the same income was taxed twice, once abroad, and once again in Canada? You wouldn’t be pleased. In fact, you may be so upset that you’re willing to take the tax man to court to fight it.

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And that’s exactly what one taxpayer did when the Canada Revenue Agency refused to grant her foreign tax credits for taxes she paid on investment income she earned outside of Canada. Before delving into the details of this recent case, decided earlier this month, let’s review Canada’s foreign tax credit system.

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Claiming a foreign tax credit is the primary way Canadian residents can avoid paying double tax on foreign income. As Canadian residents, we’re taxable on our worldwide income. That means even income earned abroad, whether it be foreign employment income or foreign investment income, is subject to Canadian tax at domestic, progressive marginal tax rates. But this foreign income, in most cases, is also subject to foreign tax in that foreign jurisdiction. To avoid paying double tax on the same income, you may be entitled to claim a foreign tax credit on your Canadian return for foreign taxes paid on that foreign income.

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For most of us, our only experience with claiming a foreign tax credit likely occurs if we earn foreign dividends, such as U.S. dividends, in a non-registered investment account. Let’s say I own stock in a publicly traded U.S. company with a high dividend yield in my non-registered trading account. The dividend income would be subject to a 15 per cent nonresident withholding tax in the United States. I would then pay Canadian tax on the gross amount of the U.S. dividend income at my normal marginal rates when I file my Canadian return, but be entitled to claim a foreign tax credit for the nonresident tax withheld, thus avoiding double tax.

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In recent years, however, it has become more challenging for some Canadian taxpayers to claim a foreign tax credit, as the CRA is now demanding additional proof that foreign taxes were paid. In some cases, the agency is requesting copies of foreign tax returns, along with transcripts or assessments from the foreign jurisdictions, showing that foreign tax was, indeed, owing and paid. It seems to no longer be sufficient to simply point to the withholding tax shown on a tax slip to be entitled to claim the foreign tax credit. Which brings us to this most recent case.

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The taxpayer is a Canadian resident who holds investment accounts in the U.S. and Switzerland. When she filed her tax returns for her 2021 to 2024 taxation years, she claimed foreign tax credits for withholding taxes paid on dividend income that she earned on shares of German and Swiss companies in those accounts.

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The CRA denied the foreign tax credits, arguing that it was not enough for the taxpayer to show that tax was withheld, but rather that the taxpayer needed to show that she actually had to pay tax to Germany and Switzerland.