How to Claim Foreign Tax Credit?
While Canadian residents are obligated to pay taxes on their global income, they can go for a foreign tax credit to reduce the taxes. That's because the federal government of Canada allows them to do so. But first, there are requirements you must meet to qualify.
If you’re a Canadian resident with worldwide income streams, your foreign income is subject to taxation. Perhaps you are running global businesses overseas or employed in a foreign country. Thankfully, you can claim a foreign tax credit to avoid double taxation.
This guide explores the basics of Canada’s foreign tax credit. You’ll learn how the tax credit works and how you can claim it to avoid getting taxed twice.
Let’s get started.
How the Foreign Tax Credit Works
Canadian residents are obligated to pay taxes on their income, including payments from foreign countries. However, most countries where you earn foreign income may want you to pay taxes to them. And it makes sense as you made money in their country.
So, what happens when both Canada and another country want to tax your income?
The good news is that the Canadian government will allow you to claim a tax credit to reduce double taxation. Notably, the foreign tax credit is available to taxpayers who have been Canadian residents at any time within the tax year.
To claim your foreign tax credit, you have to reveal the country where you generated the income. You also have to disclose your gains, profits, losses, and types of business that gave you the money, whether foreign business income or foreign non-business income.
If you have income from several countries, you have to submit separate foreign income tax credit forms for every country. In addition, if you have both foreign business income (FBI) and foreign non-business income (FNBI), you also need to submit separate forms.
Now, let’s look at how the two types of foreign businesses work.
Foreign Business Income (FBI)
FBI is the total amount of income a taxpayer earns from businesses running in a foreign country. So, any amount regarded as property income is subject to the FBI as business income. That is if the earnings are incidental to the taxpayer’s business activities.
Foreign Non-Business Income (FNBI)
FNBI is the total income a taxpayer earns from non-business activities or programs in a foreign country. Such income sources are pension income, director’s fee, employment income, dividends, commissions, interests, and taxable capital gains.
Capital gains on publicly traded securities would become foreign income if the securities got traded on the foreign stock exchange market. But if the income is exempt from income tax in the foreign country, it won’t be part of the foreign tax credit calculations.
Eligibility for CRA Foreign Tax Credit due to Tax Treaties
You can be eligible for the CRA foreign tax credit if there’s a tax treaty between Canada and a foreign country. Fortunately, Canada has tax treaties, or agreements, with several foreign countries, including the United States, United Kingdom, France, and Argentina.
The main purpose of the tax treaties is to avoid double taxation and prevent residents from evading taxes on foreign-earned income. Most importantly, tax treaties give Canada and other countries criteria to enforce or solve disputes over foreign income.
The tax treaties offer possible resolutions to potential tax disputes by defining residency and eligibility requirements for tax exemptions. In addition, they can lower tax amounts on interest and dividends. Finally, the treaties outline taxation on many income sources.
U.S. – Canada Tax Treaty
The Canada – U.S. tax treaty is perhaps the most common in Canada because of the proximity of both countries. The treaty has been fully functional since 1980 and has had at least five protocols added to it. The most recent one was in 2008.
Foreign income tax credits can apply in many key areas of the treaty, such as income earned in the U.S. For example, a treaty covering the income of a self-employed Canadian owning a U.S.-based business and the cash earned from U.S. pensions and annuities.
How to Claim the Foreign Tax Credit in Canada
If you reside in Canada, you must declare the income earned outside the country when filing your Canadian tax return. You will get taxed on the income. However, if you had already paid tax on the income outside Canada, you can claim it as a foreign tax credit.
The foreign tax credit isn’t refundable but can help to reduce the tax payable in Canada. To maximize the opportunity, ensure that you keep records of your payment documents or copies of your earnings and tax returns.
For that reason, it’s essential to file your tax returns in Canada before you claim the foreign tax credit. It will help you determine the amount of money to claim as a tax credit. You can claim a territorial or provincial tax credit, depending on where you live.
How to Claim Territorial or Provincial Foreign Tax Credit
Provincial and territorial tax credits can apply to non-business foreign income earned in other countries where tax treaties with Canada exist.
Suppose you calculate your federal foreign income tax credit and find that the foreign income tax you paid for non-business income is higher than what the federal income tax credit allows. In that case, you’ll claim a foreign tax credit from your territory or province.
To qualify for the provincial or territorial tax credit, your non-business taxes must not be less than $200. You must fill out the form for every foreign country where you earned income. However, the application for the tax credit varies in Manitoba and Quebec.
When some of your income sources are in other countries, a foreign tax credit can be a great way to reduce your taxes. All you need to do is prepare the documents that show your foreign income and tax returns. But first, consider filing your tax returns in Canada. Then, you have to convert the foreign income and foreign taxes to Canadian dollars.