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May I have a question on capital gain, pls? A US citizen

May I have a question...
May I have a question on capital gain, pls?

A US citizen has capital gain from US source (not real estate). He is also a Canadian resident. He reports this CG on Canadian tax return. Could he resource this CG as Canadian income?
Per US - Canada tax treaty, I read the following articles:
article XIII5 - would this paragraph prevent resourcing capital gain as Canadian income?
article XXIV3(b) - would this paragraph allow resourcing capital gain as Canadian income?
article XXIV4 - would this paragraph allow resourcing capital gain as Canadian income?
article XXIV6 - would this paragraph allow resourcing capital gain as Canadian income?
article XXIX2 - would this paragraph prevent resourcing capital gain as Canadian income?

I know the treaty can be conflict by itself, but confused about these articles. But my purpose is to know whether capital gain from US source can be "resourced" as Canadian income and therefore to claim foreign tax credit on 1040?

Pls answer my question by clarifying the treaty articles, not to avoid it.

Thanks!
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Answered in 36 minutes by:
6/26/2013
Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 30,621
Experience: Taxes, Immigration, Labor Relations
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LEV :

Hi and welcome to Just Answer!
For US tax purposes - for nonresidents aliens - the sourcing rules of IRC section 865 must be considered - see for reference - http://www.law.cornell.edu/uscode/text/26/865
For the sourcing of capital gains by nonresident aliens, per IRC section 865(g)(1), gain or loss from the sale or exchange of personal property generally has its source in the United States if the alien has a tax home in the United States. Per IRC section 865(g)(1), the key factor in determining if an individual is a U.S. resident for purposes of the sourcing of capital gains is whether the alien's "tax home" has shifted to the United States. If an alien does not have a tax home in the United States, then the alien’s U.S. source capital gains would be treated as foreign-source.
The issue is that US citizens are taxed on all worldwide income regardless of their residency - so - the sourcing rules would not apply to US citizens.

Similar statement we see in the tax treaty - see article XIII page 27 - http://www.irs.gov/pub/irs-trty/canada.pdf
4. All other elements of capital of a resident of a Contracting State shall be taxable only in that
State.
Thus - if the person is a resident of Canada - capital gain (with a few exemptions is taxed in Canada only.
However - for purposes of the US-Canada tax treaty - see page 9 article IV:
2. Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting
States, then his status shall be determined as follows:
(a) He shall be deemed to be a resident of the Contracting State in which he has a
permanent home available to him; if he has a permanent home available to him in both States or
in neither State, he shall be deemed to be a resident of the Contracting State with which his
personal and economic relations are closer (centre of vital interests);
So far - US citizens having residence in Canada may claim tax treaty benefits and exclude certain capital gains from US taxation.
Please be aware that treaties override general tax law of both countries and there is a special procedure to claim tax treaty benefits.

Customer:

Thanks very much. So on form 8833, I should quote article XIII4?

LEV :

For purposes to claim a tax treaty benefits and exclude that capital gain from US taxable income - you need to mention two articles - article XIII(4) which allow to exclude the gain and article IV(2) which allow you to be treated as Canadian resident.

Customer:

How about article XXIV3(b)? Is it necessary to quote it as well? Thanks again!

LEV :

I do not see any reason to quote this article for US tax purposes. That actually means - if the income is excluded from Canadian tax based on Canadian tax law - you may not claim the article XIII(4) which allow to exclude the gain from US taxable income.

Customer:

Thanks! It clarifies my confusion! So, how about article XXiX(2), does it force US to tax US citizen without regarding to XIII(4)? and how about XIII(5) - does it mean US will tax a US citizen anyway (if US citizen should be recognized as a US resident)?

Customer:

Sorry, how about XXIV3(a), should I quote this one?

LEV :

Let me verify - plz give me some time...

Customer:

Sure, thank!

LEV :

So, how about article XXiX(2), does it force US to tax US citizen without regarding to XIII(4)?
Nothing in the tax treaty forces either contracting state to tax their residents or citizens. However if the tax treaty contradicts a local law - the tax treaty takes priority.
article XXiX(2) states "Except as provided in paragraph 3..." and we see in paragraph 3 - article XIII(4) is not mentioned - and that actually eliminated this article for US citizens.
In this case - seems as your only option is not to exclude the gain on the US tax return - but to claim a foreign tax credit for Canadian taxes.
The person still will be considered a resident of Canada according to the treaty - not a resident of the US - but because of the US citizenship - article XIII(4) may not be used to exclude the gain.

LEV :

In this case - I do not see any reason to claim tax treaty benefits - you may simply claim a foreign tax credit because the same income is taxed in the US and in Canada.
You may need to attach a copy of the Canadian tax return.

Customer:

Well, is it ok by claiming FTC just based on Canadian tax return and not explain that it's "resourced"? As I'm afraid to be challenged that they are all US sourced income, why FTC is claimed on these US income?

LEV :

The issue is not how the income is sourced - but the fact of being taxed in both countries.
FTC is allowable when the same income is taxed if a foreign country to avoid double taxation.

Customer:

Alright. Thanks very much! I know what you mean is reasonable. I would appreciate it if you could possible answer my question about "how about XXIV3(a), does it mean that CG of a resident of US which may be taxed in Canada shall be deemed to arise in Canada? It's too late today. You may answer tomorrow if you don't mind. Thanks very much!

LEV :

I agree with you.
The treaty does defines who is a resident of the contracting state - so for purposes of the tax treaty - an US citizen living in Canada is a resident of Canada - that is based on article IV(2).
Still the article XIII(4) allows to exclude the gain by Canadian residents - but such exclusion is not available for US citizens who are Canadian residents - article XXIX(2) that you correctly pointed.
So article XXIX(2) effectively overrides article XIII(4) for US citizens.
"how about XXIV3(a), does it mean that CG of a resident of US which may be taxed in Canada shall be deemed to arise in Canada?
This statement is correct - but it may be only used for "for the purposes of this Article" - and may not be used for other purposes. Specifically - according to XXIV(4) - where a United States citizen is a resident of Canada - the person should claim first a foreign tax credit on the Canadian tax return - and after that credit applied - he/she may claim FTC on the US tax return.
But that is in case you choose to claim tax treaty benefits.

Customer:

Thanks so much for your hard work. In this case, he didn't pay withholding tax on CG to US and he filed Canadian return first. So on his Canadian return, no FTC is claimed. When he files 1040, he can claim FTC for Canadian tax paid by quoting treaty article XXIV(4), right?

LEV :

I see two possible resolutions.
1. File Canadian tax return; Do not claim tax treaty benefits; File US tax return and claim FTC for Canadian taxes.
2. File US tax return; Claim tax treaty benefits with Canadian tax return and FTC for US taxes.
When he files 1040, he can claim FTC for Canadian tax paid by quoting treaty article XXIV(4), right?
Specifically - according to XXIV(4) - where a United States citizen is a resident of Canada - the person should claim first a foreign tax credit on the Canadian tax return - and after that credit applied - he/she may claim FTC on the US tax return. So if you will use tax treaty provision - FTC should be claimed on Canadian tax return.

Customer:

What you mean is he should file US return first, and claim tax paid to US on Canadian return as FTC (eg, $200). If after claiming this FTC on Canadian return, he still needs to pay Canadian tax, (say $100), he can claim $100 on MODIFIED US return?

Customer:

So in this case, your first option File Canadian tax return; Do not claim tax treaty benefits; File US tax return and claim FTC for Canadian taxes is a better choice, because he can fully use $300 tax as FTC on 1040, am I right?

Customer:

Sorry, File US tax return and claim FTC for Canadian taxes shouldn't be in the quote of my previous typing.

LEV :

If after claiming this FTC on Canadian return, he still needs to pay Canadian tax, (say $100), he can claim $100 on MODIFIED US return?
Yes - that is correct. But that is in case if you choose to use tax treaty benefits - article XXIV(4) - where a United States citizen is a resident of Canada - the person should claim first a foreign tax credit on the Canadian tax return.
If you will not claim tax treaty benefits - you may simply claim FTC on your US tax return - that is according to the US tax law.
So far - I do not see any reason to use the tax treaty.

Customer:

Thanks so much for your patient answer on this complicated question! I would like to rate you now, but will have some other questions. Would you like to reply me back so we can continue on this chat or I will use reply function to ask another question? Thanks again and talk to you soon!

Lev
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Customer reply replied 4 years ago

Hi: Lev


 


I checked guide for form 1116. Yes, it doesn't say anything that FTC should be tax paid on FOREIGN sourced income, but says in my case, if tax paid to Canada (say 300 in total), then it could be fully claimed. Just to confirm do I understand it correctly? As you said, what I need to do is to attach Canadian return with 1040, right?


 


Thanks again!


 


 

Attaching Canadian tax return is not required.
If the amount is relatively small - such as $300 in your situation - I do not think attaching would be needed.
But for large amounts - the IRS usually requires to provide supporting documents and that may delay processing.
So - if you are mailing the tax return - I suggest to attach your Canadian tax return. But you are not required to do so.
Ask Your Own Tax Question
Customer reply replied 4 years ago
Hi: Lev

My concern is still whether to claim full amount ($300 in this case) is eligible without quoting treaty articles according to IRS guide.

I read the guide of F1116, the quote the followings:

"Foreign Taxes Eligible for a Credit You can take a credit for income, war profits, and excess profits taxes paid or accrued during your tax year to any foreign country or U.S. possession, or

any political subdivision (for example,

city, state, or province), agency, or

instrumentality of the country or

possession. This includes taxes paid or

accrued in lieu of a foreign or

possession income, war profits, or

excess profits tax that is otherwise

generally imposed. ....
U.S. citizens living in certain treaty

countries may be able to take an

additional foreign tax credit for foreign

tax imposed on certain items of income

from the United States. See Tax

Treaties in Pub. 514 for details.

On PUB514, I found the followings:


"Re-Sourced By Treaty

If a sourcing rule in an applicable income tax

treaty treats U.S. source income as foreign

source, and you elect to apply the treaty, the in­

come will be treated as foreign source.

You must compute a separate foreign tax

credit limitation for any such income for which

you claim benefits under a treaty, using a sepa­rate Form 1116 for each amount of re­sourced income from a treaty country. See sections

865(h), 904(d)(6), and 904(h)(10) and the regu­lations under those sections (including Regula­tion section 1.904­5(m)(7)) for any grouping

rules and exceptions


Could you kindly confirm resourcing is not a necessary prerequisite for FTC to be claimed?

Thanks!


The issue with using tax treaty benefits is - that you are required claim a FTC in the country of your residence - which is Canada.
However - claiming tax treaty benefits is optional - and you are not required to do so.
Considering your situation - you may simply claim a FTC on your US tax return - that is according to the US tax law without any regards XXXXX XXXXX tax treaty.
As an alternative - you may deduct the full amount of foreign taxes - including provincial taxes on schedule A.
You may verify which way is more beneficial.

The statute related to the FTC - see here - http://www.law.cornell.edu/uscode/text/26/subtitle-A/chapter-1/subchapter-N/part-III/subpart-A
Specifically - see section 901(b) Amount allowed
Subject to the limitation of section 904, the following amounts shall be allowed as the credit under subsection (a):
(1) Citizens and domestic corporations
In the case of a citizen of the United States and of a domestic corporation, the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States;

So far - I do not see specific requirements related to income sourcing.
Lev
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Category: Tax
Satisfied Customers: 30,621
Experience: Taxes, Immigration, Labor Relations
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Customer reply replied 4 years ago

Thanks very much for your detailed explanation. I really appreciate it!

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