Foreign Tax Credits: Common Errors and CRA Adjustments
When Canadians earn income abroad, through employment, investments, or business activities, that income is typically taxed in the country where it’s earned. Canada also taxes residents on their worldwide income. This overlap in taxation authority can result in the same income being taxed twice. To prevent this, the foreign tax credit (FTC) allows taxpayers to claim a credit on their Canadian return for qualifying foreign income taxes paid.
Used correctly, the FTC reduces Canadian tax owing by the amount of eligible foreign tax, within the limits set out in section 126 of the Income Tax Act and applicable tax treaties. The goal is straightforward: to ensure that income is taxed only once, not twice. In practice, however, the rules are technical, and the documentation requirements are demanding. Mistakes in calculating or applying the credit are common, and the Canada Revenue Agency (CRA) frequently adjusts claims during review or audit to correct them.
Understanding where these errors occur can help taxpayers avoid reassessments, penalties, and interest, while maintaining compliance in an increasingly complex cross-border environment.
Claiming the Wrong Type of Foreign Tax
Not all foreign taxes qualify for a credit under section 126 of the Income Tax Act. Only foreign income or profit taxes that are substantially similar to Canadian income tax are generally eligible.
Common mistakes include:
- Claiming withholding taxes on exempt income (for example, treaty-exempt pension or dividend income).
- Attempting to claim foreign property or wealth taxes, which are generally not income-based.
- Including social security or payroll contributions, which are generally not creditable unless they specifically qualify under a tax treaty.
The CRA frequently adjusts FTC claims to remove ineligible taxes or reclassify them as deductible expenses instead.
Using Gross Instead of Net Foreign Income
A common error when claiming the FTC is calculating the credit based on gross foreign-source income rather than the net income that was actually subject to tax in the foreign jurisdiction. Under subsection 126(1) of the Income Tax Act, the FTC is limited to the portion of Canadian tax otherwise payable on the foreign-source income, which must be determined on a basis consistent with the income that was taxed abroad.
The CRA’s long-standing administrative position is that foreign-source income must be computed using Canadian tax principles, but on the same conceptual basis as the income against which the foreign tax was levied. If the foreign jurisdiction imposed tax on income after deducting locally allowed expenses, the corresponding foreign-source income for Canadian FTC purposes must also reflect those expenses. Using a gross revenue figure inflates the foreign-source income and leads to an overstated credit, contrary to the limitation formula in subsection 126(1).
Example:
A Canadian resident operates a consulting business in the United States and earns USD $100,000 of gross revenue. On the U.S. return, the taxpayer deducts USD $30,000 of business expenses, and U.S. tax is paid on the net USD $70,000 of income. For FTC purposes, only USD $70,000 constitutes the relevant foreign-source income. Calculating the credit on the full USD $100,000 may overstate the taxpayer’s limitation and is inconsistent with subsection 126(1) and CRA policy.
This principle applies equally to employment, business, and investment income. Where taxpayers report gross foreign amounts without adjusting for expenses actually deducted abroad (or deductible under Canadian principles), the CRA routinely recalculates the allowable FTC on a net-income basis. This often results in a reduced credit and, in some cases, interest or penalties following reassessment.
Failing to Apply the FTC Limitation Formula
The FTC cannot exceed the proportion of Canadian tax payable that applies to the foreign-source income. The foreign tax credit cannot exceed the portion of Canadian tax otherwise payable that is attributable to the taxpayer’s net foreign-source income. The calculation is:
FTC = (Net foreign income ÷ Net world income) × Canadian tax otherwise payable
This limitation ensures that the FTC does not reduce Canadian tax on domestic income. It restricts the credit to offset only the Canadian tax payable on the specific foreign-source income. When taxpayers omit the formula and claim the full foreign tax paid, the CRA routinely recalculates the credit using the statutory limitation and disallows any excess FTC claimed.
Double Counting Across Multiple Jurisdictions
Double counting across multiple jurisdictions is a significant issue that can lead to errors. When income is earned in more than one foreign country, taxpayers sometimes combine all foreign taxes into a single total on their Canadian return. However, the CRA requires that the foreign tax credit be calculated separately for each country in which the income is sourced and foreign tax is paid.
This separation is important because each jurisdiction may have different foreign tax rates, treaty provisions, and FTC limits under section 126 of the Income Tax Act. When income and taxes from several countries are merged, it becomes impossible to verify whether the correct limitation and treaty rules were applied for each one. For example, a taxpayer receiving dividends from both the United States and the United Kingdom must determine the income and tax withheld from each country individually; combining them into a single figure can distort the allowable credit.
The same issue can arise when income is earned through partnerships or other flow-through entities with operations in multiple jurisdictions. Without properly allocating the income and related foreign taxes by country, the CRA may recalculate the claim and reduce the credit.
Maintaining a clear, country-by-country breakdown of foreign income and foreign taxes is crucial. It ensures the FTC is computed correctly, aligns with applicable treaty obligations, and minimizes the likelihood of CRA adjustments or reassessments. By isolating income and taxes by country, taxpayers can demonstrate a clear audit trail and ensure the FTC is calculated in accordance with section 126 and any relevant tax treaties.
Missing or Inadequate Documentation
The CRA frequently requests proof to support foreign tax credit claims, such as foreign tax returns, assessments, or withholding slips. When these records are incomplete, inconsistent, or lack clear explanations, the CRA may deny the credit, even if the foreign tax was legitimately paid.
In most cases, electronic brokerage statements or PDF copies of tax vouchers are acceptable, provided they clearly identify the type of income, the amount of foreign tax withheld, and the country and payer involved. The objective is to establish a direct and verifiable link between the foreign-source income reported in Canada and the foreign taxes actually paid.
Delays or gaps in providing this documentation are among the most common reasons the CRA reduces or disallows FTC claims. Maintaining organized, accessible records and supplying them promptly during a review can make the difference between a smooth review and a costly reassessment.
Overlooking Treaty Relief and Carryover Provisions
It is worth noting that tax treaties may reduce or eliminate foreign taxes; however, taxpayers sometimes overlook these provisions and claim credits based on the unreduced foreign tax. In such cases, the CRA may reduce the FTC to reflect the treaty-reduced amount.
Unused FTCs may also be carried back three years or carried forward ten years (for non-business income) under subsection 126(7), but many taxpayers fail to track these balances properly. The CRA will often correct the applicable year of claim or deny a carryforward that has expired.
The Bottom Line
The foreign tax credit system is a balancing act between fairness and precision. Adjustments by the CRA typically reflect an effort to align claims with the technical limits in section 126 of the Income Tax Act and the applicable treaty provisions.
As global mobility increases, cross-border tax compliance continues to grow more complex, and careful attention to the detailed mechanics of the foreign tax credit remains one of the most effective ways to prevent double taxation and avoid audit surprises.
If you require assistance preparing an FTC claim, or if the CRA is reviewing credits you have previously claimed, our office can provide expert guidance to ensure compliance and minimize potential complications.
**Disclaimer
This article provides information of a general nature only. It does not provide legal advice, nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions, you should consult a lawyer.
Elias Zafiridis