Claiming US Tax on a Canadian Corporate Return

Is US tax a credit or a deduction on the T2?

Qualifying US income tax normally reduces the corporation's federal tax as a foreign tax credit on Schedule 21. A deduction from income is an alternative for qualifying non-business tax under section 20(12); the same tax cannot support both claims.

Is the US tax on business income or investment income?

US tax on profit from a business the Canadian corporation carries on in the US is generally business-income tax. US tax on its dividends, interest, or capital gains is generally non-business-income tax. Withholding is just a collection method: tax withheld from US business receipts may be business-income tax if the corporation carries on that business there (CRA folio, paragraphs 1.15–1.23 and 1.37).

US customers alone do not establish a US business; locate the work and calculate US-source income. See Form 1120-F filing separately.

Tax paid by a shareholder or US subsidiary is not the Canadian corporation's Schedule 21 credit (CRA folio, paragraphs 1.28 and 1.38).

Do US state income taxes count, and what about gross-receipts taxes?

A US state tax can count when it is imposed on the Canadian corporation's own net income or profit from its US business. The CRA folio expressly discusses state unitary taxes: a net-income tax may qualify, while a minimum franchise tax, tax payable without income, or capital tax may not.

State income tax on a Canadian business may be non-business tax, but a credit needs eligible foreign-source income (CRA folio, paragraphs 1.17 and 1.27).

A gross-receipts tax normally fails the net-income test. CRA recognizes a narrow exception when it is tightly linked and subordinate to a qualifying income-tax regime. A levy that fails may still be a business expense. Keep the state return. State income tax can still matter when the treaty blocks US federal tax, because state taxes are generally outside the treaty (CRA folio, paragraphs 1.7–1.12.1 and 1.68).

What limits the credit, and does the small business rate matter?

The credit cannot exceed eligible US tax or Canadian federal tax on the related US income. Calculate each category and country using Canadian net income and allocated shared expenses (Income Tax Act, section 126; CRA folio, paragraphs 1.74–1.88). The business-credit formula also limits the claim by federal tax remaining after non-business credits.

The small business deduction applies to eligible active business income carried on in Canada, not US branch profit. It does not directly lower the section 126 tax figure used to cap the credit. US income earned outside Canada also gets no federal tax abatement. Claiming a foreign credit instead reduces taxable income eligible for the small business deduction on T2 line 405. Calculate both together; do not apply the small business rate to US profit (T2 guide, Chapters 4 and 7).

If losses limit either credit, a corporation may use a section 110.5 addition to taxable income to claim more credit; the addition also enters its non-capital loss calculation (CRA folio, paragraphs 1.93–1.96).

Can unused US credits carry to another year?

An unused business-income credit can generally go back 3 tax years or forward 10 tax years, but only against federal tax on business income from the same country in a year the corporation carries on business there. Track it in Schedule 21 Part 3; request a carryback in Part 4 by the current-year return's filing due date. Claim the available current-year credit: leaving it unused can lose that part of the carryover (CRA folio, paragraphs 1.98–1.104).

An unused non-business credit does not carry. Compare the federal credit, any provincial credit on remaining eligible tax, and a section 20(12) deduction in the T2 income calculation. Tax deducted from income cannot also be credited, and the deduction changes the foreign income used in the credit limit (CRA folio, paragraphs 1.23–1.24).

What if the US withheld tax the treaty did not allow?

Treaty-excess withholding is a US refund issue, not a Canadian credit. The CRA says tax above the treaty rate is not foreign tax paid for credit purposes; seek the excess from US tax authorities (CRA folio, paragraphs 1.33–1.35). If the treaty says none was owed, none of that withholding belongs in the Canadian credit. See US tax withheld on payments to Canadians for the refund route.

A Form 1042-S shows an amount withheld, but does not establish that the US was entitled to keep it.

Does Ontario or another province give its own credit?

Yes. Every province and territory offers a corporate credit for qualifying foreign non-business tax that exceeds the federal non-business credit. There is no provincial credit for foreign business tax. The corporation needs Canadian residence throughout the year, a permanent establishment in the province or territory, and foreign investment income (CRA: provincial and territorial foreign tax credits).

For provinces and territories whose corporate tax the CRA administers, calculate each province and country separately in Schedule 21, then transfer the credit to Schedule 5. Quebec and Alberta administer their own corporate taxes, so their credits are not on the federal return. If a province has two corporate rates, use the higher rate; Ontario uses its basic rate.

What proof should the corporation keep?

Keep the US and state tax returns, assessments, payment receipts, and a calculation tying each tax to income reported on the T2. For withheld tax, keep the payer's Form 1042-S or equivalent statement, plus the contract and treaty analysis showing what tax was final. Keep the exchange-rate method and the allocation of expenses to US income (CRA folio, paragraphs 1.42–1.45).

Retain evidence for an electronic T2; attach it to a paper return. Later-assessed US tax, once paid, can support a credit for its tax year; amend that T2. A reassessment caused by foreign tax paid or refunded can be made up to 3 years after the normal reassessment period (section 152(4)(b)(iv)). Tax years that differ may require proration. Report later US refunds to the CRA (CRA folio, paragraphs 1.32–1.36 and 1.45). See filing the T2.

Example

US branch profit

Illustrative amounts: a Canadian corporation earns US$100,000 at its US permanent establishment and pays US$21,000 of income tax. Suppose that tax converts to C$28,000, but Canadian losses and allocated expenses reduce its federal credit limit to C$18,000. It claims C$18,000 now and tracks the eligible C$10,000 excess for a possible carryback or carryforward.

State income tax

In US dollars, the corporation pays US$5,000 of state tax computed on its own net branch income. That tax may count with its US business-income tax. A separate US$5,000 gross-receipts levy needs its own classification and may fail the income-tax test.

Treaty-excess withholding

Illustrative amounts in US dollars: a payer withholds US$15,000 from the corporation, but the treaty says the US may not tax that payment. The corporation seeks a US refund of US$15,000; it does not put that amount into Schedule 21.

Different for you?

• You keep stock in US warehouses and pay state tax: see Canadian sellers with US inventory for the separate state and sales-tax questions.
• You paid the US tax personally: use Foreign income on a Canadian return, not the corporation's Schedule 21.
• You need to convert the underlying US amounts: see US-dollar sales and marketplace payouts.
• Several years, states, or taxpayers are involved: gather each return, payment record, and treaty position for corporate tax help; who paid the tax and when may change the claim.