Social Security Taxes and the Foreign Tax Credit
Section 126 of the Income Tax Act (the “Act”) provides for a foreign tax credit for taxes paid to foreign jurisdictions. The CCRA stated in paragraph 5 of IT-122R2, that U.S. social security taxes paid by an employee are income taxes that may qualify as “non-business-income taxes” under paragraph 126(7) of the Act for purposes of the foreign tax credit under paragraph 126(1)(a). The CCRA has also confirmed that German and French social security contributions qualify as “non-business-income taxes”.
Question 1
Will the CCRA extend the treatment given to the U.S., the French and German contributions to social security contributions in other countries as well?
Response 1
We have reviewed the treatment of social security taxes as income or profits taxes for the purposes of the foreign tax credit and we concluded that the position in IT-122R2 is not supportable in law, because the social security taxes reviewed do not qualify as taxes. Consequently, we are revising our position on this point. As a rule, social security taxes will no longer be accepted as non-business income taxes for the purposes of the foreign tax credit. The technical interpretations regarding the tax treatment of social security contributions in France and Germany as foreign tax credits are thus obsolete and unreliable.
Question 2
What about social security taxes in the U.S.?
Response 2
The general rule is that social security taxes will no longer be regarded as non-business income taxes for the purposes of the foreign tax credit. However, in the Canada-U.S tax convention, Canada has specifically agreed to give a foreign tax credit for payments under the Federal Insurance Contributions Act, more commonly known as FICA taxes. So in accordance with our tax treaty with the U.S., we will continue to allow a foreign tax credit for FICA taxes.
Question 3
Can you explain the reasons for the change in the general position?
Response 3
The position in Interpretation Bulletin IT-122R2 that U.S. social security taxes collected under the U.S. Federal Insurance Contributions Act are income or profits taxes was based on the Seley 13 case, a 1962 decision of the Tax Appeal Board. The Board held that the social security contributions paid by a Canadian taxpayer to the U.S. qualified as an income or profits tax for the purposes of the foreign tax credit. The Department of National Revenue accepted that decision and this was reflected in IT-122R2. However, our reliance on the Seley case was reconsidered in light of the fact that Canadian courts have accepted as authority (as was notably the case recently in Frank Yates 14 ), the meaning of the word “tax” given by the Supreme Court of Canada in Lawson 15 . In that case, the Supreme Court said:
A tax is a levy, enforceable by law imposed under the authority of a legislature, imposed by a public body and levied for a public purpose.
This judicial interpretation of the meaning of the word “tax” by the Supreme Court has been cited on several other occasions. Since a payer of social security derives specific economic benefits from his contributions, the amount cannot be said to be levied for a public purpose, and therefore it cannot be an income or profits tax. For this reason, social security contributions generally do not qualify as income or profits taxes because they are not really taxes at all, within the judicially accepted meaning of that term.
Question 4
Is this change effective for the 2003 taxation year of taxpayers?
Response 4
In order to give us enough time to inform the public adequately and for administrative ease, the new position will only be applied for the year 2004 and subsequent taxation years. IT-122R2 is being cancelled and it is expected that the change in position will be explained in a Technical Newsletter.