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 Canada Revenue Agency (CRA) stated in paragraph 5 of IT-122R2, that US social security taxes paid by an employee are income taxes that may qualify as “non-business-income taxes” under subsection 126(7) of the Act for purposes of the foreign tax credit under paragraph 126(1)(a). The CRA has also confirmed that German and French social security contributions qualify as “non-business-income taxes”.
We have recently 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, the CRA is revising its 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.
As provided in the Canada-U.S tax convention however, Canada has specifically agreed to give a foreign tax credit for payments under the Federal Insurance Contributions Act, more commonly known as FICA taxes. In accordance with our tax treaty with the U.S., the CRA will continue to allow a foreign tax credit for FICA taxes.
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 case, a 1962 decision of the Tax Appeal Board (62 DTC 565, 62 TAB 243). 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 then 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 the case Yates v. The Queen, 2001 DTC 761, [2001] 3 CTC 2565), the meaning of the word “tax” given by the Supreme Court of Canada in Lawson [1931] S.C.R. 357. 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.
We have recently considered a situation where the contributions made by an employee to a foreign social security system would not make the employee eligible to any benefits where the employment in the foreign country was temporary and for a short period of time.
The CRA will accept that a contribution by an employee resident in Canada to a foreign public pension plan be considered as a non-business income tax for the purpose of section 126 of the Income Tax Act where the following two conditions apply:
- the employee is compelled to make the contribution pursuant to the legislation of the foreign country; and
- it is reasonable to conclude that the employee will not be eligible for any financial benefit from his/her contribution considering that the employment in the foreign country was temporary and for a short period of time.[Footnote 1]
The changes are effective for the 2004 and subsequent taxation years and IT-122R2 has been cancelled and annotated as such in Part 5 of the 2004 Index to Income Tax Interpretation Bulletins and Technical News issued on April 27, 2005.