19 July 2001 External T.I. 2001-0078275 - CONTRIBBUTION & INCOME

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Tax treatment of income received from a United Sates 401(k) plan.

Position TAKEN:

Withdrawal of contributions is not taxable. Withdrawal of income earned by the plan and of contributions made by US employer is taxable. CCRA will accept a reasonable allocation by the taxpayer between taxable and non-taxable portions.

Reasons:

There are no provisions in the Act allowing for the deduction of contributions to 401(k) plans. Generally, the full amount of pension receipts is taxable less any amount that represents the withdrawal of the non-deductible contributions.

XXXXXXXXXX 2001-007827
T. Young, CA
July 19, 2001

Dear XXXXXXXXXX:

Re: 401(k) Pension Plan Withdrawals and Taxation in Canada

This is in reply to your letter dated March 29, 2001, requesting our opinion concerning the taxation of withdrawals from a United States 401(k) plan.

In your letter, you state that the taxpayer, who is resident in Canada, has worked in the United States (US) and contributed to a 401(k) plan for 18 years. You stated that for the first 12 years, the taxpayer always reported US employment income net of the amounts deducted by his employer, and remitted to his 401(k) plan. Since then, the CCRA has been requiring that the taxpayer's gross employment earnings be included in income. You have asked us how to calculate the taxable portion of income received out of the 401(k) plan by the taxpayer.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R4, "Advance Income Tax Rulings", dated January 29, 2001. Where the particular transactions are completed, as appears to be the case in your situation, the enquiry should be addressed to the relevant Tax Services Office. Also, it would be necessary to review all relevant documentation before a determination of the tax implications could be made. Therefore, we can only provide you with the following general comments.

Our comments are limited to an individual who is a resident of Canada and is employed at a location in the US. They do not apply to an individual who is employed in Canada by a non-resident employer or to an individual who is employed both within and outside of Canada by the same employer.

US 401(k) plans are considered pension plans when they include both employer and employee contributions. This is generally the case; however, there may be situations where the plan is fully funded by the employee. If this were the case, consideration of the specific situation would have to be made on a case-by-case basis.

Canadian residents are required to report their gross income from employment when filing their Canadian income tax returns. When a US employer withholds an amount from employment income and contributes it to a 401(k) plan, the employer is doing it on the employee's behalf. This is similar to a Canadian employer withholding employee contributions to a registered pension plan. However, unlike contributions to a registered pension plan, an employee cannot deduct contributions to a 401(k) plan under the provisions of the Income Tax Act (the "Act").

When a taxpayer receives income out of a 401(k) plan, it is taxable as pension income in Canada. However, the taxpayer is permitted to exclude from income the portion of the income that represents a return of employee contributions to the extent that the contributions were included in the employment income in the year or in previous years (the "Previously Taxed Amounts"). The taxpayer will be required to maintain records of contributions and the amount of income earned in a plan. However, it is our understanding that the US Internal Revenue Code requires employers to provide this information to their US employees so it should be readily available from the employer for Canadian resident employees as well.

As noted above, no deduction is available for any amounts contributed to a 401(k) plan by an employee because no provision of the Act provides for one. However, when these amounts are received, as noted above, the amount representing the Previously Taxed Amounts received out of the plan is not taxed. Accordingly, there is no double taxation of amounts received by an employee out of a partially employer-funded 401(k) plan. However, an issue arises on the withdrawal of funds from a 401(k) plan with regard to foreign tax credits. At the time of a payment from a 401(k) plan, US taxes may be paid on the full amount of the withdrawal, if the withdrawal amount is fully included in income for US tax purposes at that time. In Canada, the employee's contributions are not included in income at withdrawal (since they have previously been included in income). Thus, depending upon the amounts withdrawn and other factors, there may be instances where the US taxes paid may not be fully utilized as a foreign tax credit. The existing provisions of the Canada-US Income Tax Convention do not provide any relief in such circumstances.

We trust our comments will be of assistance to you.

Yours truly,

John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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