12 April 2011 External T.I. 2010-0385701E5 - US Social Security Lump Sum

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.

Principal Issues: Subsection 56(8) provides an election to a Canadian resident individual to exclude from income in the year received, the portion of a lump-sum Canada Pension Plan benefit that is in respect of previous years, and consequently, the calculation of additional tax pursuant to section 120.3 will be invoked. Can the election at subsection 56(8) be made in respect of a retroactive lump-sum U.S. Social Security benefit?

Position: Yes

Reasons: Paragraph 5(a) of Article XVIII of the Canada-US Tax Convention provides that a benefit under the social security legislation in the United States paid to a resident of Canada shall be taxable in Canada as though it were a benefit under the Canada Pension Plan, except that 15 percent of the amount of the benefit will be exempt from Canadian tax. Therefore a resident of Canada in receipt of a retroactive lump-sum U.S. Social Security benefit is eligible to make the election pursuant to subsection 56(8).

XXXXXXXXXX 
									Paul Oatway
									2010-038570

April 12, 2011

XXXXXXXXXX :

I am writing in response to your email dated October 29, 2010 concerning the issue of whether a Canadian resident individual can opt to apply subsection 56(8) (the "Election") of the Income Tax Act (the "Act") in respect of a retroactive lump-sum benefit received under the social security legislation in the United States ("U.S.").

Written confirmation of the tax implications inherent in a particular transaction is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. We are, however, prepared to offer the following general comments, which may be of assistance.

Paragraph 5 of Article XVIII of the Canada-U.S. Convention on the Taxation of Income and Capital (the "Convention") grants Canada the exclusive right to tax benefits under the social security legislation in the U.S. received by a resident of Canada. Subject to the conditions expressed in paragraph 5(a) of Article XVIII of the Convention, a benefit under the social security legislation in the U.S. paid to a resident of Canada shall be taxable in Canada as though it were a benefit under the Canada Pension Plan ("CPP"), except that 15 percent of the amount of the benefit shall be exempt from Canadian tax.

Where paragraph 5 of Article XVIII of the Convention applies, paragraph 110(1)(h) of the Act may provide an additional deduction from taxable income for individuals in receipt of benefits under the social security legislation in the U.S. In computing taxable income of the 2010 and subsequent taxation years, an individual may deduct an additional 35 percent of the total of all such benefits received in the year where the conditions of paragraph 110(1)(h) are met. The deduction is available to individuals (and their surviving spouses or common-law partners) who were resident in Canada and receiving benefits under the social security legislation in the U.S., in each taxation year since before 1996.

Subsection 56(8) of the Act provides the option to an individual to exclude from income in the year received, any CPP benefits that relate to one or more prior years (except where the prior year benefits are less than $300) and to pay tax on those benefits as if they had been received in the prior years to which they relate. Section 120.3 of the Act provides the calculation for the payment of tax on this basis.

Article 2 of the Technical Explanations of the Fourth Protocol of the Convention provides an explanation of paragraph 5(a) of Article XVIII of the Convention. It states:

The Protocol returns to a system of residence-based taxation in which social security benefits are exclusively taxable in the State where the recipient lives. Social security benefits will generally be taxed as if they were benefits paid under the social security legislation in the residence State. Therefore, social security benefits will be taxed on a net basis at graduated rates and low-income recipients will not pay any tax on these benefits. However, the Protocol modifies the residence State's taxation of cross-border benefits in order to take into account how the benefits would have been taxed in the source State if paid to a resident of that State.

In the case of Canadian recipients of U.S. social security benefits, the Protocol provides that only 85 percent of these benefits will be subject to tax in Canada. This reflects the fact that, although in Canada social security benefits are fully includible, a maximum of 85 percent of United States social security benefits are includible in income for U.S. tax purposes. See Code section 86. This is also consistent with the taxation of social security benefits under the Convention prior to the effective date of the 1995 Protocol, since at the time the pre-1996 rule was adopted the United States included a maximum of 50 percent of the social security benefits in income.

It is our view that in accordance with paragraph 5(a) of Article XVIII of the Convention, 85 percent of a retroactive lump-sum benefit received by a Canadian resident individual under the social security legislation in the U.S. is to be taxed as though it were a benefit under the CPP. As such, an individual in receipt of a retroactive lump-sum benefit under the social security legislation of the U.S. is eligible for the Election pursuant to subsection 56(8).

In such a situation, an individual cannot make the Election pursuant to subsection 56(8) of the Act when filing an income tax return electronically. An individual can only make the Election by filing a paper income tax return, and the benefit statement received from the U.S. Social Security Administration must be included. The benefit statement must provide a breakdown of the lump-sum amounts in respect of the previous years. The entire amount of the benefit received in the year under the social security legislation in
the U.S. must be included in income on line 115 - "Other pensions or superannuation". The portion of the benefit that is exempt from Canadian tax pursuant to paragraph 5(a) of Article XVIII of the Convention (i.e. 15 percent) subject to paragraph 110(1)(f) of the Act, and if applicable paragraph 110(1)(h) of the Act (i.e. an additional 35 percent) is taken as a deduction in the calculation of taxable income at line 256 - "Additional deductions".

There is no prescribed form or manner to file the Election pursuant to subsection 56(8). However, the Canada Revenue Agency ("CRA") recommends that a letter or note be included with the return indicating that the individual is applying paragraph 5(a) of Article XVIII of the Canada-US Convention on the Taxation of Income and Capital to have the benefit under the social security legislation in the U.S. taxed as though it was received under the CPP. The note should also indicate that the individual is choosing to apply subsection 56(8) of the Income Tax Act in respect of the retroactive portion of the benefit.

When processing the return, the CRA will determine the most beneficial tax calculation by comparing two separate tax calculations. The first calculation involves including the entire lump-sum payment amount in taxable income in the year received, and calculating the tax payable in the usual manner. The second calculation ("special tax calculation") adds to tax payable in the taxation year the benefit was received, the tax that would have been payable under Part I of the Act for each taxation year had the retroactive portion of the benefit not been included in computing income in the year received because of subsection 56(8), but instead had been included in computing income in the particular taxation year to which the portion relates. A comparison is made of the taxes payable resulting from the two calculations, and the calculation that is most beneficial to the taxpayer is the one that is used. If the special tax calculation is to the taxpayer's benefit, the portion of the lump-sum payment that relates to previous years is not included in the calculation of net income or taxable income for the year in which it is received. For purposes of the special tax calculation, the deduction pursuant to paragraph 110(1)(h) is only available, as the case may be, in the 2010 and subsequent taxation years, and is only applicable to the taxation year in which the benefit was received. Therefore, if the special tax calculation involves pre-2010 taxation years, but the taxpayer otherwise qualifies for the additional 35 percent deduction in the year the benefit was received (i.e. the 2010 or subsequent taxation years), it is unlikely that the Election pursuant to subsection 56(8) would be of any benefit.

CRA will not adjust any previous-year returns with regard to the special tax calculation for prior years. Taxpayers, therefore, cannot make changes to those tax years such as contributions to an RRSP and tax credits.

I trust that these comments will be of assistance.

Yours truly,

Guy Goulet CA, M.Fisc.
Manager
For Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch