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: Whether the income inclusion resulting from the conversion of a traditional U.S. Individual Retirement Account ("IRA") into a Roth IRA in 2010 may be spread out over the 2011 and 2012 taxation years in accordance with U.S. tax rules. 2. Whether IRA income is eligible for pension income splitting.
Position: 1. No. 2. No.
Reasons: 1. A Canadian resident who converts a traditional IRA into a Roth IRA in 2010 would generally be required to include the full conversion amount in their income for the 2010 taxation year in accordance clause 56(1)(a)(i)(C.1). There is nothing in the Canada-U.S. Tax Convention that would resolve this mismatch in the timing of the income inclusion. 2. The definition "eligible pension income" in subsection 118(7) does not include IRA income.
June 25, 2012
Re: Conversion of U.S. Traditional IRA into Roth IRA in 2010
This is in response to your letter of February 11, 2011 in which you ask for clarification of the tax consequences in a situation where a Canadian resident converts a traditional United States (the "U.S.") Individual Retirement Account ("IRA") into a Roth IRA in 2010. You also asked whether income received from a traditional IRA is eligible for pension income splitting.
Tax treatment on conversion of a traditional U.S. IRA into Roth IRA in 2010
The U.S. has special rules for individuals who convert a traditional IRA into a Roth IRA in 2010. Under these rules, any amount required to be included in income in the U.S as a result of the conversion is included in income in equal amounts over a two-year period, beginning in 2011. You would like to know whether Canada provides comparable tax treatment.
As explained below, a Canadian resident who converts a traditional IRA into a Roth IRA in 2010 would generally be required to include the full conversion amount in their income for the 2010 taxation year. There is no provision in the Canada-U.S. Tax Convention (the "Convention") that would resolve this mismatch in the timing of the income inclusion. However, we understand that individuals did have the option under U.S. rules to elect to include the full conversion amount in their 2010 U.S. income.
A traditional IRA is characterized as a foreign retirement arrangement. This term is defined in subsection 248(1) of the Income Tax Act (the "Act") and section 6803 of the Income Tax Regulations as a plan or arrangement governed by section 408(a), (b) or (h) of the U.S. Internal Revenue Code (the "Code"). A Roth IRA is governed by section 408A of the Code and is therefore not a foreign retirement arrangement.
Clause 56(1)(a)(i)(C.1) of the Act requires that payments received by a taxpayer from a foreign retirement arrangement be included in their income, except to the extent the amount would not be subject to income tax under the laws of the country under which it is established (i.e., the U.S.) if the taxpayer were resident in that country. In addition, proposed subsection 56(12) of the Act provides that an individual is deemed to have received an amount as a payment from a foreign retirement arrangement where, as a result of a transaction, event or circumstance, the income tax laws of the foreign country in which the arrangement is established treats the amount as having been distributed from the arrangement to the individual. An example of the application of this provision is where a Canadian resident converts a traditional IRA into a Roth IRA simply by amending the plan terms. Under the Code, the conversion amount is treated as a distribution from the IRA and therefore included in the individual's income for U.S. tax purposes. Proposed subsection 56(12) of the Act ensures that the conversion amount is treated as having been received by the individual and therefore included in the individual's income for Canadian tax purposes.
Pursuant to paragraph 1 of Article XVIII of the Convention, amounts received from a traditional IRA by a Canadian resident may be taxed in Canada. However, as an exception, amounts that would be exempt from taxation in the U.S. if paid to a U.S. resident may not be taxed in Canada. In the case at hand, the 2010 conversion amount is not exempt from taxation in the U.S., as the taxation of this amount is simply being deferred. Consequently, the Convention does not apply to prevent the 2010 conversion amount from being taxed in Canada.
Taxation of Roth IRAs
Roth IRAs do not enjoy the same tax deferral benefits under the Act as traditional IRAs and registered plans. Income and distributions from a Roth IRA are generally taxable on a current basis according to the rules that apply to custodial accounts, trusts, annuity contracts or endowment contracts, depending on the characteristics of the particular arrangement.
However, in many cases, Article XVIII of the Convention may apply to either defer or relieve taxation in Canada. These rules are discussed in more detail in Income Tax Technical News No. 43 (ITTN-43) Taxation of Roth IRAs, which is available on our website at www.cra-arc.gc.ca. Of particular relevance to your query are the comments in section 2, which explain that the relief available under the Convention applies as long as no contribution is made to the Roth IRA after December 31, 2008, by or on behalf of the individual, while the individual is resident in Canada. The conversion of a traditional IRA into a Roth IRA would be considered to be a contribution to the Roth IRA for this purpose.
Pension Income Splitting
Section 60.03 of the Act permits an individual receiving eligible pension income to split that income with the individual's spouse or common-law partner, provided certain conditions are satisfied. "Eligible pension income", which is defined in subsection 118(7) of the Act, does not include income from an IRA.
We trust that these comments will be of assistance.
Mary Pat Baldwin, CA
Financial Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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