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: What is the tax treatment to a Canadian resident taxpayer of (i) a transfer from his U.S. 401(k) plan to a U.S. IRA and (ii) the subsequent withdrawal of amounts from the IRA. Is the portion of the payment from the IRA that represents a return of the taxpayer's contributions to his 401(k) deductible from the amount required to be included in income?
Position: Provided general overview of the Canadian income tax treatment of 401(k) to IRA transfer and IRA withdrawals. It is our long established position that the entire amount received from an IRA, including the portion of that payment equal to the taxpayer's 401(k) contributions previously included in income, are to be included in the taxpayer's income under clause 56(1)(a)(i)(C.1).
Reasons: Amounts received from an IRA are included in income as a superannuation or pension benefit pursuant to clause 56(1)(a)(i)(C.1) of the Act and there is no provision in the Act allowing for a deduction of amounts equal to the employee's contributions to the 401(k) that were transferred to the IRA.
June 19, 2012 Jason R. Ward
Re: Taxation of Transfer from U.S. 401(k) Plan to U.S. Individual Retirement Account ("IRA") and Subsequent Payments from IRA
This is in response to your letter of May 17, 2011, wherein you requested our comments on the tax consequences to a Canadian resident individual under the Income Tax Act (the "Act") upon both the transfer of amounts from a U.S. 401(k) plan to a U.S. IRA, and the subsequent receipt by the individual of payments from the IRA.
In the particular scenario described in your letter, an individual ("Mr. X") and his U.S. employer made contributions to a 401(k) plan in respect of employment services he rendered to the employer. Mr. X is now retired and intends to transfer the entire balance of his entitlements under the 401(k) plan to an IRA in the current year and start withdrawing amounts from the IRA.
Mr. X was unable to claim a deduction for his contributions to the 401(k) plan in computing his income for Canadian tax purposes, as the contributions were made prior to January 1, 2009 - the date Article 13(3) of the Fifth Protocol to the Canada-United States Tax Convention (the "Treaty") came into force. You are particularly concerned that Mr. X. will not be able to claim a deduction for amounts paid to him from the IRA equal to his contributions to the 401(k) plan, which have previously been included in his Canadian income for tax purposes under section 5 of the Act.
We infer from your letter that Mr. X was a resident of Canada throughout the period in which he rendered services to his U.S. employer, and that he rendered those services primarily outside Canada and not in connection with a business carried on by his employer in Canada; for the purposes of our comments below, we have assumed that this is the case.
Although this Directorate does not comment on transactions involving specific taxpayers except by way of an advance income tax ruling in respect of proposed transactions, we are pleased to provide the following general comments.
Transfer from 401(k) to IRA
The transfer of Canadian resident taxpayer's entitlements in a 401(k) plan to an IRA will generally constitute an amount received by the taxpayer under paragraphs 6(1)(g) or 56(1)(a) of the Act, and will be included in the income of the taxpayer in the year of the transfer in accordance with those provisions.
The amount transferred from the 401(k) plan that is required to be included in the taxpayer's income under paragraphs 6(1)(g) or 56(1)(a) of the Act may be claimed as a deduction under subparagraph 110(1)(f)(i) of the Act by virtue of the exemption contained in paragraph 1 of Article XVIII of the Treaty. This exemption is only applicable to the extent the amounts would have been exempt from U.S. tax if paid to a resident of the U.S. The net result is that the transfer of funds from the 401(k) plan to the IRA is tax free for both Canadian and U.S. tax purposes.
Taxation of Payments from IRA
The determination of how an amount received by a Canadian resident taxpayer out of an IRA would be taxed in Canada requires a review of all of the facts, including the terms of the particular IRA. IRAs established under subsections 408(a), (b) or (h) of the United States Internal Revenue Code of 1986 (the "Code") are prescribed to be foreign retirement arrangements ("FRA") for purposes of the Act.
Pursuant to clause 56(1)(a)(i)(C.1) of the Act, a taxpayer who receives a payment out of or under an FRA must include the entire amount of the payment in income, except to the extent the amount would not be subject to income taxation in the U.S. if the recipient were a U.S. resident. In the situation where funds were previously transferred from a 401(k) plan to an FRA, then paid from the FRA to a Canadian taxpayer, there are no provisions in the Act which would allow the taxpayer to reduce their income inclusion under clause 56(1)(a)(i)(C.1) by the amount of his contributions to the 401(k) plan.
A taxpayer may be entitled to claim a foreign tax credit with respect to the U.S. withholding taxes deducted from any lump-sum or periodic withdrawal from a 401(k) plan or an IRA. The CRA's general views on the foreign tax credit are contained in Interpretation Bulletin IT-270R3 "Foreign tax credit".
We trust the above 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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