11 March 1986 Income Tax Severed Letter 5-0193 - []

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.

XXXX R.A. Primeau (613) 957-2127

March 11, 1986

Dear Sirs:

Re: Qualified United States Retirement Plans

This is in reply to your letter of November 29, 1985.

It is your view, that a lump sum distribution from a U.S. qualified retirement or pension plan which is received by a Canadian resident would be exempt from taxation in Canada by virtue of paragraph 1 of Article XVIII of the 1980 Canada-U.S. Income Tax Convention. In your opinion, such amount, since it is subject to a special 10- year averaging method tax, is excluded from taxable income in the U.S.

In this regard you have quoted Internal Revenue Code Section 402(e)(3) as follows:

"Allowance of deduction - the ordinary income portion of a lump sum distribution for the taxable year shall be allowed as a deduction from gross income for such taxable year, but only to the extent included in the taxpayer's gross income for such taxable year".

You feel that your position is further supported by the fact that the lump sum amount which is subject to the special 10-year averaging method tax is not even reported as being a component of "Adjusted Gross Income" or "Taxable Income" on either U.S. Form 1040 (U.S. Individual Income Tax Return) or Form 1040NR (U.S. Non-resident Alien Income Tax Return).

We have examined the copies of the above-mentioned forms as well as Form 4972 and related instructions used for calculating the special 10-year averaging method tax, all of which were forwarded with your letter. These forms indicate that a lump sum payment from a U.S. qualified retirement or pension plan has an "ordinary income" portion and a "capital gains" portion. The use of the special 10-year averaging method for the "ordinary income" portion is apparently optional as the instructions for Form 4972 state: "If you do not use the 10-year averaging method, report the ordinary income part of the lump sum on Form 1040, line 16." The instructions for Form 4972 also state: "Report the capital gain part less any attributable Federal estate tax on Schedule D or, if applicable, 40% of the result on Form 1040, line 14." We note that lines 15 and 17 of Form 1040NR are the same as lines 14 and 16 of Form 1040. Finally, the instructions for Form 4972 state: "If your distribution included both capital gain and ordinary income..., you may make an election to treat the long-term capital gain part as ordinary income. Then you will be able to use the 10-year averaging method for both parts."

From the above, it is apparent that a lump sum payment from a U.S. qualified retirement or pension plan is taxable in one way or another, i.e. either in the normal manner on Form 1040 or Form 1040NR, or under the special 10-year averaging method, or by a combination of both methods.

In our opinion, an amount which at the option of the taxpayer is taxed under the special 10-year averaging method rather than under the normal method is not an amount "that would be excluded from taxable income" in the U.S. within the meaning of Article XVIII of the treaty. The exemption in this Article is simply intended to apply to amounts recognized as a return of capital out of a pension plan, i.e. amounts not taxable in the U.S. under either of the above methods. Therefore, the exemption in Article XVIII would not apply in the manner which you have suggested.

We trust that the above adequately explains our position in this matter.

Yours truly,

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch