5 May 1986 Income Tax Severed Letter 5-0392 - [860505]

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.

Dear Sirs:

This is in reply to your letter of November 25, 1985. We apologize for the delay in responding to you.

You have asked us to consider a situation involving an individual who is and has been a resident of the United States (the "U.S.") for the past seven years. This individual, who is a citizen and former resident of Canada, is considering returning to Canada from the U.S. on a permanent basis and is concerned with the tax impact that such a move will have on the income which accrues in his U.S. pension fund.

It is your understanding that subsection 94(1) of the Income Tax Act (the "Act") could apply to tax a resident of Canada currently on the income accruing in a U.S. pension plan (which is also a trust) of which the Canadian resident is a beneficiary. You indicate that subsection 94(1) will apply in this manner if contributions. to the U.S. pension plan are made either directly or indirectly by an employee who is a beneficiary of the plan (such direct or indirect contributions being able to take many forms, including payroll deductions), whereas subsection 94(1) will not apply if only the employer contributes to the plan.

You further understand that in the year in which benefits are received by the Canadian resident from the U.S. pension plan, subsection 6(10) of the Act will permit the taxation of only that portion of the withdrawal which was not previously taxed. In other words, Canada would not tax the full amount of the benefits from the plan in the year or years received because of the application of subsection 94(1) in previous years.

You indicate, however, that the U.S. will not impose withholding tax on the pension benefits until received by the beneficiary. Thus, to the extent that Canada taxes the pension income in years preceding the years in which the U.S. will tax it, there will be double taxation on such income without the availability of a foreign tax credit against Canadian taxes payable. You have found no mechanism in either the Act or the 1980 Canada-U.S. Income Tax Convention (the "treaty") which provides relief from this double taxation.

You have asked us to confirm your understanding of the tax consequences in the situation outlined above and furthermore request whether we would implement an administrative policy to alleviate this double taxation burden.

In the situation which you have given us, it is apparent that the requirement in subclause 94(1)(b)(i)(A)(III) that the individual has, before the end of the year, been resident in Canada for a period of, or periods the aggregate of which is, more than 60 months will be met by this taxpayer in the year of his return to Canada because of his previous years of residence in Canada. Also, we assume that the fair market value of his beneficial interest in the U.S. pension plan is not less than 10% of the aggregate fair market value of all beneficial interests in the plan, as required by subparagraph 94(1)(d)(i). If our assumptions are correct, we agree that that subparagraph would cause the "FAPI" rules to apply. Nor would subsection 75(3) of the Act prevent such application because it is clear that that subsection only prevents the attribution provision in subsection 75(2) from applying.

We also agree with you that there would be double taxation in the above situation, although not quite in the way you have described. When the U.S. pension benefits are received by the Canadian resident, they will be fully exempt from taxation under paragraph 6(1)(g) of the Act by virtue of subparagraph 6(1)(g)(iii). However, such pension benefits will be taxable in Canada when received, by virtue of subparagraph 56(1)(a)(i) of the Act and Article XVIII of the treaty, to the extent that they would have been taxable in the U.S. had the recipient been a resident thereof. The 15% non-resident withholding tax paid to the U.S., which also is permitted by Article XVIII of the treaty, will then be taken into account in calculating the taxpayer's foreign tax credit against Canadian taxes payable in the year or years in which the pension benefits are received.

As it is the responsibility of this Department to administer the Income Tax Act and treaty in accordance with the existing provisions thereof, we cannot take an administrative position that subsection 94(1) would not be applied in a case such as the one above. We therefore suggest that you may wish to write to the Department of Finance requesting a legislative change to remedy the situation. We note that, in view of the words "other than in prescribed circumstances" in subparagraph 94(1)(b)(i) of the Act, this could perhaps be most easily accomplished by way of an addition to the Income Tax Regulations which provides that subsection 94(1) will not apply in circumstances such as the ones you have described.

We trust that the above will assist you in this matter.