7 April 1999 External T.I. 9825505 - EMPLOYER CONTRIBUTION TO 401(K) PLAN

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: What are the tax consequences of participating in a US 401(k) plan: RRSP deduction limit, rollover to a RRSP, etc.

Position: Probably an EBP.

Reasons: Question of fact.

XXXXXXXXXX 5-982550
Fouad Daaboul
Attention: XXXXXXXXXX

April 7, 1999

Dear Sirs:

Re: Employer Contributions to a US 401(k) Plan

We are writing in response to your letter received in our office on September 30, 1998, wherein you asked us our views in respect of your participation in your employer's 401(k) plan. We also acknowledge the information provided during our telephone conversation (XXXXXXXXXX/Daaboul).

As indicated in Information Circular 70-6R3, confirmation of the tax consequences flowing from completed transactions must be obtained from your local tax services office. This Directorate will provide a technical interpretation concerning the provisions of the Income Tax Act (the "Act") and Regulations (the "Regulations") but not with respect to specific factual or hypothetical transactions. We may, however, provide the following general comments concerning the provisions of the Act, in accordance with the above-mentioned Information Circular, which are not binding on the Department.

You indicated in your letter that you are a Canadian resident who provides services in Canada to a US employer that carries on a business in Canada. You also indicated that your employer contributes annually up to 15% of your gross earnings to a 401(k) plan under which you are the beneficiary. You have confirmed that you did not make any contribution to the 401(k) plan, whether directly or indirectly through deductions at source made by your employer, and the only contributions made to the plan are your employer's contributions. This categorization of who is actually making the contribution to the plan is a key factor in the tax treatment afforded to the arrangement.

Question 1

What are the consequences of your employer contributions to the 401(k) on your registered retirement savings plan ("RRSP") contribution limit?

Answer

An employer funded (in whole or in part) U.S. 401(k) plan is generally considered a pension plan for purposes of the Act. Such a foreign plan is also subject to the employee benefit plan ("EBP") rules and impacts upon the calculation of the RRSP deduction room for an individual who participates in the plan.

Section 8308.1 of the Regulations requires that a pension adjustment be calculated for an employee who is resident in Canada who works for an employer carrying on a business in Canada and who participates in such foreign plans. The employee's RRSP deduction limit is reduced by the employee's pension adjustment for the preceding year. An employee's pension adjustment is the total of all the employee's pension credits for the year. Pending income tax legislation provides that for years after 1995 but before 2004 the pension credit is calculated under 8308.1 in respect of each employer as the lesser of:

a) 18% of the employee's "compensation" received from the employer less $600, and

b) the money purchase limit for the year.

Pursuant to subsection 147.1(1) of the Act, the money purchase limit for a year will be $13,500 for years after 1995 and before 2003, $14,500 for 2003, $15,500 for year 2004, and, subject to a specific formula, a minimum of $15,500 for years after 2004.

The term "compensation" is defined in subsection 147.1(1) of the Act and basically means for a Canadian resident employee the employee's income from an employer in respect of an employment or office of the employee with the employer which is required to be included in the employee's income by section 5 or 6 of the Act. Generally, this would be the amount reported in box 14 of your T4 - Statement of Remuneration Paid.

Question 2

What are the tax implications on withdrawals from the 401(k) plan and the possible transfer of such withdrawals to an RRSP.

Answer

Where an employer has contributed to the 401(k) plan or the plan is part of a more comprehensive arrangement under which the employer has contributed, the plan will be subject to the "employee benefit plan" rules of the Act. Annual distributions from an employee benefit plan, less the portion based on the terms of the plan that can reasonably be considered to be a return of employee contributions to the plan, will be included in employment income of the recipient pursuant to paragraph 6(1)(g) of the Act. Such a taxable amount is not eligible for rollover to an RRSP but will form part of the taxpayer's earned income for purposes of determining the taxpayer "RRSP deduction limit" as this term is defined in subsection 146(1) of the Act.

Pursuant to subparagraph 60(j)(ii) of the Act, a taxpayer may be able to transfer certain amounts that are included in the taxpayer's income for the year to an RRSP or registered pension plan. One such amount for the year is the amount determined under section 60.01 of the Act, which provides that an amount received by a taxpayer from a foreign retirement arrangement ("FRA") may be so transferred if certain requirements are met. A FRA is defined in subsection 248(1) of the Act as a "prescribed plan or arrangement". Section 6803 of the Regulations provides that an IRA referred to in 408(a), (b), or (h) of the Internal Revenue Code of the U.S. is an FRA. A 401(k) plan is not so prescribed and thus payments received from such plans are not eligible for a rollover to an RRSP.

We trust our comments will be of assistance to you.

Yours truly,

Paul Lynch
for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch