22 December 1998 External T.I. 9831675 - ROTH IRA, CANADIAN TAX ISSUES

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:

How will Roth IRAs be treated for tax purposes in Canada?

Position:

Questions and Answers provided.

Reasons:

Used a series of questions and answers to provide the Departments views on contributions, conversion and taxation of trusts.

		December 22, 1998

	HEADQUARTERS	HEADQUARTERS
	Audit Directorate	M.P. Sarazin
	Large Business Audit Division	952-9853
	Technical Applications Section

	Attention:  Peter Bush
		983167
	   Roth Individual Retirement Accounts

This is in reply to your memorandum dated December 2, 1998, wherein you requested our general views regarding the taxation of a resident of Canada who converts an existing individual retirement account (“IRA”) into a Roth IRA, contributes to a Roth IRA or withdraws amounts from a Roth IRA. In addition, you would like to know whether the income earned within the Canadian’s Roth IRA would be subject to tax under the Income Tax Act (the “Act”).

Comments

It is our understanding that for post-1997, the United States Internal Revenue Code of 1986 (the “I.R. Code”) established a new type of tax-favoured IRA called the Roth IRA (section 408A). Under the I.R. Code, Roth IRA plans are treated as ordinary or traditional IRAs, except for the following:

(a) Contributions to the Roth IRA are not deductible by the contributor. (Individuals with an adjusted gross income in excess of certain limits are not entitled to contribute to a Roth IRA.)

(b) Amounts held in ordinary (but not educational) IRAs may be transferred to or converted into a Roth IRA. An individual has an income inclusion for the taxable distribution from the ordinary IRA in the year of the conversion of the ordinary IRA to a Roth IRA. For 1998 only (if no election is filed to have the full income inclusion for the year), the amount that would have been included in gross income if the individual had taken a distribution (i.e., deductible contributions and untaxed earnings) is included in gross income “ratably” over the four-tax-year period beginning with the tax year in which the payment or distribution is made (i.e. 1998, 1999, 2000 and 2001). Under the I.R. Code, only taxpayers who have an adjusted gross income for U.S. tax purposes in the year of transfer or conversion that does not exceed $100,000 U.S. are eligible for such a transfer or conversion. To qualify, married individuals must file a joint return and have an aggregate adjusted gross income for U.S. tax purposes in the year of transfer or conversion that does not exceed $100,000 U.S.

(c) Qualified distributions from the Roth IRA are not included in the recipient’s gross income under the I.R. Code. To be a qualified distribution, the distribution must satisfy a five-year holding period and must meet certain other requirements.

We have been asked the following general questions in respect of Roth IRAs.

Question

Would contributions to a Roth IRA by a resident of Canada be deductible in computing the Canadian resident’s income under the Act even though, under the I.R. Code, a U.S. citizen is not entitled to deduct his or her contributions to Roth IRAs in computing his or her U.S. taxes payable?

Position

Since there is no provision in the Income Tax Act (Canada) (the “Act”) providing for a deduction of such contributions, the amounts contributed by a Canadian resident to an IRA (Regular or Roth) are not deductible in Canada under the Act.

Question

Would the income earned within the Roth IRA be taxable in Canada each year or only on receipt of disbursements from the plan?

Position

Under section 6803 of the Income Tax Regulations (the “Regulations”), a plan or arrangement is prescribed to be a foreign retirement arrangement if it is a plan or arrangement to which subsection 408(a), (b) or (h) of the I.R. Code, as amended from time to time, applies. Since there is no reference to subsection 408A of the I.R. Code, Roth IRAs would not qualify as foreign retirement arrangements for purposes of the Act.

Under section 94 of the Act, the income of a non-resident trust is subject to Canadian taxation in the circumstances specified in paragraphs 94(1)(a) and (b) of the Act. The provisions of clause 94(1)(b)(i)(E) of the Act exempts foreign retirement arrangements from these foreign accrual property income (“FAPI”) rules. Since Roth IRAs are not foreign retirement arrangements, Roth IRA trusts will not be exempted from the FAPI rules relating to foreign trusts. In addition, paragraph 81(1)(r) will not exempt an individual from including income earned in his or her Roth IRA deposit accounts in his or her income for the year. In our view, no treaty provision would allow for these amounts to be excluded from Canadian taxation. Therefore, Roth IRA earnings would be taxable under the ordinary provisions of the Act relating to the nature of the earnings.

Question

How will amounts received by a resident of Canada out of his or her Roth IRA be taxed in Canada?

Position

If the Roth IRA is viewed as a pension, the amounts received out of a Roth IRA will not taxable in Canada as a result of the application of the Canada-U.S. Income Tax Convention (1980) (the “Convention”). Under paragraph 1 of Article XVIII of the Convention, pension income arising in one Contracting State that is paid to a resident of the other Contracting State will be exempt from tax in the other Contracting State if the pension would have been excluded from a recipient’s income in the first Contracting State if he or she were resident in the first Contracting State. Since pension income received out of the Roth IRA are not taxable in the U.S., pension income received out of a Roth IRA by a resident of Canada would not be taxable in Canada.

If the Roth IRA is not considered a pension plan, the decision in Abrahamson (91 DTC 213) would likely have application to most payments received from a Roth IRA (i.e. the Roth IRA is a non-resident inter-vivos trust - amounts withdrawn from the trust are capital, except for earnings in the year).

Question

Will the amount transferred from a Canadian resident individual’s IRA to the individual’s Roth IRA be included in the individual’s income for purposes of the Act?

Position

The Department of Finance has announced in its Press Release # 98-129 dated December 18, 1998 that amounts that are required to be included in an individual’s income under the I.R. Code as a result of the transfer of amounts from an IRA to a Roth IRA or the conversion of an IRA to a Roth IRA will also be included in the income of a resident of Canada for purposes of the Act.

Question

Where an individual has elected to include the conversion amount in his or her income over a four year period under the I.R. Code and the individual is a resident of Canada, will the individual be entitled to a foreign tax credit under the Act in respect of U.S. taxes paid in the second, third and fourth years after the conversion of the regular IRA to a Roth IRA?

Position

Since the individual will be required to include the conversion amount in his or her income on the same basis as required under the I.R. Code, the individual may be eligible to claim the foreign tax credit.

We trust that the above comments will be helpful.

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