20 May 2010 Internal T.I. 2008-0304421I7 - Inherited IRA or U.S. pension 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.

Principal Issues: In the case where a Canadian individual inherits an IRA or a U.S. pension plan, can the U.S. Estate taxes paid in respect of the plan or the regime be deducted by him against his taxable income in accordance with paragraph 1 of Article XVIII of the Canada - U.S. income tax convention and subparagraph 110(1)f)(i)

Position: Yes.

Reasons: Interpretation of the Canada - U.S. income tax convention and ITA.

									May 20, 2010

Patrick Massicotte Income Tax Rulings
Senior Analyst Directorate
Competent Authority Services Yannick Roulier
International & Large Business, Compliance Programs (613) 957-2134
Canada Revenue Agency
Enterprise Building
427 Laurier Ave. W. 5-06 2008-030442
Ottawa, Ontario, K1A 0L5

Inherited IRA or U.S. pension plan

This is further to your December 18, 2008 electronic calendar request for a meeting on January 26, 2009 and your electronic mail of January 27, 2009. At the January 26, 2009 meeting, Income Tax Rulings ("ITR") agreed to reconsider its interpretation of paragraph 1 of Article XVIII of the Canada - United States Tax Convention ("Convention") where an Individual Retirement Account ("IRA") or a U.S. pension plan ("USPP") is inherited by a Canadian individual.

Unless otherwise stated, all statutory references in this letter are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended ("ITA").

Background

You have presented hypothetical situations where a Canadian individual inherits an IRA that was previously owned by a deceased individual ("Decedent") resident in the United States ("U.S.") or a USPP of which the Decedent was a member. In the situations outlined in the Consultation Request, U.S. Estate taxes are paid to the U.S. government in respect of the value of the IRA or the USPP upon the Decedent's death.

You explained that where an IRA or a USPP is inherited by an individual who resides in the U.S., any amount paid out of the IRA or USPP to the individual either directly or through the Decedent's estate, is generally taxable in the U.S. in application of U.S. income tax rules. In these circumstances, section 691(c) of the Internal Revenue Code ("IRC") provides that in computing the income of the beneficiary of the IRA or USPP, a deduction in respect of the U.S. Estate taxes attributable to the IRA or the USPP is allowed under certain conditions. Where an IRA or a USPP is inherited by an individual who resides in Canada, an amount paid out of the IRA or USPP to the individual either directly or through the Decedent's estate is generally taxable in Canada in the hands of the individual in application of Canadian income tax rules. Paragraph 1 of Article XVIII of the Convention confirms Canada's right to tax such amounts of pensions and annuities received by a resident of Canada, but limits Canada's right to tax to the amount that would not be excluded from taxable income in the U.S. if the recipient were a resident thereof. However, Canada has no section 691(c) IRC equivalent and no deduction is allowed under the ITA for the amount of U.S. Estate taxes paid. ITR's existing position as previously stated is that no relief for the U.S. Estate taxes paid is available to a Canadian resident pursuant to paragraph 1 of Article XVIII of the Convention. Thus, the U.S. Estate taxes paid do not give rise to a deduction in computing the taxable income of the Canadian resident under subparagraph 110(1)f)(i) and the burden of tax is therefore more severe when the IRA or USPP recipient is a Canadian resident.

Issues

In your view, the U.S. Estate tax regime is not integrated in a proper manner with the Canadian income tax system in the hypothetical situations submitted. This leads to excessive taxation and appears inequitable. Taking into consideration the purpose of paragraph 1 of Article XVIII of the Convention and its interaction with section 691(c) IRC, you requested that we reconsider our interpretation of paragraph 1 of Article XVIII where an IRA or USPP amount is inherited by a Canadian individual with a view to allowing a deduction for related U.S. Estate taxes.

Discussion

We have re-examined ITR's positions on this issue in light of Patrick Massicotte's "Treaty Policy Consultation Request" document (the "Consultation Request") attached to the December 18, 2008 request for a meeting, which identified specific technical interpretations issued by our Directorate on this issue. Following our review of the argumentation submitted, we conclude that paragraph 1 of Article XVIII of the Convention can be interpreted in a manner that allows a Canadian individual to exclude from his taxable income in Canada the portion of the amounts distributed under a USPP or IRA that could be considered excluded from taxable income in the U.S., had the individual been a resident of the U.S., as a consequence of the deduction allowed under section 691(c) of the IRC, except where the payment of income is made through the Decedent's estate.

The Convention has been concluded between Canada and the U.S. for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and on capital. Article II of the Convention specifies the taxes that are covered by the Convention. In the case of the U.S., it specifies that the Convention shall apply to the Federal income taxes imposed by the IRC of 1986. Paragraph 2(b) of Article II adds that the Convention shall also apply to U.S. Estate taxes to the extent, and only to the extent, necessary to implement the provisions of paragraph 3(g) of Article XXVI and Article XXIX-B. These Articles contain rules which aim to integrate the U.S. Estate tax regime with the Canadian income tax system in specific circumstances. These specific circumstances do not include those mentioned above. Also, no double taxation arises in the hypothetical situations submitted, though we agree that there is economic double taxation.

The purpose of paragraph 1 of Article XVIII of the Convention is to confirm the income taxation power of the state of residence on pensions and annuities paid to one of its residents, though such income may be sourced in the other contracting state. Our reading of paragraphs 1 and 2(b) of Article XVIII of the Convention leads us to conclude that the expression "excluded from taxable income" is intended to apply, among others things, to the capital portion of annuities. This is suggested in the "Treasury Department Technical Explanation of the Convention between the United States of America and Canada" published by the Internal Revenue Service and effective January 1st, 1985.

Following our review, we are of the view that the expression "excluded from taxable income" as used in paragraph 1 of Article XVIII may be interpreted to allow the exclusion, in computing the taxable income in Canada, of the portion of the amounts distributed under a USPP or IRA that could be considered excluded from taxable income in the U.S., had the recipient been a resident thereof, as a consequence of the deduction allowed under section 691(c) of the IRC. Unlike a deduction for a personal allowance, the deduction under section 691(c) is directly linked to the amount distributed under a USPP or IRA. Our understanding is that the negotiating parties to the Convention intended that amounts distributed under a USPP or IRA that can be considered excluded from taxable income in the U.S. should also be excluded from taxable income in Canada when received by a Canadian resident. Consequently, by adopting a purposive approach of interpretation to circumscribe the intent of the contracting parties to the Convention, we can interpret broadly the words "excluded from taxable income" in paragraph 1 of Article XVIII of the Convention in order to resolve this U.S. Estate taxes issues.

This position is restricted to amounts paid out of an IRA or USPP directly to a Canadian recipient, and cannot be extended to amounts paid through the Decedent's estate. Pursuant to subsection 108(5), distributions of income from a foreign trust, including a foreign estate, lose their character for Canadian tax purposes as they go through the trust. Consequently, Article XXII rather than Article XVIII would apply to such payments of income.

We trust the above comments will be of some assistance.

For your information a copy of this letter will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases.

Yours truly,

Alain Godin, Manager
for Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

cc. Blair Hammond
International Legislative Affairs
Legislative Policy, Legislative Policy and
Regulatory Affairs Branch