23 August 2010 External T.I. 2009-0313171E5 - 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 a U.S. pension plan, is there any provision in the Canada - U.S. Income Tax Convention that would allow the individual to claim a foreign tax credit for the U.S. Estate taxes paid?

Position: No, but the amount of U.S. Estate taxes may be deducted by the Canadian individual 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).

Reasons: Interpretation of the Canada - U.S. Income Tax Convention and the ITA.

XXXXXXXXXX 							2009-031317
								Yannick Roulier
Attention:  XXXXXXXXXX 

August 23, 2010

Sir:

Re: U.S. Estate taxes - inherited U.S. pension plan

This is further to your letter of February 26, 2009, requesting our comments regarding a situation where a U.S. pension plan ("USPP") is received 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").

Hypothetical situation submitted

You have presented a hypothetical situation where a Canadian individual becomes entitled to receive payments under a USPP of which her predeceased spouse ("Decedent"), resident in Canada at the moment of his death, was a beneficiary. In the situation submitted, the surviving spouse receives a pension at a reduced rate of 60% of the entitlement of the Decedent. Upon the death of the Decedent, U.S. Estate taxes were exigible upon the calculated principal portion of the future pension income stream that will be paid to the surviving spouse, as it is considered to be U.S. situs property.

You mentioned that there is no deferral of U.S. Estate taxes when the beneficiaries are non-U.S. citizen spouses. However, the U.S. Estate taxes attributable to the USPP can still be deferred with respect to pension payments in two specific situations. First, in certain circumstances the U.S. Estate taxes can be deferred until each periodic pension payment is received, at which time U.S. Estate taxes would be paid on the principal portion of that pension payment. Alternatively, the U.S. Estate taxes can be deferred if, among other things, the principal portion of the pension payment is transferred to a qualified domestic trust ("QDOT"), as defined for U.S. tax purposes, within 60 days of receipt. Then the U.S. Estate taxes would be paid upon payment of the principal out of the QDOT.

You submit that in such situations the ITA would not provide any foreign tax credit to the surviving spouse for the U.S. Estate taxes paid upon receipt of the pension payment. Moreover, Article XXIX-B of the Convention would not provide appropriate relief either.

Questions

You ask whether there is any provision in the Convention that would permit a Canadian foreign tax credit for U.S. Estate taxes paid upon receipt of the pension payment by the surviving spouse directly from the regime or through a QDOT?

Comments

The particular circumstances outlined in your letter seem to relate to a factual situation involving specific taxpayers. As explained in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, the Income Tax Rulings Directorate of the Canada Revenue Agency ("CRA") does not comment on transactions involving specific taxpayers except by way of an advance income tax ruling in respect of proposed transactions. When the situation involves a specific taxpayer and a completed transaction, the question should be directed to the appropriate Tax Services Office of the CRA for their views, along with all relevant facts and documentation. Nevertheless, we are prepared to offer the following general comments which may be of assistance. Our comments constitute technical interpretations. They are not income tax rulings and are not binding on the CRA.

Based on the ITA and the Convention, we agree with you that no Canadian foreign tax credit could be claimed by the surviving spouse pursuant to subsection 126(1) in respect of the U.S. Estate taxes paid in the hypothetical situation submitted.

That being so, we understand that where an individual who resides in the U.S. becomes entitled to receive pension payments pursuant to a USPP, any amount paid out of the USPP to the individual either directly, through the Decedent's estate or through a QDOT, 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 USPP beneficiary, a deduction in respect of the U.S. Estate taxes attributable to the USPP is allowed under certain conditions.

Where a USPP entitlement is acquired by an individual who resides in Canada, an amount paid out of the USPP directly to the individual would generally be 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 the amounts from such pensions or 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.

We are of the view that the expression "excluded from taxable income" as used in paragraph 1 of Article XVIII should be interpreted to exclude, in computing the taxable income of a resident of Canada, the portion of the amounts distributed under a USPP that would be excluded from taxable income in the U.S., had the recipient been a resident thereof, notably as a consequence of the deduction allowed under section 691(c) of the IRC. Consequently, a deduction equal to the section 691(c) deduction that would be allowed pursuant to this provision under the IRC may be claimed by a Canadian resident in accordance with subparagraph 110(1)(f)(i).

Unlike a deduction for a personal allowance, the deduction under section 691(c) is directly linked to the amount distributed under a USPP. Our understanding is that the negotiating parties to the Convention intended that amounts distributed under a USPP 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, we interpret broadly the words "excluded from taxable income" in paragraph 1 of Article XVIII of the Convention in order to exclude the amounts that would be excluded from taxable income in the U.S. pursuant to section 691(c) of the IRC.

This position applies to amounts paid out of a USPP directly to a Canadian recipient whether the U.S. Estate taxes are paid upon the Decedent's death or deferred. However, it cannot be extended to amounts paid through a QDOT. This is because where the principal portion of the pension payment is transferred to a QDOT and then paid out to the Canadian surviving spouse, any distribution of income from the QDOT would, pursuant to subsection 108(5), lose its character as pension income as it goes through the trust for Canadian tax purposes. In such circumstances, Article XXII rather than Article XVIII would apply to such payments of income, such that no amount could be "excluded from taxable income" as per paragraph 1 of Article XVIII of the Convention.

We trust the above comments will be of some assistance.

Yours truly,

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