23 May 1997 External T.I. 9624315 - EMPLOYEE-FUNDED 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:

1) whether amounts deferred under 401(k) plan (employee contributions only) are taxable when employee becomes resident of Canada and contributes while resident and working in Canada;

2) whether earnings taxable under 94 and 94.1.

Position:

Assuming 401(k) feature is not part of a plan to which employer contributions are made, then

1) the amount may be a subsection 5(1) amount by virtue of subsection 56(2) or constructive receipt or, failing this, a "deferred amount" under a salary deferral arrangement.

2) yes unless exceptions apply.

Reasons:

1) cannot confirm on a general enquiry basis that these amounts are more properly viewed as SDA "deferred amounts" or current salary which is taxable under 5(1);

2) earnings in non-resident trust once beneficiary is resident in Canada can be subject to tax under section 94 and 94.1; will not confirm that exceptions can apply on a technical interpretation.

XXXXXXXXXX 962431

Attention: XXXXXXXXXX

May 23, 1997

Dear Sirs:

Re: Employee-Funded 401(k) Plan

This is in reply to your letter of July 10, 1996, in which you request a technical interpretation concerning the tax consequences for a Canadian resident participant in the above-noted plan. We apologize for the delay in responding which was caused by our workload.

Your letter describes a particular 401(k) plan (the "Plan") established by several employers for their employees; the substantial majority of the employers are U.S. corporations and the substantial majority of the employees are citizens and residents of the U.S..

Your request for an interpretation relates to employee participants who started participating in the Plan while resident in the U.S. and working for a U.S. employer but who later begin working for a Canadian participating employer, become resident in Canada and continue to participate by contributing to the Plan.

Your questions appear to relate to an actual or proposed 401(k) plan and the Department is unable to respond except in the context of an advance ruling, or if the plan is already established, through the Tax Services Office. If you wish to proceed with your enquiry on the basis of an advance ruling request, we would require a copy of the Plan document and copies of the relevant Internal Revenue Code provisions and interpretations by the Internal Revenue Service relating to this kind of plan. We may provide, however, the following general views which are not binding on the Department.

A. Taxation of Contributions

If the Plan does not provide for or permit employer contributions, it is our view that it cannot be a "retirement compensation arrangement" or an "employee benefit plan" for the purposes of the Income Tax Act (the "Act"). However, to our knowledge a 401(k) feature is usually included in a plan to which an employer contributes. In such circumstances, the arrangement is either an employee benefit plan or, with respect to a Canadian-resident beneficiary, a "resident's arrangement" as defined in subsection 207.6(5) of the Act. We have issued numerous technical interpretations which explain the tax consequences concerning foreign plans to which the "employee benefit plan" or "retirement compensation arrangement" provisions of the Act apply. Assuming, however, that it is possible to establish a 401(k) plan which is not part of an arrangement or plan to which employer contributions are made, our views are as follows.

An amount of current compensation which is deferred at the request of the employee is generally taxed under subsection 5(1) of the Act by virtue of subsection 56(2) of the Act or because the amount has been constructively received. In some situations deferred compensation may not be subject to taxation in this manner and then the amount might be taxed under subsection 6(11) and paragraph 6(1)(a) of the Act as a "deferred amount" under a "salary deferral arrangement" (both terms being defined in subsection 248(1) of the Act). As you point out subsection 6(13) exempts Canadian-resident employees from subsection 6(11) where the employees were members of the plan while non-resident and the conditions therein are satisfied.

B. Taxation of Earnings

Paragraph 7 of Article XVIII of the Canada-U.S. Tax Convention exempts, upon election, a resident of Canada from Canadian income tax on any accrued but undistributed income of a U.S. resident trust where the trust is generally exempt from U.S. income tax and operated exclusively to provide pension, retirement or employee benefits. If the Plan you describe is not operated exclusively to provide one of these types of benefits, it is our view that the following tax consequences could occur.

Any earnings on amounts held in a foreign trust could be subject to tax under section 94 of the Act once a beneficiary becomes resident of Canada unless the trust is not discretionary (i.e. a trust as described in paragraph 94(1)(c) of the Act). Should the trust not be subject to tax under paragraph 94(1)(c) of the Act, paragraph 94(1)(d) will apply but there will be no tax consequences in the event that the resident employee's beneficial interest in the trust is less than 10% of, basically, all beneficial interests in the trust. We cannot confirm based on the description of the Plan you have provided whether an employee has a 100% beneficial interest in the trust (his or her account) or a proportionate beneficial interest in a trust in which all other employee-contributors also have beneficial interests.

Where either paragraph 94(1)(c) or (d) of the Act applies, there is a temporary exemption from taxation under section 94 for the first 60 months that the beneficiary is resident in Canada (subclause 94(1)(b)(A)(III) of the Act).

Subsection 75(2) may also apply to tax the earnings in the arrangement when the beneficiary becomes resident unless the arrangement is excepted by virtue of paragraph 75(3)(c) of the Act.

Section 94.1 of the Act could also apply if, after the beneficiary has resided in Canada for 60 months, the trust is subject to either paragraph 94(1)(c) or (d) of the Act and the beneficiary continues to participate in the Plan and one of the main reasons for acquiring, having or holding the interest in the trust was motivated by the tax considerations as described in subsection 94.1(1) of the Act.

We trust our comments will be of assistance to you.

Yours truly,

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