18 July 1988 Income Tax Severed Letter

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.

18/7/88

General Position

Canadian Tax Treatment of Amounts received by residents of Canada out of an United States Individual Retirement Arrangement (IRA) and U.S. Pension Plans including 401(k) Plans

An IRA may be set up as either a trust account or a custodial account with a bank, a federally insured credit union, a savings and loan association or any person who has IRS approval to act as a trustee or custodian.

The IRS permits the individual to set up a model trust account by using Form 5305 titled Individual Retirement Trust Account. The individual may set up a model custodial account by using Form 5305-A titled Individual Retirement Custodial Account.

In addition, a simplified employee pension (SEP) is an individual retirement arrangement that permits an individual's employer to contribute to the IRA each year. Such an arrangement is referred to as a SEP-IRA. The IRS has created a model SEP agreement by using Form 5305-SEP titled Simplified Employee Pension - Individual Retirement Accounts Contribution Agreement.

1. Trust Account (No amounts rolled over from a US Pension Plan)

Subject to 3 and 4 below, income earned in the IRA trust in the year by a resident of Canada will be subject to tax in Canada by virtue of paragraph 94(1)(d) of the Income Tax Ace (Act). However, no tax will be payable by a beneficiary of a foreign trust if the beneficiary has been a resident in Canada for a period or periods the aggregate of which is less than 60 months.

Subject to 3 and 4 below, when a beneficiary of a trust account receives a lump sum amount out of an IRA trust account the amount received, to the extent it does not represent income earned in the trust in the year, will be exempt from tax in Canada. If income earned by the trust in the year the Stomp sum is received, is included in the lump sum it is considered to be "income from a trust" and is included in the taxpayers income for the year by virtue of section 12 of the Act.

2. Custodial Account (No amounts rolled over from a US Pension Plan)

Subject to 3 and 4 below, depositors of a custodial IRA account, which are considered to be equivalent to bank accounts, are required to include in income all amounts of income earned in the account in the taxation year pursuant to section 12 of the Act.

Subject to 3 and 4 below, in the year the depositor receives a lump sum payment out of the custodial account, all amounts received out of the account will be exempt from tax in Canada except for the income earned in the account in the year the IRA is redeemed. The income earned in the account in the year of redemption will be taxable in the hands of the depositor pursuant to section 12 of the Act.

3. U.S. Pension rolled into an IRA

Under the U.S. Code an individual may roll a lump sum payment received out of a U.S. pension fund including a 401(k) plan to an IRA. Where a Canadian resident receives an amount out of the U.S. pension plan, such amount is included in his income as pension payments. However, provided he is permitted to roll the amounts to an IRA, Article XVIII of the Canada-U.S. Income Tax Convention (Convention) requires Canada to provide a resident of Canada with an exemption for any amounts rolled into an IRA. When amounts are subsequently received out of such an IRA, it is our view that the payment which relates to the lump sum pension payments rolled into the IRA, together with any income earned in the IRA, will continue to be subject to tax as pension payments pursuant to subparagraph 56(1)(a)(i) of the Act. That is amounts rolled to an IRA from a US pension fund including a 401(k) plan retain their identity as pension funds and will be taxed as such.

4. Combination IRA (Capital contribution from a U.S. Pension Plan and Other Sources)

Where amounts are permitted to be rolled into an IRA, Canada is required to provide a resident of Canada with an exemption for amounts rolled into an IRA by virtue of Article XVIII of the Convention. if the amounts are rolled into an existing IRA the following, rules will apply.

(a) Income earned in the current year will be subject to tax as set out in 1 and 2 above to the extent that it is attributable to capital contributed to the IRA from sources other than a rollover of pension benefits.

(b) When a lump sum amount is withdrawn from the IRA only the portion of the withdrawal which relates to pension benefits rolled into the IRA, together with a proportional share of the earned income in the IRA, will be subject to tax as a pension payment pursuant to subparagraph 56(1)(a)(i) of the Act. The remaining portion is taxed in accordance with 1 and 2 above.

5. Annuity from an IRA

Where a resident of Canada purchases an annuity under an IRA and commences to receive annuity payments under the arrangement, the following treatment will apply.

(a) In the case of an annuity acquired in situation 1 and 2 above it is our view that the portion of the annuity payment that represented the capital in the IRA which was used to purchase the annuity would be exempt from tax in Canada by virtue of paragraph 60(a) of the Act. The remainder will be taxed as an annuity payment.

(b) In the case of an annuity acquired in situation 3 above, the total annuity received will be included in income as pension income pursuant to subparagraph 56(1)(a)(i) of the Act.

(c) In the case of an annuity acquired in situation 4 above, the portion of the payment which relates to the lump sum payment rolled into the IRA, together with a proportional share of the income earned in the IRA, will continue to be taxed as pension payments under subparagraph 56(1)(a)(i) of the Act. The remainder of the payment from the annuity will be treated the same as 5(a) above.

6. Rollover from an IRA to a RRSP

Where a lump sum amount is paid out of an IRA to a resident of Canada it will generally be taxed in the United States either at a 30% withholding rate or at regular U.S. tax rates if received by a U.S. citizen who is resident of Canada. As indicated above all amounts received out of either an IRA custodial account or IRA trust will be exempt from tax in Canada except in situations 3 and 4 above.

Rollover of a lump sum amount received from an IRA to a RRSP is as follows:

(a) In a case of a lump sum payment received out of an IRA by a taxpayer in situation 1 and 2 above, no rollovers are permitted.

(b) Where a lump sum payment is received out of an IRA by a taxpayer in situation 3, the full amount of the payment may be rolled to a RRSP.

(c) A taxpayer would be permitted to roll only that portion of the lump sum payment received out of the IRA to a RRSP as is taxed under subparagraph 56(1)(a)(i) of the Act in situation 4 above. The remaining portion of the payment would not be eligible for a rollover.

Rollovers may also be permitted with respect to the portion of annuity payments included in income by virtue of paragraph 5(b) and (c) above. However, under the proposed pension reform, rollovers would be limited to lump sum payments except where the transitional rules apply.

7. SEP-IRA

It is our view that amounts received out of a SEP-IRA should be treated as being received from an employee benefit plan and taxed when received out of the plan. Where the amounts are attributable to services rendered by the taxpayer in a period during which he was not resident in Canada, the amounts received out of the SEP- IRA may be taxed as pension benefits and would be eligible for a rollover to a RRSP. However, under the proposed pension reform, rollovers would be limited to lump sum payments except where the transitional rules apply.

401(k) Plans

It is our view that the 401(k) plan is a U.S. Pension Plan. Where the employer contributes to the plan the amounts received out of a 401(k) plan are considered to be amounts received out of an Employee Benefit Plan and are subject to tax when received by the taxpayer. In any case where, the amounts are attributable to services rendered by the taxpayer in a period during which he was not resident in Canada, the amounts received out of the plan would be taxed as pension benefits and would be eligible for a rollover to a RRSP. However, under the proposed pension reform rollovers would only be permitted with respect to lump sum payments except where the transition rules apply.

Where the employer does not contribute to the plan and the amounts are attributable to services rendered by the taxpayer in a period during which he was a resident in Canada, the full amount received will be taxed as pension income with no deduction for return of amounts contributed as would be the case if the amounts were received from an Employee Benefit Plan. For such an individual amounts included in income as pension benefits are eligible for rollover into an RRSP while amounts included in income under paragraph 6(1)(g) of the Act as payment from Employee Benefit Plan are not.