US/Canada Tax Treaty Treatment of Retirement Plans

US/Canada Tax Treaty Treatment of Retirement Plans

How the US-Canada Treaty Taxes Retirement Plan Income

When it comes to applying tax treaty rules between two countries that have entered into a double taxation agreement, one of the key ingredients involves the tax treatment of pension and retirement both in the U.S. and abroad. More specifically, how does each governing body treat income from pension sources from the other country for tax purposes? For example, how does Canada tax a U.S. person living in Canada and receiving 401K distributions?  Likewise, how does the United States tax a Canadian individual who resides in the United States and earns income from an RSP or RRSP? There are many different aspects of the US and Canada tax treaty on matters involving pensions which is based on the citizenship and residency of the taxpayer and the source of the pension. Let’s take a look at some of the basic issues involving the US-Canada tax treaty on matters involving retirement plans, along with some Taxpayer tips:

General Rule – ARTICLE XVIII Pensions and Annuities

• • • “Pensions and annuities arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State, but the amount of any pension included in income for the purposes of taxation in that other State shall not exceed the amount that would be included in the first-mentioned State if the recipient were a resident thereof.”

    • This paragraph refers to the situation in which pension is being sourced in the first country but paid to a resident residing in the other country. In other words, the country where the taxpayer resides is not the same country where the pension is sourced. In this scenario, the general rule is that the state of residence can tax the pension but it shall not exceed what the tax would have been if the taxpayer was residing in the first contracting state, which is where the pension is sourced.

    • However:

      • “Pensions may also be taxed in the Contracting State in which they arise and according to the laws of that State; but if a resident of the other Contracting State is the beneficial owner of a periodic pension payment, the tax so charged shall not exceed 15 per cent of the gross amount of such payment; and

      • Annuities may also be taxed in the Contracting State in which they arise and according to the laws of that State; but if a resident of the other Contracting State is the beneficial owner of an annuity payment, the tax so charged shall not exceed 15 per cent of the portion of such payment that is liable to tax in the first-mentioned State.”

        • Taxpayer Tip: The second paragraph clarifies the general rule laid out in the first paragraph above, by stating that the first contracting state where the pension is sourced can still levy a 15% tax when the pension is a periodic pension payment. It is important to note, that this paragraph refers specifically to periodic payments. Moreover, paragraph B is similar to paragraph a except it refers to annuity payments as opposed to periodic pension payments.

Article 13 of the 2007 Protocol

• • • “The 2007 protocol to the US and Canada tax treaty further clarifies and summarizes the definition of pension and annuity:

      • “Paragraphs 3 and 4 of Article XVIII (Pensions and Annuities) of the Convention shall be deleted and replaced by the following: 3. For the purposes of this Convention:”

      • The term “pensions” includes any payment under a superannuation, pension or other retirement arrangement, Armed Forces retirement pay, war veterans pensions and allowances and amounts paid under a sickness, accident or disability plan, but does not include payments under an income-averaging annuity contract or, except for the purposes of Article XIX (Government Service), any benefit referred to in paragraph 5; and

      • The term “pensions” also includes a Roth IRA, within the meaning of section 408A of the Internal Revenue Code, or a plan or arrangement created pursuant to legislation enacted by a Contracting State after September 21, 2007 that the competent authorities have agreed is similar thereto. Notwithstanding the provisions of the preceding sentence, from such time that contributions have been made to the Roth IRA or similar plan or arrangement, by or for the benefit of a resident of the other Contracting State (other than rollover contributions from a Roth IRA or similar plan or arrangement described in the previous sentence that is a pension within the meaning of this subparagraph), to the extent of accretions from such time, such Roth IRA or similar plan or arrangement shall cease to be considered a pension for purposes of the provisions of this Article.

      • For the purposes of this Convention:

        • (a) The term “annuity” means a stated sum paid periodically at stated times during life or during a specified number of years, under an obligation to make the payments in return for adequate and full consideration (other than services rendered), but does not include a payment that is not a periodic payment or any annuity the cost of which was deductible for the purposes of taxation in the Contracting State in which it was acquired; and

        • (b) An annuity or other amount paid in respect of a life insurance or annuity contract (including a withdrawal in respect of the cash value thereof) shall be deemed to arise in a Contracting State if the person paying the annuity or other amount (in this subparagraph referred to as the “payer”) is a resident of that State. However, if the payer, whether a resident of a Contracting State or not, has in a State other than that of which the payer is a resident a permanent establishment in connection with which the obligation giving rise to the annuity or other amount was incurred, and the annuity or other amount is borne by the permanent establishment, then the annuity or other amount shall be deemed to arise in the State in which the permanent establishment is situated and not in the State of which the payer is a resident.”

Paragraph 7 of Article XVIII (Pensions and Annuities)

• • • • Paragraph 7 of Article XVIII (Pensions and Annuities) of the Convention shall be deleted and replaced by the following:

        • A natural person who is a citizen or resident of a Contracting State and a beneficiary of a trust, company, organization or other arrangement that is a resident of the other Contracting State, generally exempt from income taxation in that other State and operated exclusively to provide pension or employee benefits may elect to defer taxation in the first-mentioned State, subject to rules established by the competent authority of that State, with respect to any income accrued in the plan but not distributed by the plan, until such time as and to the extent that a distribution is made from the plan or any plan substituted therefor.

          • Taxpayer Tip: Thus, if an individual who is a citizen or resident of a contracting state but a beneficiary of a pension trust located in the other country (source) and is generally exempt from taxation in the other (source) country, then the individual can elect to defer tax in the residence country which as accrued but not been distributed — until it has been distributed. In other words, the resident/citizen of the first country can avoid tax on non-distributed income growth within the pension trust, until it has been distributed.

Article XVIII (Pensions and Annuities)

• • • • • • Taxpayer Tip: In general, a very important component of pension and retirement for the US and Canada tax treaty is that it allows for the taxpayer to include certain employment based pension and related contributions that are being made to certain retirement plans. The next few paragraphs provide in-depth information within the treaty regarding how each country can tax pension generated from the other contracting state. Depending on whether the taxpayer is being taxed under U.S. tax or Canadian tax law, in addition to the fact that depending on whether the pension is a Roth IRA or other tax free mechanism or not will overall determine the overall tax implications for pension contributions and ultimately, distributions

Article XVIII (Pensions and Annuities) 

• • • “Contributions made to, or benefits accrued under, a qualifying retirement plan in a Contracting State by or on behalf of an individual shall be deductible or excludible in computing the individual’s taxable income in the other Contracting State, and contributions made to the plan by the individual’s employer shall be allowed as a deduction in computing the employer’s profits in that other State, where:

      • • (a) The individual performs services as an employee in that other State the remuneration from which is taxable in that other State;

        • (b) The individual was participating in the plan (or another similar plan for which this plan was substituted) immediately before the individual began performing the services in that other State;

        • (c) The individual was not a resident of that other State immediately before the individual began performing the services in that other State;

        • (d) The individual has performed services in that other State for the same employer (or a related employer) for no more than 60 of the 120 months preceding the individual’s current taxation year;

        • (e) The contributions and benefits are attributable to the services performed by the individual in that other State, and are made or accrued during the period in which the individual performs those services; and

        • (f) With respect to contributions and benefits that are attributable to services performed during a period in the individual’s current taxation year, no contributions in respect of the period are made by or on behalf of the individual to, and no services performed in that other State during the period are otherwise taken into account for purposes of determining the individual’s entitlement to benefits under, any plan that would be a qualifying retirement plan in that other State if paragraph 15 of this Article were read without reference to subparagraphs (b) and (c) of that paragraph.

          • This paragraph shall apply only to the extent that the contributions or benefits would qualify for tax relief in the first-mentioned State if the individual was a resident of and performed the services in that State. 1

• • • For the purposes of United States taxation, the benefits granted under paragraph 8 to a citizen of the United States shall not exceed the benefits that would be allowed by the United States to its residents for contributions to, or benefits otherwise accrued under, a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.

    • Contributions made to, or benefits accrued under, a qualifying retirement plan in a Contracting State by or on behalf of an individual who is a resident of the other Contracting State shall be deductible or excludible in computing the individual’s taxable income in that other State, where:

    • The individual performs services as an employee in the firstmentioned state the remuneration from which is taxable in that State and is borne by an employer who is a resident of that State or by a permanent establishment which the employer has in that State; and

      • (b) The contributions and benefits are attributable to those services and are made or accrued during the period in which the individual performs those services. This paragraph shall apply only to the extent that the contributions or benefits qualify for tax relief in the first-mentioned State.

        • For the purposes of Canadian taxation, the amount of contributions otherwise allowed as a deduction under paragraph 10 to an individual for a taxation year shall not exceed the individual’s deduction limit under the law of Canada for the year for contributions to registered retirement savings plans remaining after taking into account the amount of contributions to registered retirement savings plans deducted by the individual under the law of Canada for the year. The amount deducted by an individual under paragraph 10 for a taxation year shall be taken into account in computing the individual’s deduction 17 limit under the law of Canada for subsequent taxation years for contributions to registered retirement savings plans.

• • • • • For the purposes of United States taxation, the benefits granted under paragraph 10 shall not exceed the benefits that would be allowed by the United States to its residents for contributions to, or benefits otherwise accrued under, a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States. For purposes of determining an individual’s eligibility to participate in and receive tax benefits with respect to a pension or retirement plan or other retirement arrangement established in and recognized for tax purposes by the United States, contributions made to, or benefits accrued under, a qualifying retirement plan in Canada by or on behalf of the individual shall be treated as contributions or benefits under a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.

    • Contributions made to, or benefits accrued under, a qualifying retirement plan in Canada by or on behalf of a citizen of the United States who is a resident of Canada shall be deductible or excludible in computing the citizen’s taxable income in the United States, where: (a) The citizen performs services as an employee in Canada the remuneration from which is taxable in Canada and is borne by an employer who is a resident of Canada or by a permanent establishment which the employer has in Canada; and (b) The contributions and benefits are attributable to those services and are made or accrued during the period in which the citizen performs those services. This paragraph shall apply only to the extent that the contributions or benefits qualify for tax relief in Canada.

    • The benefits granted under paragraph 13 shall not exceed the benefits that would be allowed by the United States to its residents for contributions to, 18 or benefits otherwise accrued under, a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States. For purposes of determining an individual’s eligibility to participate in and receive tax benefits with respect to a pension or retirement plan or other retirement arrangement established in and recognized for tax purposes by the United States, contributions made to, or benefits accrued under, a qualifying retirement plan in Canada by or on behalf of the individual shall be treated as contributions or benefits under a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.

    • For purposes of paragraphs 8 to 14, a qualifying retirement plan in a Contracting State means a trust, company, organization or other arrangement: (a) That is a resident of that State, generally exempt from income taxation in that State and operated primarily to provide pension or retirement benefits; (b) That is not an individual arrangement in respect of which the individual’s employer has no involvement; and (c) Which the competent authority of the other Contracting State agrees generally corresponds to a pension or retirement plan established in and recognized for tax purposes by that other State.

    • For purposes of this Article, a distribution from a pension or retirement plan that is reasonably attributable to a contribution or benefit for which a benefit was allowed pursuant to paragraph 8, 10 or 13 shall be deemed to arise in the Contracting State in which the plan is established. Paragraphs 8 to 16 apply, with such modifications as the circumstances require, as though the relationship between a partnership that carries on a business, and an individual who is a member of the partnership, were that of employer and employee.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.