16 October 2007 Canada-U.S. Tax Treaty Impact on Retirement Plans Amendments to the Canada-U.S. Tax Treaty (Treaty) could introduce considerable relief as early as 2008 for cross-border employees who participate in qualifying retirement plans (QRPs) and their employers. This Communiqué will be of interest to all employers who transfer employees across the Canada-U.S. border, where those employees continue to participate in the home plan or elect to participate in a plan in their new employment location. Tax Relief The Treaty will set out specific rules to accommodate pension arrangements for employment transfers. It will shield against current negative tax consequences faced by cross-border employees and allow their employers to claim deductions for contributions made to QRPs for those employees. If ratified by both countries in 2007, measures relating to QRPs will apply to taxation years beginning in 2008. Qualifying Plans The following Canadian registered arrangements are considered to be QRPs: a registered pension plan (RPP), a group registered retirement savings plan (RRSP), a deferred profit sharing plan (DPSP), or an RRSP or registered retirement income fund (RRIF) that is funded exclusively by rollover contributions from one or more RPP, group RRSP or DPSP.
The following U.S. arrangements are considered to be QRPs: a qualified plan under section 401(a) of the Internal Revenue Code (IRC), including a 401(k) plan, an individual retirement plan that is part of a simplified employee plan under section 408(k) of the IRC, a section 408(p) simple retirement account, a section 403(a) qualified annuity plan, a section 403(b) plan, a section 457(g) trust providing s under a section 457(b) plan, a Thrift Savings Fund under section 7701(j) of the IRC, and any individual retirement account under section 408(a) of the IRC funded exclusively by one or more of the foregoing plans. Canadian Plans The following chart shows the impact of the Treaty on employees participating in a Canadian QRP. Service Location Residence U.S. Tax to Employee U.S. Tax to Employer Citizenship Scenario 1 U.S. Scenario 2 Not a U.S resident immediately before rendering services Deductible/ Canada U.S. Deductible/ Scenario 3 Canada Canada Deductible/ Deductible 1 U.S. The first scenario deals with participation in a QRP where the employee is transferred to U.S. employment, earns employment income taxable in that country, continues to earn s under the Canadian QRP, and does not participate in any U.S. tax-exempt retirement plan. Provided the period of U.S. employment does not exceed five years in a given ten-year period, the member s 1 For U.S. citizens, the s under the Canadian QRP cannot exceed s under a generally corresponding U.S. QRP. Page 2 of 5
contributions to the Canadian QRP will be deductible in computing his or her U.S. taxable income. Also, any s accrued, including contributions made on the member s behalf, will be excluded from the member s U.S. taxable income. Any contributions made by the employer to the Canadian QRP are deductible in computing the employer s U.S. profits. The first scenario complements the Canadian RPP rules that allow continued participation in an RPP during the first five years of employment outside of Canada. Problems will arise, however, where Canadian rules allow participation beyond five years as the treaty provides no relief beyond that period. To counter tax avoidance, s under the Canadian QRP cannot exceed s that would be provided if the member were a Canadian resident working in Canada. For U.S. citizens, the Canadian QRP s cannot exceed s available under a generally corresponding pension plan established and recognized for tax purposes by the U.S. Under the second and third scenarios, the participant in the Canadian QRP is employed in Canada and earns taxable income in Canada. The outlay associated with that income is deductible in determining Canadian business income by a Canadian resident employer or by a permanent establishment of the employer in Canada. The member s contributions to the Canadian QRP will be deductible in computing his or her U.S. taxable income and any s accrued, including contributions made on the member s behalf, will be excluded from U.S. taxable income. This U.S. tax treatment applies only to the extent that the member is treated no better, in the Canadian QRP, than any similarly situated Canadian resident. The s granted under the Treaty cannot exceed the s available under a generally corresponding pension plan established and recognized for tax purposes in the U.S. For the purposes of determining eligibility to participate in U.S. retirement plans, participation in the Canadian QRP is considered participation in a generally corresponding U.S. pension plan. A U.S. pension plan generally corresponding to an RPP would be a qualified plan under section 401(a) of the IRC, for example. Since RPPs are usually less generous than 401(a) plans, this requirement will almost always be satisfied. The difference between the second and third scenarios is that, under the former, the member is a resident of the U.S. whereas, under the latter, the member is a resident of Canada but a citizen of the U.S. Taxation based on citizenship is a unique feature of U.S. taxation law. Page 3 of 5
U.S. Plans The following chart shows the impact of the Treaty on a member participating in a U.S. QRP. Service Location Residence Canadian Tax to Employee Canadian Tax to Employer Citizenship Scenario 4 Canada Scenario 5 Not a Canadian resident immediately before rendering services Deductible/ U.S. Canada Deductible/ Deductible Scenario four deals with the situation where a participant in a U.S. QRP is transferred to Canadian employment, earns employment income taxable in that country and continues to earn s under the U.S. QRP. The member does not participate in a Canadian tax-exempt retirement plan. Provided the period of Canadian employment does not exceed five years in a given ten-year period, the member s contributions to the U.S. QRP would be deductible in computing his or her Canadian taxable income and any s accrued, including contributions made on the member s behalf, would be excluded from Canadian taxable income. Any contributions made by the employer to the U.S. QRP would be deductible in computing that employer s Canadian profits. Benefits under the U.S. QRP cannot exceed s that would be provided if the member were a U.S. resident working in the U.S. Under scenario five, a Canadian resident participates in a U.S. QRP and is employed in and earns taxable income in the U.S. The outlay associated with that income would be deductible in determining U.S. business income by a U.S. resident employer or a permanent establishment of the employer in the U.S. The member s contributions to the U.S. QRP will be deductible in computing his or her Canadian taxable income and any s accrued, including contributions made on the member s behalf, will be excluded from the member s Canadian taxable income. This Canadian tax treatment applies only to the extent that the member is treated no better, in the U.S. QRP, than any similarly situated U.S. resident. Page 4 of 5
In addition, annual member contributions in a taxation year cannot exceed the member s RRSP deduction limit, after deducting any RRSP contributions deducted under Canadian law for the taxation year. The amount deducted by the member by virtue of the Treaty will be taken into account in determining the RRSP deduction limit for subsequent years. The interaction of these Treaty provisions with the Income Tax Act is not clear and it is expected that the Act will require amendment to reflect these changes. Comments The existing Treaty provisions provided little or no protection for Canadians transferred to the U.S. who continued active participation in Canadian QRPs. Canadian residents working in the U.S. could not participate, without adverse tax consequence, in U.S. 401(k) and similar plans. U.S. citizens participating in Canadian QRPs had to face U.S. tax consequences associated with that participation. These problems, amongst others, have now been addressed by the Treaty. These changes will facilitate the transfer of employees across the 49 th parallel. For more information, contact your Mercer consultant or the following Mercer consultants: Fotini Stephen Marcel Théroux Doris Legendre 416 868 2582 416 868 2158 514 841 6790 Fotini.Stephen@mercer.com Marcel.Theroux@mercer.com Doris.Legendre@mercer.com Mercer publishes the Communiqué as a general summary and commentary on topical issues. The information in the Communiqué in no way constitutes specific advice and should not be used as a basis for formulating business decisions. To determine what implications the information contained in the Communiqué will have for your company, please contact your Mercer consultant. Reproduction of the Communiqué is permitted if its source is acknowledged. Mercer Offices: Calgary 403 269 4945 Edmonton 780 483 5288 Halifax 902 429 7050 London 519 672 9310 Montreal 514 285 1802 Ottawa 613 230 9348 Québec City 418 658 3435 Saskatoon 306 683 6950 St. John's 709 576 7146 Toronto 416 868 2000 Vancouver 604 683 6761 Winnipeg 204 947 0055 Mercer Website: www.mercer.ca Page 5 of 5