New protocol to US-Canada tax treaty agreed

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Norbert Schlenker
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New protocol to US-Canada tax treaty agreed

Post by Norbert Schlenker »

http://www.fin.gc.ca/news07/data/07-070_1e.html

Help for cross-border employees on pension/401k/RRSP contributions and stock options. Withholding on interest abolished. Confirmation of the stepup rule on cost basis for investments when moving cross-border.
telly1
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Post by telly1 »

From Norbert's link, here's what most of us will find most interesting:

"Current rule: No rule in respect of contributions, meaning no assurance that they may be deducted for tax purposes in the country of employment.

New rule: Provided certain conditions are met, cross-border commuters may deduct, for residence country tax purposes, the contributions they make to a plan or arrangement in the country where they work. Similarly, those who move for work and meet certain conditions can deduct, for source country tax purposes, their contributions to a plan or arrangement in the other country, for up to five years. In both cases, accruing benefits are not taxable.

Examples: (1) A resident of Canada is employed in the U.S., and contributes to an employer-sponsored pension plan there. The employee’s contributions to the plan (up to the employee’s remaining RRSP deduction room) will be deductible for Canadian tax purposes. (2) An employee of a Canadian company is assigned for three years to a related U.S. company. The employee keeps contributing to the employee pension plan of the Canadian company. For U.S. tax purposes, both the employee and the U.S. company will be able to deduct the contributions."

"The Protocol signed on September 21, 2007 proposes to change and update many of the provisions of the existing Canada-U.S. Income Tax Convention. This fifth Protocol will enter into force once it is made law (“ratifiedâ€￾) by both the Canadian and United States governments (or on January 1, 2008, if it is ratified in 2007)."

So it looks like many of us cross-border commuters can start contributing to the 401k (or RRSP) beyond just the amount to get us a company match. This is great news. Given the current value of the USD, I wish it were effective today!
Norbert Schlenker
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Post by Norbert Schlenker »

Forgot this earlier. Hat tip to Bruce Cohen at the Financial Webring Forum for the pointer.

http://www.financialwebring.org/forum/v ... 124#213124
steveh
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Roth IRA Treatment under the new treaty protocol

Post by steveh »

So does this new protocol (once approved) resolve any issue wrt tax treatment of Roth IRA's? That is, as I understand it, the CRA currently does not recoginze Roth IRA's as a pension plan, and as such for any US citizen who is resident in Canada, the CRA requires that all income inside the Roth (interest, dividend or capital gain from the time of entry into Canada) be included in taxable income on an annual basis. Under this protocol it appears that the CRA would need to treat Roth IRA's as the US IRS treats them, i.e., income/growth is not taxable in any given year nor on the eventual withdrawal of funds (assuming the Roth has been established for 5 years). Is that correct?
Thanks.
Norbert Schlenker
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Re: Roth IRA Treatment under the new treaty protocol

Post by Norbert Schlenker »

steveh: [i]Under this protocol it appears that the CRA would need to treat Roth IRA's as the US IRS treats them, i.e., income/growth is not taxable in any given year nor on the eventual withdrawal of funds (assuming the Roth has been established for 5 years). Is that correct?[/i]

Without the actual language of the protocol, there is no way to be sure. Given what's in the press release, I see no reason to believe (or even hope) that CRA would be required to treat a Roth IRA like a regular IRA. I wouldn't get my hopes up.
steveh
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Roth Treatment

Post by steveh »

Norbert, thanks for your comment. The US Treasury website includes a link to the actual protocol as it is written . I'll try to copy the announcement link here - go to the bottom of the announcement page to find the link to the protocol document.

http://www.treasury.gov/press/releases/hp569.htm

Article 13 (Pensions and Annuities) now includes the following:

"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."
Norbert Schlenker
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Post by Norbert Schlenker »

Thanks for the pointer to the specific language, steveh. The pensions article (XVIII) has been almost entirely rewritten, so I'm not sure I have this right, but it looks to me like at best a partial win for returning Canadians with a Roth IRA.

What the new paragraph 3(b) gives - explicit recognition of a Roth IRA as a pension account - the new paragraph 7 mostly takes away - because taxation of the income inside the account is not tax free but just deferred until distributions start.

I could be wrong. I'm still trying to parse some of the syntax. :lol: :lol:
steveh
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Tax Treaty and the Roth IRA

Post by steveh »

If taxation would now be deferred until withdrawals are taken from the Roth account the treatment of the Roth would become like the treatment of traditional IRA’s (or RRSPs) from what I understand about the treatment of traditional IRAs held by US (or dual) citizens resident in Canada. However, withdrawals from traditional IRA’s would be subject to taxation in the US (at least the amount of the withdrawal that is not attributed to “basisâ€￾ in the IRA is), as well as taxation in Canada in which case the taxes paid in the US should become a credit against taxes to be paid in Canada. Is this correct for traditional IRAs?

But with a Roth IRA, there would be no tax payable in the US on withdrawal, yet there would now be tax in Canada on that withdrawal. Is that how you would interpret the treaty assuming this protocol is approved?

And, as a more general question which I don’t know the answer to, can taxes paid in one country only be offset against taxes paid on the same or similar income in the other country? Or does that answer depend on the type of income being taxed? So in the above situation, if in Canada a US citizen would be paying tax on his/her Roth withdrawal, can that tax be used as a foreign tax credit on US taxes somehow, even though the Roth withdrawal has no tax in the US?

Perhaps this situation is similar to investments held in a non-registered account. For example if a US citizen emmigrates to Canada, and owns a non-registered investment with a market value of $100,000US on the date of emmigration and which has a cost basis of $50,000 for US tax purposes, then the CRA will see this non-registered investment as having a cost basis of $100,000US times the exchange rate on the date of entry into Canada. If the individual sells the investment immediately then for US tax purposes there will be a $50,000 capital gain, and for Canadian tax purposes there is no gain. Does the individual get a credit for US taxes paid on this gain on their Canadian taxes?

Hope that's not too many questions at once!
bruce
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Post by bruce »

Wow, this could be big! I just spent some time reading (okay, my eyes were glazing over) the protocol. Clear as mud. I'm not sure what this all means but it sounds like there are certainly some possible upsides.

Norbert - Thanks for posting this!

Steveh - I think you're on the right path with your interpretations. Your questions all sound reasonable to me as I have many of the same concerns. Unfortunately I suspect that it will be a while before we get the appropriate answers.

I'm sure Mark Serbinski and team will be looking into the proposed new rules to better understand the implications for clients. Perhaps he'll be able to post more information of his web site (maybe even write an article???)!
nelsona
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Post by nelsona »

My quick take on new Roth treatment;

Roth becomes a pension, and thus will be taxed in canada to the extent that it is taxed in US, that is none.

The language addressing Roths specifically refers -- I believe -- to the funding of a Roth by a Cdn resident. Such funding would NOT be sheltered.

Again this is my quick take.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
nelsona
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Post by nelsona »

new paragrapph 7 does NOT take anything away from Roth, since this para already existed and was meant for RRSps.

While it could be applied to Roth the big difference between roths and rrsps is that US does NOT treat Roth withdrawals as income, while Canad does include RRSP withdrawals as income.

The overriding clause, that one country will not include in income any more than the source country does, remains in effect.

By thw way, before this protocol, CRA was treating internal Roth income exactly as IRS treats internal RRSP income for those who do not elect to defer taxation. in fact, thru special arrangements, Roth were being treated exactly like IRS was treaing RRSP with election, ie. deferring taxation on post-immigrant gains until withdrawal.

Now, with the treaty pension protection, Roth contributions made while resident in US will be forever tax-free.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
bruce
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Post by bruce »

Thanks Nelsona. Wow, that's really good news if your interpretation is correct. To think that I just made a bunch of adjustments to my Roth last week. Oh well, over the long haul, this should still save me quite a bit.

I'm curious to see how the new protocol will impact the Canadian "exit tax" on US citizens. When leaving Canada, you can now do the deemed disposition for both countries a the same time. I understand that Canada allows you to defer the tax payment until the underlying securites are actaully sold. That's fine for a Canadian citizen but for a USC *both* countries would need to allow deferment in order for this to help.
martinleroux
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Post by martinleroux »

Could the new rules have an effect on US taxation of RRSP withdrawals?

Previously I'd understood that the cost basis for an RRSP was the US dollar book value at the time one became a US resident, i.e. RRSP withdrawals were taxable in the US only to the extent that they exceeded the book value at this time. Under the new rules would the US cost basis now be the **market value** at the time one became a US resident?
nelsona
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Post by nelsona »

It won't be market value. Rememebr that the 'bump up' provision for deemed dispositions, in effect since sept 2000 only applies to investments that are subject to deemed disposition. RRSPs are not, so this portion does not apply.

There could be a biggewr issue for RRSPs: IRS could now take the position that ALL RRSP income is taxable, since the treaty going forward will allow for a deduction, thus making all RRSP income in the future taxable in US. I don't know what the rules might be for those with rRSPs before the new protocol.

But we could indeed see IRS say RRSp income is 100% as taxable as in Canada.

That would suck, and may require some careful planning between now and ratification.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
bruce
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Post by bruce »

Good point. Seems likely to me that if the US allows a deduction for RRSP contributions, they'll want their take upon withdrawal. Same thing will likely happen to Americans that contribute to 401k or IRA while working in Canada.... CRA will come knocking.

(Welcome to the tax planning nightmare that USC's deal with every year!)
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