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Phil Hogan, CPA, CA, CPA (CO)
Cross-Border Tax and Investment Specialist
The Canada-US tax treaty can be quite complex and difficult to understand if you don’t have a lot of experience in interpreting the treaty and applying treaty rules through income tax return elections and forms. In very general terms the tax treaty was negotiated between Canada and the US to ensure that residents of Canada and the US did not pay double tax on the same level of income and to ensure that each respective country collects their fair share of tax on various types of income.
In this post I’ll discuss Article XVIII (18) of the Canada-US income tax treaty and how the related article paragraphs affects US Citizens living in Canada. I won’t review each paragraph of article XVIII and only those sections that are highly relevant to US expats in Canada.
Paragraph 1 states:
“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 such pension that would be excluded from taxable income in the first-mentioned State if the recipient were a resident thereof shall be exempt from taxation in that other State.”
Paragraph 1 simply outlines that pensions paid to individuals arising in one country can be taxed in the recipients country also. However any amounts that would have been excluded from the arising country will also be excluded for purposes of the recipients country.
We see this a lot where an American living in Canada receives a pension from the US that has both a taxable and non-taxable distribution. As you can see from form 1099-R pension distributions will be recorded at their gross amounts in box 1 and their taxable amounts in 2a. The difference between these 2 amounts is the non-taxable portion. Therefore, in this example, only amounts in box 2a will be taxable in Canada, converted to CAD.
Paragraph 2 states:
- (a) 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
- (b) 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 would not be excluded from taxable income in the first-mentioned State if the beneficial owner were a resident thereof.
Essentially paragraph 2 of the treaty ensures that periodic pension payments will only attract a 15% withholding or a maximum of 15% tax for US expats in Canada. Lump sum payments may be treated differently, however both CRA and the IRS have administratively maintained 15% for most purposes.
For example, an individual that is not a US citizen, tax resident or Green Card Holder living in Canada and receiving pension payments from the US will receive those payments less a 15% US tax withholding. If this same person was a US citizen they would pay tax on the pension income to the US on their annual 1040 return, but only to a maximum of 15%. Any amounts calculated above 15% would be re-sourced via form 1116 down to 15%.
Paragraph 3 states:
- (a) 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
- (b) 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.
In general terms paragraph 3 outlines the definition of what a pension is for purposes of the treaty. It also discusses some technical points specific to ROTH IRAs. Note that contributions to IRAs are not deductible for Canadian purposes. I won’t include it here, however paragraph 4 outlines the definition and some technicals of annuities and how they related to the treaty.
Paragraph 5 states:
Benefits under the social security legislation in a Contracting State (including tier 1 railroad retirement benefits but not including unemployment benefits) paid to a resident of the other Contracting State shall be taxable only in that other State, subject to the following conditions:
- (a) a benefit under the social security legislation in the United States paid to a resident of Canada shall be taxable in Canada as though it were a benefit under the Canada Pension Plan, except that 15 per cent of the amount of the benefit shall be exempt from Canadian tax; and
- (b) a benefit under the social security legislation in Canada paid to a resident of the United States shall be taxable in the United States as though it were a benefit under the Social Security Act, except that a type of benefit that is not subject to Canadian tax when paid to residents of Canada shall be exempt from United States tax.
Paragraph 5 is quite important for expats in Canada as I see mistakes on social security payments on 1040 income tax returns all the time. Paragraph 5 of the treaty explains that social security, CPP and OAS payments made to a resident of Canada will only be taxable in Canada. That also means that social security payments made to an American living in Canada will not be taxable on their US return. This is quite surprising to most as intuitively it doesn’t make much sense, however this is the case regardless. The proper way of disclosing this on your US return is to ensure you file form 8833 to elect for this exclusion under the treaty.
I won’t review these paragraphs in great detail, however Paragraphs 8 through 17 deal with how Qualified Retirement Plans (QRP) and other pension plan contributions are handled between Canada and the US. Once again, these paragraphs and how it related to specific pension contributions are beyond the scope of this article, but should be noted for reference in case a taxpayer needs to consult a cross-border tax advisor for help on the matter. Often clients have questions on how contributions to various private, corporate and recognized plans like RRSPs are handled between Canada and the US.
For most taxpayers the goal here is not to fully understand the technical interpretation of a particular treaty article, but rather to understand when there might be an issue that warrants a conversation with a competent cross-border professional.