2017-0735631E5 Distribution of funds from an IRA and 401(k)

Principal Issues: Whether the distribution of funds from an IRA and 401(k) after expatriation from the U.S. is excluded from income in Canada?

Position: Yes.

Reasons: IRA is included in income upon expatriation pursuant to subsection 56(12); subsequent distribution relieved under clause 56(1)(a)(i)(C.1). The 401(k) is included in income only upon distribution but is tax-relieved under the Treaty.

Author: Graham, Kanwal
Section: 56(1)(a); 56(12); 248(1) "foreign retirement arrangement" and "superannuation or pension benefit"; Regulation 6803; Article XVIII(1) of the Canada-U.S. Treaty

XXXXXXXXXX                                                            2017-073563
                                                                                    K. Graham

December 6, 2023

Dear XXXXXXXXXX:

Re: U.S. expatriate and distributions from an IRA and 401(k)

We are writing in reply to your email of December 23, 2017, in which you asked whether the distribution of funds from fully collapsing an Individual Retirement Account (“IRA”) and 401(k) Plan (“401(k)”), by an expatriate of the United States (“U.S.”) would be subject to tax in Canada.

The hypothetical scenario you presented can be more fully described as follows:

A taxpayer who is a Canadian resident (“Individual”) for the full tax year renounces his U.S. citizenship. At that time, he holds a traditional IRA (footnote 1) and a 401(k) which is classified as a pension for purposes of the Income Tax Act (“Act”), each with a fair market value (“FMV”) of $500,000 USD. One week later, in the same tax year, he fully collapses the two plans and has all funds distributed to him. Contributions to the IRA and 401(k) were made prior to the Individual becoming a resident of Canada.

Under the U.S. tax rules pertaining to expatriation, the Individual is classified as a “covered expatriate.” Consequently, he is subject to the tax provisions of the U.S. Internal Revenue Code section 877A, which will apply to the IRA and 401(k) as follows:

* The IRA is classified as a “specified tax deferred account,” and upon expatriation, the Individual will be treated as having received a distribution of his entire interest in the IRA the day before the date of expatriation, resulting in an income inclusion for U.S. tax purposes. Appropriate adjustments will be made to subsequent distributions to reflect such treatment. Accordingly, the distribution upon collapse of the IRA will not result in an income inclusion for U.S. tax purposes to the extent that it was subject to tax on expatriation.

* The 401(k) is classified as a “deferred compensation item,” but since the Individual did not file U.S. form W-8CE on time, he will be treated as having received a distribution for U.S. tax purposes equal to the present value of the accrued benefit of his 401(k) on the day before the date of expatriation, resulting in an income inclusion for U.S. tax purposes. Appropriate adjustments will be made to subsequent distributions to reflect such treatment. Accordingly, the distribution upon collapse of the 401(k) will not result in an income inclusion for U.S. tax purposes to the extent that it was subject to tax on expatriation.

You have asserted that no Canadian tax should be due on the distributions upon collapse of the two plans, pursuant to paragraph 1 of Article XVIII of the Convention Between Canada and the United States of America with Respect to Taxes on Income and on Capital (the “Treaty”), and have requested our confirmation of this.

Our Comments

This technical interpretation provides general comments about the provisions of the Act. This technical interpretation does not comment on the application of any provision of a foreign law, including the Internal Revenue Code. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC70-6R12, Advance Income Tax Rulings and Technical Interpretations; however, we offer the following general comments, which may be of assistance to you.

Please note that all legislative references in this letter refer to the Act or the Income Tax Regulations (“Regulations”), unless otherwise specified.

Subparagraph 56(1)(a)(i) provides that superannuation or pension benefits are to be included in income, including, pursuant to clause 56(1)(a)(i)(C.1), “the amount of any payment out of or under a foreign retirement arrangement established under the laws of a country, except to the extent that the amount would not, if the taxpayer were resident in the country, be subject to income taxation in the country”. The IRA would be characterized as a “foreign retirement arrangement” pursuant to subsection 248(1) and section 6803 of the Regulations.

IRA

As a result of the Individual renouncing his U.S. citizenship, he will be treated as having received a distribution of his entire interest in the IRA under the tax laws of the U.S. Pursuant to subsection 56(12), for the purpose of paragraph 56(1)(a), where an amount in respect of the IRA is considered to be distributed under the U.S. income tax laws, it will be deemed to be received by the Individual as a payment out of the IRA.

Consequently, the Individual will have an income inclusion for purposes of the Act at the time of expatriation. Further, when he collapses the IRA and receives an actual distribution of funds therefrom, he will not be required to include the amount in income pursuant to clause 56(1)(a)(i)(C.1) to the extent that the amount will not be taxed in the U.S.

401(k)

Since the 401(k) is not a “foreign retirement arrangement” as defined in the Act, the Individual will not have an income inclusion under the Act upon expatriation. However, upon collapse of the plan, he will have an income inclusion pursuant to subparagraph 56(1)(a)(i) in respect of a “superannuation or pension benefit,” a term defined in subsection 248(1).

However, to the extent that the distribution to the Individual from the 401(k) upon its collapse were to be excluded from taxable income in the U.S. were he a resident thereof, paragraph 1 of Article XVIII of the Treaty would provide relief from tax for the same amount in Canada (accomplished through a deduction in the computation of taxable income pursuant to subparagraph 110(1)(f)(i)).

We trust our comments are of assistance.

Yours truly,

Charles Taylor
for Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 As defined in subsections 408(a), (b) or (h) of the U.S. Internal Revenue Code

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