cross-border-us-canada

As we discussed in my March AER column, “When a pension isn’t a pension,” pension income is taxable. That’s true whether the pension income is from a Canadian or a foreign plan.

A recent tax case (McKenzie v The Queen, 2017 TCC 56), however, looked at whether Canada could impose tax on the receipt of the proceeds of a U.S. individual retirement account (IRA) that Canadian resident Susanne McKenzie inherited from her mother, Betty Ann Wicks, who died in 2007.

CRA reassessed McKenzie, a Canadian resident and U.S. citizen, and included $21,740 (US$21,979 at a 0.9891 exchange rate) in her 2011 income. She reported the U.S.-dollar amount on her U.S. tax return that year, and it was characterized as a distribution of her mother’s IRA, which named her as beneficiary.

The amount was reported on a U.S. 1099-R slip issued by Morgan Stanley Smith Barney as taxable pension income, classified as a death distribution to a beneficiary. The US$21,979 was taxed in the U.S., but McKenzie did not include the Canadian equivalent amount of $21,740 in her 2011 Canadian income tax return.

CRA’s position was that the “U.S. pension [that the Appellant] received in 2011 must be included in [the Appellant’s] income according to [the Income Tax Act].”

McKenzie’s representative argued there is “an alternate taxing mechanism for a U.S. IRA” and, as such, “the U.S. IRA should receive capital treatment.” The second argument was that, even if the IRA is taxable under the Income Tax Act (ITA), a special section of the ITA meant to prevent double taxation of the same income amount would apply to the IRA proceeds.

Alternate taxing mechanism

Her first argument was that “there are two approaches for taxing U.S. IRAs for Canadian income tax purposes and that the [ITA] provides the taxpayer with the discretion to choose which of the two methods should apply.” McKenzie reasoned that IRAs should be treated as “an inherited portfolio of securities.” This position was based on the assertion that the IRA, as a custodial arrangement, “is not a trust and is not deemed to be a trust for Canadian income tax purposes.”

CRA stated that the amount received by the appellant from the IRA is taxable in Canada pursuant to the ITA, and that the taxpayer’s “alternative taxing mechanism argument is not supported by any provision of the [Income Tax] Act or by case law.”

Double taxation

McKenzie also argued that “due to the expansive definition of the term ‘taxpayer’ […], [her mother] was subject to a deemed disposition upon her death in 2007. […] As the withdrawals from the U.S. IRA would also be subject to Canadian tax […], the result is double taxation.” She claimed, therefore, that the relevant section of the ITA should prevent a double inclusion.

The decision

The judge cited the relevant section of the ITA, which states that “any payment out of or under a foreign retirement arrangement established under the laws of a country” will be included in computing the income of the taxpayer for a taxation year. The section deals with the “specific scheme for the taxation of amounts from arrangements such as the U.S. IRA.” The judge stated that the argument of “an alternate taxing mechanism with respect to the U.S. IRA is not persuasive and cannot stand.”

As for the double taxation argument, the ITA contains a provision to prevent double taxation of the same income. For the provision to apply, the taxpayer would have to prove there was an inclusion in her income of an amount, and that the same amount had already been either directly or indirectly included in her income.

Since McKenzie’s mother was a U.S. resident and citizen, not a Canadian resident, she was not subject to tax on the IRA proceeds in Canada and, therefore, the amount was not taxed twice in Canada.

The judge concluded that McKenzie should be taxed on the IRA proceeds, but did allow her to claim a foreign tax credit of $3,296 relating to the U.S. income tax paid on the amount she received from her deceased mother’s IRA.

As this case shows, it’s important to remind clients to get personalized advice about inherited IRAs so they report any taxable amounts properly.

Jamie Golombek, CA, CPA, CFP, CLU, TEP is the Managing Director, Tax & Estate Planning with CIBC Financial Planning and Advice in Toronto.

Originally published in Advisor's Edge Report

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