In a previous post on the rollover of a US retirement plan to an RRSP, I argued that the IRS viewed “periodic” as non-restrictive in treaty pension provisions.
The consequence being: When Article XVIII paragraph (2)(b) of the US-Canada tax treaty limited the US tax on a Canadian resident’s “periodic pension payment” to 15%, that limit also applied to lump-sum payments (such as a full liquidation) from a 401(k) plan or an Individual Retirement Account (IRA).
But the IRS recently clarified their position on the US-Canada treaty, and it is decidedly not the one they took in Letter Ruling 9041041, where they reasoned that “the term ‘periodic’ is simply descriptive of a pension payment generally”.
Instead they quietly revised Tax Treaty Table 1 in Feb 2019 to insert a straightforward assertion in footnote ii:
“In Canada, the 15% rate does not apply to a lump-sum payment.”
That’s a blow to RRSP rollovers under subsection 60(j) of the Income Tax Act (Canada), which involve a lump-sum withdrawal from a US plan. Such a withdrawal is likely to face a higher rate of US tax without treaty protection.
In some cases, it might still be possible to do a tax-neutral 60(j) rollover. Canada considers the full US tax liability to be “non-business income tax paid to a foreign country” for purposes of the Canadian foreign tax credit, even if it exceeds the treaty rateCRA Document 2011-0398741I7. But the taxpayer’s income from other sources in the year of the rollover would need to produce sufficient Canadian tax to fully utilize the credit. More US tax makes this a higher bar to clear.
Anyone wishing to claim, contrary to the IRS’s footnote, that the 15% treaty rate applies to their lump-sum withdrawal in Canada, may wish to explain their interpretation of the treaty on a Form 8275 disclosure with their return, to preserve a potential “reasonable basis” defense against the 20% accuracy penaltyReg § 1.6662-3(c)(2) if they don’t prevail on the merits of their position.
The IRS’s revisions to Tax Treaty Table 1 suggest that they are taking a piecemeal approach to parsing treaty language, rather than applying interpretive principles consistently between countries. The United Kingdom gets a similar “no lump sum” callout in the same footnote. But there’s no indication that they are reversing course on Australia, where they took the opposite stanceLetter Ruling 200416008.
If there’s anything good to be said for the IRS’s newly-elucidated position on the Canada treaty, it’s that it reciprocates Canada’s own interpretation in the mirror situation. A US resident seeking treaty benefits on a lump sum payment from a Canadian pension plan or RRSP will have their hopes dashed by section 5 of the Income Tax Conventions Interpretation Act (Canada):
“periodic pension payment” means… a pension payment other than
(a) a lump sum payment… under a registered pension plan,
(b) a payment before maturity… under a registered retirement savings plan, …
Perhaps someone at the IRS noticed that Canada wasn’t playing nice here.