The United States – Canada Income Tax Convention, provides that a beneficiary of a Canadian Registered Retirement Savings Plan (RRSP) may elect, under rules established by the competent authority of the United States, to defer U.S. income taxation with respect to income accrued in the plan but not distributed, until such time as a distribution is made from such plan, or any plan substituted therefor. Deferral is only available for income that is reasonably attributable to contributions made to the plan by the beneficiary while the beneficiary was a resident of Canada. The technical explanation to the Convention states that the purpose of this provision is to avoid a mismatch of U.S. taxable income and foreign tax credits attributable to the Canadian tax on such distributions.
Under rules set out by the U. S. Securities and Exchange Commission, specifically Section 15(a)(1) of the Exchange Act, securities brokers and dealers are restricted to providing services only to residents of their own country. As a result, an undue burden would be placed on Canadians who move to the U.S. but who wish to keep their RRSP accounts intact in Canada.
In recognition of the problems facing Canadians in this situation, the SEC issued an order pursuant to Section 15(a)(2) of the Exchange Act, that any Canadian broker-dealer that is a member of a Canadian exchange is exempt from the requirements of Section 15(a)(1) of the Exchange Act if they meet certain conditions.
If you are having problems opening, trading, or maintaining an RRSP in Canada after moving to the U.S., you should refer your broker to this Order.
Canada generally does not tax contributions to or accumulations in an RRSP. Under the Convention, Canada generally will impose a withholding tax of 25 percent on distributions to non-residents. The withholding tax for periodic payments, such as an RRIF which has been annuitized is 15%. An election may be filed under Sec 217 if the tax calculated on the return is less than the withholding tax.
Because an RRSP is not a "qualified" plan for U.S. tax purposes, contributions made in Canada are deductible for U.S. purposes in a limited way. Article XVIII(8) of the Convention permits the deduction of RRSP contributions for U.S. purposes if certain conditions are met, limited to the amount which would otherwise be deductible for a contribution to an Individual Retirement Account (IRA). U.S. tax on earnings in the plan attributable to Canadian contributions are deferred until there is a distribution if proper disclosure of the existence of the RRSP is made each year (as described below). This results in U.S. tax generally will being imposed in the same years that Canadian tax is imposed, so that U.S. citizens, green card holders, and residents may credit the Canadian tax against their U.S. tax liability.
The Convention provides that deferral is available until there is a distribution from the RRSP "or any plan substituted therefor." Canadian law permits tax-free rollovers from an RRSP to either another RRSP or to a Registered Retirement Income Fund (RRIF). For purposes of the Convention, a rollover of an amount from an RRSP into an RRIF that is treated as tax-free under Canadian law will be interpreted to be a rollover into a plan "substituted" for the RRSP. Amounts rolled over from the RRSP into the RRIF will qualify for continued deferral of U.S. tax until income is distributed from the RRIF. Accordingly, the amounts rolled over (and earnings on those amounts) will be eligible for deferral from U.S. tax until distributed, to the extent such amounts would have been eligible for deferral if they remained in the RRSP.
How to Disclose
For U.S. tax purposes, an RRSP is treated as an investment account, and an election to defer taxation of accrued income is deemed to be made when the RRSP is disclosed on foreign bank account reporting forms. This defers taxation of income earned within an RRSP, as long as the contributions were made while a resident of Canada. Department of the Treasury form FINCEN 114 (and form 8938, if required) are used to report the RRSP each year. Appropriate disclosure should also be made in answering the questions on Schedule B of Form 1040.
Consequences of Moving
No rollovers of Canadian RRSP’s to U.S. IRA’s or similar plans are advisable, since such a transfer would be considered a distribution under Canadian law, and would trigger taxation in both countries under the Convention. Accordingly, persons moving to the U.S. after a work period in Canada should consider leaving the RRSP intact, and drawing funds from the plan only upon retirement or as required by Canadian law.
New Broker /SEC rules can prevent a U.S. resident from trading a Canadian RRSP with the exception of Canadian self-directed tax advantaged retirement plans and temporary residents, Canadian salespersons are prohibited under the Securities Exchange Act of 1934 from dealing with clients in the U.S. unless they are registered with a dealer registered in the U.S.
Special Election for RRSPs
A special election is permitted to non-resident recipients of the kinds of income otherwise subject to non-resident withholding tax, namely:
- alimony and maintenance;
- certain superannuation or pension benefits;
- death benefits;
- unemployment insurance benefits;
- transitional assistance benefits under the Canada-US Auto Pact;
- prescribed benefits under a government assistance program;
- retirement compensation arrangement benefits or the purchase price of an interest in such an arrangement;
- retiring allowances;
- supplementary unemployment benefit plan payments;
- registered retirement savings plan payments;
- deferred profit sharing plan payments;
- registered retirement income fund payments.
The purpose of section 217 is to avoid placing the non-resident recipient of such payments (typically a retired individual) in a less favourable position than if the recipient were resident in Canada and entitled to the usual deductions permitted in determining taxable income and tax credits reducing tax payable under Part I of the Act.
This section therefore presents an interesting tax planning opportunity for non-resident persons who have built up substantial Registered Retirement Savings Plan (RRSP) accounts.
By withdrawing the RRSP funds while a non resident, generally the lower of the non resident withholding tax rate and the amount taxable under section 217 will apply, providing the individual with a unique opportunity to withdraw RRSP accumulations at much lower rates of tax than would otherwise be payable if they were to return to Canada as residents and have the withdrawals taxed in the normal manner.
There are a number of budget changes introduced in 1996 which provide that in determining the Part I tax rate that applies where a non-resident elects under the section, the non-resident's non-Canadian income (and Canadian-source income subject to Part XIII but not eligible for the s. 217 election) is taken into consideration. This will not mean that Canada will tax that other income under Part I, but only that the foreign income may increase the rate of tax that applies to the non-resident's Canadian-source Part I income.
As well, the requirement that more than half a non-resident's income be included in the non-resident's taxable income earned in Canada, in order for any Part I tax credits to be available, has been deleted.