Weekly Q&A

Q: I am a US resident and I just inherited a Registered Retirement Savings Plan (“RRSP”) from a Canadian resident.  Do I have to pay tax in Canada or in the US on the RRSP distribution?

A: Yes and no. 

As a named beneficiary of the inherited RRSP account, who is not the spouse of the deceased annuitant, the value of the RRSP at the time of death is taxed as income in the terminal Canadian tax return of the deceased.

This means that the value on the date of death will be distributed as capital and will not be subject to Canadian non-resident withholding tax.  However, if the distribution from the inherited RRSP has increased from the date of death, the increase in value will be taxable in Canada.  The increased value will be subject non-resident tax, not the entire distribution.  The non-resident withholding tax of 25% will be deducted from the distribution paid.  Please not that the statutory non-resident tax rate of 25% may be reduced to 15% under the U.S-Canada Income Tax Convention (1980).

Furthermore, as you are a resident of the US and have received an inheritance from a non-resident alien, the distribution is not taxable in the US.  However, you will likely have an information return due to report the distribution from a foreign estate is the amount exceeds a reporting threshold (i.e. Form 3520 “Annual Return to Report Transactions and Receipt of Certain Foreign Gifts”).

Finally, any income earned after the death of the individual, will be taxable in the US. However, you will be allowed to claim a foreign tax credit for US federal tax purposes, on Form 1116, in respect of the Canadian tax paid.  A foreign tax credit may or may not be allowed stateside.

Pensions Rentals

With globalization of the workforce it is not uncommon for Canadians to spend a portion of their working life abroad and return to Canada for retirement. Likewise Canada, being a hub for many multinational companies, hosts a large number of foreign employees who may contribute into a Canadian retirement plan and collect pension income once they leave Canada. Furthermore, considering the close proximity of the Canada-US border, Canadian and US commuter-employees may contribute to a pension plan of the country of their employment. The requirements for reporting, deductibility and income recognition of each type of a retirement arrangement may differ. The rules are typically driven by the tax laws of both the country where the plan is domiciled and where the participant resides. In addition, relieving provisions of a bi-lateral income tax treaty may also be relevant. With an accurate classification of the plan, timing of income recognition and an adequate disclosure, participants can achieve the most tax efficient results on both events at the time of contribution and distribution from a foreign pension plan.

There are lot to consider for non-residents when investing into US or Canadian real property. Both countries impose unfavorable income tax default rules in relations to rental income generated by non-residents. Such rules can be mitigated by an appropriate election and annual filing obligations. In addition, tax compliance requirements and tax cost may significantly differ depending on the structure of the ownership, i.e. whether the property is held individually or through an entity. Considering that rental income earned in another country is also subject to reporting and taxation in the investor’s home country, it is important that expenses are optimized (to avoid timing difference of income recognition) and a foreign tax credit is utilized. Finally, if a property is gifted or held by the investor at death, it may become subject to additional taxes, including gift, estate, generation-skipping, inheritance and capital gain on deemed disposition and probate/stamp tax.

The domestic tax rules and actual tax consequences related to various types of investment income (interest, dividends, capital gains, rentals, and royalties) are often misaligned which may even lead to double taxation. Tax relief available in one country can be construed as tax evasion in the other. It is therefore critical that a person who assists you with your cross-border tax compliance needs to understand your residency status, classification of income where it is domiciled, classification of income in your country of residency, and is able to apply any relevant tax treaty benefits. There is a large number of business strategies and vehicles available to maximize tax efficiency for individuals and business entities with foreign investments. We prefer to work with your investment advisor to ensure that all your objectives, whether tax ramifications or cash flow, are achieved