30 July 1999 External T.I. 9906645 - 401(K) EMPLOYEE CONTRIBUTIONS

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Tax implications of Canadian resident employee contributions to 401(k) plans

Position: Provided general information on the topic.

Reasons: General comments on this topic were developed with respect to commuters in document E9832786.

xxxxxxxxxx 990664
W. C. Harding
Attention: xxxxxxxxxx

July 30, 1999

Dear Sirs:

Re: Contributions to United States 401(k) Plans

This is in reply to your letter of February 23, 1999, with respect to the above noted topic, which was addressed to the Vancouver Island Tax Services Office and referred to us for reply.

As indicated in Information Circular 70-6R3, confirmation of the tax consequences flowing from completed transactions must be obtained from your local tax services office. This Directorate will provide a technical interpretation concerning the provisions of the Income Tax Act (the "Act") and Regulations (the "Regulations") but not with respect to specific factual or hypothetical transactions. However, as requested by the Vancouver Island Tax Services Office, we can provide the following general comments which may or may not apply to the specifics of your situation. Please note that in accordance with the above-mentioned Information Circular, these are not binding on the Department.

Our comments are limited to an individual who is a resident of Canada and is employed at a location in the United States. They do not apply to an individual who is employed in Canada by a nonresident employer or to an individual who is employed both within and outside of Canada by the same employer.

The comments are applicable to situations in which both the employer and the employee contribute under an arrangement of which the 401(k) provision is a part. This is generally the case. However, there may be situations where a plan is fully funded by the employee. If this is the case consideration of the specific situation would have to be made on a case by case basis.

Canadian residents are required to report their gross income from employment when filing their Canadian income tax returns. When an American employer withholds an amount from employment income and contributes it to a 401(k) plan the employer is doing it on the employee's behalf. This is similar to a Canadian employer withholding employee contributions to a Canadian registered pension plan. However unlike contributions to a registered pension plan, an employee cannot deduct contributions to a 401(k) plan under the provisions of the Income Tax Act.

Where an employer has contributed to a 401(k) plan or the plan is part of a more comprehensive arrangement under which the employer has contributed, the plan will be subject to the "employee benefit plan" rules of the Act. Annual distributions from an employee benefit plan, less the portion based on the terms of the plan that can be considered to be a return of employee contributions to the plan, will be included in employment income of the recipient for income tax purposes. A Canadian employee will be required to maintain records of contributions and the amount of income earned in a plan. However, it is our understanding that American employers are required under the American Internal Revenue code to provide this information to their U.S. employees so it should be readily available from the employer for Canadian resident employees.

As noted above, the Department cannot allow a deduction for any amounts contributed to a 401(k) plan by an employee because no provision of the Act provides for one. However, when these amounts are received, as noted above, the amount of the employee contributions received out of the plan are not taxed. Accordingly, there is no double taxation of amounts received by an employee out of a partially employer-funded 401(k) plan. However, an issue arises on the withdrawal of funds from a 401(k) plan with regard to foreign tax credits. At the time of a payment from a 401(k) plan, U.S. taxes may be paid on the full amount of the withdrawal, if the withdrawal amount is fully included in income for U.S. tax purposes at that time. In Canada, the employee's contributions are not included in income at withdrawal (since they have previously been included in income). Thus, depending upon the amounts withdrawn and other factors, there may be instances where the U.S. taxes paid may not be fully utilized as a foreign tax credit. The existing provisions of the Canada-U.S. Income Tax Convention do not provide any relief in such circumstances. Note that an employee's participation in a 401(k) plan is elective and the issue described above should be considered by an employee prior to choosing to participate in a 401(k) plan.

We trust these comments will be of assistance.

Yours truly,

P. Spice
for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

cc Nadine Smith
Client Services
Vancouver Island Tax Services Office