New York CPAs Seek Changes to Process to Elect to Defer Tax on Canadian Retirement Savings Plans

The NYSSCPA's International Taxation Committee deliberated the topic of RRSP late elections, and drafted the attached comments. If you would like additional discussion with us, please contact Melissa Gillespie, Chair of the International Taxation Committee, at (212) 880-2620, or Ernest J. Markezin, NYSSCPA staff, at (212) 719-8303.

We understand that you might have the matter under consideration, and believe that U.S. treatment of RRSPs is a matter to which we can lend some clarity.

We have prepared this letter to share our views in relation to these matters.

RRSP -- Late Elections

Pursuant to Paragraph 7 of Article XVIII, Pensions and Annuities of the U.S.-Canada Tax Treaty (the "Treaty"), a U.S. person is permitted to make an election to defer the recognition of any income derived by an RRSP in which he or she has a beneficial interest provided that an appropriate election is made. Specifically, Paragraph 7 of Article XVIII, Pensions and Annuities of the Treaty states:

Generally, Form 8891 would be required to be completed by any U.S. person in the year he or she acquires an interest in an RRSP and by any Canadian person with an interest in an RRSP for the first year that he or she becomes a U.S. person. If a taxpayer fails to make an election in the tax return for the first year that the election would be relevant to the taxpayer, there is a significant cost and burden associated with having the election made effective from the time it first became relevant.

Specifically, it is necessary for a taxpayer to apply for a private letter ruling, which would involve engaging tax professionals to draft the ruling request and significant fees payable to the IRS. This financial burden is often significant relative to the income of an RRSP.

While we acknowledge that ignorance is no excuse, there is a general lack of familiarity with Form 8891 by both taxpayers and tax advisers alike. Many taxpayers do not disclose such financial interests to their tax return preparer; nor do tax return preparers request such information from a taxpayer because each is unaware of the need to report the interest in an RRSP to the IRS. The taxpayers are genuinely surprised to discover that their retirement savings, which they cannot access and which are meant to be invested and growing tax-free in Canada, could be subject to U.S. tax and U.S. tax reporting.

In the vast majority of cases, the failure to make a legitimate election is the result of an oversight or misunderstanding by taxpayers or tax return preparers. Given that the treaty is meant to shelter the income derived by an RRSP from U.S. tax, an omission to make such an election on a timely basis should not be viewed as an attempt to avoid tax.

Since 2009, the IRS has engaged in three offshore voluntary disclosure programs relating to foreign bank accounts and various other foreign reporting requirements: one program is currently in process. The purpose of each program is to encourage taxpayers to bring their foreign information reporting obligations into full compliance. Over the past few years, the IRS has come to realize there are certain assets, for example, foreign bank accounts, foreign pension funds, and foreign retirement accounts, that require additional guidance from the IRS as to how to report and what is reportable.

The failure to report these accounts, in many situations, is not due to the intent to evade tax but due to the fact that it is an area which is very complicated and many taxpayers and tax practitioners, were, and still are, unaware of the reporting rules relating to such foreign investments. In this environment, it seems inconsistent to force taxpayers to require a private letter ruling for which they are seeking to make an election after the due date for filing the relevant income tax return.

We respectfully recommend the following:

Additionally, we ask that Treasury consider giving greater guidance in relation to the treatment of foreign retirement plans, and consider mechanisms for addressing potential inequities associated with such plans.

As has been seen with the IRS' appropriate focus on offshore reporting in recent years, markets are experiencing greater globalization. As a result, there are significant numbers of immigrants who have worked in their home country before coming to the U.S. and significant numbers of U.S. persons working abroad. While living and working abroad, these people often would have been required to participate in a local retirement savings plan. Such plans typically prevent taxpayers from accessing the amounts invested until they reach retirement age. The foreign jurisdiction, seeking to encourage self-sufficiency in retirement, often provides no or low taxes on the income of the retirement savings plan in the same way the U.S. provides tax concessions to Employer-Sponsored Retirement Plan 401(k) plans and Individual Retirement Accounts (IRAs). Despite the fact that the U.S. would support this objective, it appears that U.S. tax law could potentially tax the income derived in the foreign retirement plan on a current basis or, if deferred, subject it to interest and other charges.

While this matter is addressed specifically in the Treaty to allow deferral for RRSPs, U.S. persons with investments in retirement plans in jurisdictions not covered by any U.S. tax treaty or retirement plans in locations with treaties that do not address the tax treatment of retirement plans, are often left in a difficult situation. To the extent that the retirement savings plan is a trust, they may be required to recognize the income currently (as in the case of a grantor trust) or, to the extent that the retirement savings plan is a corporation, it could be a controlled foreign corporation resulting in current income inclusion or a passive foreign investment company resulting in either current income recognition or a harsh interest charge at the time of distribution of the income.

Such treatments are inconsistent with the shared objective of the U.S. and foreign government, i.e., financial security in retirement for the U.S. person.

Treasury should consider mechanisms to address this inequitable result. Such mechanisms may include:

• Introducing provisions to future tax treaties and protocols that would mirror the election allowed in the Treaty; and

• Legislation to provide for the deferral of tax on compulsory employer contributions to foreign retirement plans and income in legitimate foreign retirement savings plans that were compulsorily established by a U.S. person while they were living or working outside the U.S.