Release date: May 6, 2014
Guest: Brandi Scales
Running time: 9:43 minutes
In this next installment of our “Top global mobility issues facing Tax Directors” series, Brandi Scales addresses the topic of foreign pensions. This podcast outlines the importance of understanding the different classifications of foreign plans, as well as the effect parameters such as length of stay and tax treaties have on the treatment of these plans. The concept of pension adjustments is also discussed.
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You’re listening to another episode of PwC’s Tax Tracks at www.pwc.com/ca/taxtracks. This series looks at the most pressing technical and management issues affecting today’s busiest tax directors.
Chantal: Hello, it’s Chantal McCalla of PwC Canada. Welcome to the sixth instalment in our PwC multi- part podcast series on the “Top mobility Issues for Tax Directors to think about.” With us today is Brandi Scales, a senior manager with PwC who focuses on human resource issues and opportunities.
Brandi: Thanks Chantal.
Chantal: Brandi, from the previous podcasts in our Mobility Series, we have learned there are a number of key issues that directors need to consider with respect to mobility and their employees. Now for our session today on foreign pension plans, why don’t you start us off with a brief overview on why directors should be concerned about foreign pension plans?
Brandi: Sure, Chantal. I think the key point to understand is how the foreign pension plan will be treated in Canada. Employees that contribute to foreign pension plans while working in Canada are an issue for both the employee and the employer. In Canada, we generally classify a pension plan as either a Salary Deferral Arrangement, a Retirement Compensation Arrangement, or an Employee Benefit Plan. Of course all three of these plans are treated quite differently under the Canadian rules from both a reporting and an income recognition standpoint. So I would say the key point for directors is to ensure you understand what type of plan you’re dealing with under the Canadian rules.
Chantal: So, of the three classifications, which one is most common?
Brandi: That’s a very good question. Typically, most foreign pension plans are not classified as a Salary Deferral Arrangement. Hence that really leaves us with two options: Retirement Compensation Arrangement (RCA) or an Employee Benefit Plans (EBP). Now generally speaking, most foreign pension plans will be classified as an EBP for at least the first 5 years an employee is resident in Canada. That’s because there is a specific exemption to the RCA rules for foreign pension plans where members are on a temporary assignment in Canada. Of course this exemption requires that an employee was a member of the plan prior to becoming a Canadian resident, and also that the contributions are being made for services rendered during the period of Canadian residency, and finally, that the employee has not been a resident for 5 of the last 6 years preceding the services for which the contribution was made. Now I appreciate that’s a lot to take in during an audio podcast so I’ll summarize it by saying -- there is a very good possibility that many foreign pension plans can meet the EBP classification at least for the first five years. One other point to note is in addition to all the assumptions I just listed, if the plan’s custodian is also a non-resident of Canada, the employer contributions to the plan will also be deductible.
Chantal: So, what happens if an employee is resident in Canada for more than 5 years?
Brandi: Well, at that point there still are a few options available. First, you can always localize the employee and have him transfer to the Canadian plan if there’s one available. That’s the best option if you’re expecting the employee to remain in Canada for at least the foreseeable future. Another alternative is for the company to file an election with the CRA to not have the pension plan treated as an RCA. The company and the employee will need to meet a few considerations to make this election, but it is a viable option if you expect the employee will be returning to his home country in the next few years. If the company chooses this option, the plan will continue to be treated as an EBP under the Canadian rules. Lastly, the company could always allow the plan to be treated as an RCA going forward. This alternative, while quite complicated, is also a great option when dealing with highly compensated employees.
Chantal: Brandi, I understand some employees can even take a deduction for any contributions they have made to a foreign pension plan while working in Canada. Can you elaborate on that?
Brandi: Yes, that’s correct. Canada has a number of tax treaties that actually allow temporary foreign employees working in Canada to claim a deduction on their Canadian return for pension or social security contributions they are making back in their home country. The US, UK, France and Germany are just a few examples. Again there are requirements that the employee must meet and he or she will need to complete an additional form with their tax return, but the reality is it’s a very significant benefit to the employee. It is important to note the deduction is limited to five years, so it’s really intended as temporary relief.
Chantal: Brandi, we have been talking a lot about foreign employees coming to Canada to work, but what about Canadian residents working outside Canada. What do they need to know?
Brandi: Currently, there is only a deduction available if that foreign country is the US. For all other countries there is no offsetting deduction available for Canadian residents making contributions to a foreign pension plan. If the employee is however working in the US, a deduction is available assuming the amount is also deductible in the US and the employee has RRSP room available in order to make the deduction. Again there is a specific form which an employee must complete and attach to his or her return.
Chantal: OK, so what is the one key thing we have not discussed today?
Brandi: Pension adjustments. The CRA requires that the employer, and even in some cases employees, must calculate a pension adjustment annually for any contributions being made to a pension plan. I won’t get into the specifics about the calculation as it is rather complicated, however, I will stress that it must be done. The purpose of a pension adjustment (PA) is to ensure that the employee’s RRSP room is properly adjusted annually to reflect the benefit they are receiving as a result of contributing to a pension plan. Hence, if a PA adjustment is not reported, the employee’s RRSP room will be overstated and consequently, the employee may have actually over-contributed to his or her RRSP unknowingly. The unfortunate part of this scenario is that it actually happens quite frequently and there are significant penalties involved; hence it really is a critical point to take away from this podcast.
Chantal: Alright, this gives me a pretty good understanding of the pitfalls we need to watch out for. My last question to you, Brandi, is one I’m asked quite a bit. What happens once the employee starts receiving distributions from a foreign plan?
Brandi: That’s a great final question, Chantal. The answer really depends on a number of factors, but assuming that the employee is no longer a resident of Canada - and of course the plan is not a resident of Canada – then there would really be no Canadian tax implication from a distribution. For example, if we have an employee who came to Canada on a five-year assignment and continued to contribute to the home country’s pension plan while here, but after the five years ceased his Canadian residency to return home and retire, well in that scenario Canada would not actually look to tax the distribution. However, if we change up the facts a bit and now the employee is a resident of Canada at the time of distribution, well then Canada would tax the distribution, but they would also allow a foreign tax credit for any withholding taxes that foreign country may apply to the distribution. I will also add, distributions from pension plans is a topic that’s covered under most of Canada’s tax treaties, so specific rules or agreements may apply depending on which foreign country we’re dealing with. So it’s always best to also consult the tax treaty when looking at these types of situations.
Chantal: Point taken. Thank you for sharing your insights with us today, Brandi.
Brandi: Thank you Chantal, it has been a pleasure.
Chantal: For any questions, Brandi’s contact details are available on our PwC podcast website www.pwc.com/ca/taxtracks.
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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.