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The CrossBorder Report

Vol. 1, No. 1 Fall 1998

This is the inaugural issue of The CrossBorder Report. The focus will be two-fold. First, to report important legislative developments, primarily from the U.S., and their impact on cross-border transactions. Second, to review issues the Canadian practitioner will commonly encounter in such areas as estate planning, U.S. citizens in Canada, and Canadian corporations doing business in the U.S.

U.S. Citizens & Green Card Holders Should Consider 1998 Roth IRA Contributions

The Taxpayer Relief Act of 1997 created a new type of individual retirement account ("IRA") called a Roth IRA. Contributions to a Roth IRA are not deductible, but the earnings are not taxable. In addition, the IRA owner does not have to begin taking distributions until after age 70-1/2, and can continue to contribute after 70-1/2. This makes the Roth IRA a powerful wealth builder for taxpayers who do not have to tap their IRA accounts during their retirement years.

The good news for U.S. citizens and green card holders resident in Canada is Article XVIII of the Canada-U.S. treaty. Article XVIII states that Canada must provide the same tax treatment as the U.S. In effect, U.S. citizens and green card holders may add an additional US$2,000 ($4,000 for joint filers) per year to a retirement plan.

There are limits as to how much a taxpayer can contribute to a Roth IRA based on the taxpayer's income. The general rule allows contributions up to a maximum of $2,000 with a phasing out for income levels over US$95,000 (US150,000 for joint filers).

Withdrawals will be exempt from both U.S. and Canadian tax where: (1) the withdrawl is made after age 59 1/2; (2) received as a consequence of the death of the contributor; (3) received while the contributor is disabled: or (4) the withdrawal is a qualified first-time home-buyer expense. In addition to one of the above the account must, generally, have been open five years.

Contributions for 1998 can be made until April 15, 1999.

Revenue Canada Assessment Policy of FTCS Claimed by U.S. Citizens

Revenue Canada ("RC") recently released two draft papers regarding FTCs claimed by U.S. citizens. The result: RC is now disallowing the FTC's claimed by U.S. citizens resident in Canada. The basic principle is as follows:

FTCs shall not exceed the amount of U.S. tax on U.S. source income which would have been payable by a non-U.S. person resident in Canada claiming full entitlement to Treaty or Code relief, if relevant.

The analysis employed by RC is complex and is beyond the scope of this newsletter. Some of the results of this policy change include:

1. Diarizing U.S. workdays- this technique formerly generated U.S. source income and U.S. regular tax on this income. The result was avoidance of U.S. AMT tax and a full FTC in Canada. (AMT tax was not creditable in Canada). Now, unless the treaty would not exempt this employment income in the U.S.(i.e. taxpayer is in the U.S. for more than 183 days or a salary of more than$10,000 is paid by a U.S. based employer) diarizing days is not effective. Note: a portion of the U.S. AMT may now be creditable under RCs new policy.

2. U.S. Pension income- U.S. tax paid in excess of 15% is no longer creditable in Canada. A credit must now be claimed on the U.S. return.

3. U.S. bank interest and T-bills- generally, a non-U.S. person resident in Canada would pay no U.S. withholding tax on these items. Therefore, RC will not allow FTC for U.S. tax paid on these items by a U.S. citizen.

4. Other interest and dividends subject to treaty withholding rates of 10% and 15%- generally there is no change for these items. The exception is U.S. tax paid on interest in excess of the 10% rate. Canada does not provide a deduction under 20(12) for U.S. tax paid in excess of 10% up to 15%.

The new policy requires, where appropriate, a resourcing of income and claiming FTCs in the U.S. Form 1040. To date, the IRS has not objected to this change. Revenue Canada has indicated a willingness to intercede should the IRS refuse allowance of these additional credits.