Canada: Tax Treaty Implications For Canadian Residents Receiving U.S. Social Security Be

Last Updated: January 26 1998


Revenue Canada has released details of how an amendment to the Canada-U.S. tax treaty affecting Canadian residents who collect U.S. social security benefits will be implemented.

The agreement amending the tax treaty, which came into force on December 16, 1997, means that U.S. social security benefits paid to Canadian residents will be taxable only in Canada.

Until the Canada-U.S. tax treaty was amended, it allowed the U.S. to apply its flat tax of 25.5% to most recipients' payments, starting with the payment for January 1996. The new agreement means that tax withheld by the U.S. for 1996 and 1997 will be refunded (net of Canadian federal and provincial income tax) to any recipient whose Canadian tax on the benefit would be less than the U.S. tax.

Revenue Canada will administer the refund program. The following frequently-asked questions ("FAQs") and answers have been issued by Revenue Canada to aid taxpayers in understanding the situation.

FAQs Related to Social Security Paid by the U.S. to a Resident of Canada

Q1. Have the changes to the Canada-U.S. Tax Treaty that were announced by the government of Canada in 1997 been passed into law by the Canadian government?

A1. Yes. Both the Canada and the U.S. governments have passed legislation ratifying the tax treaty changes that were announced in 1997. Formal letters have now been exchanged between the two governments, and the tax treaty changes are in force.

Q2. What U.S. social security benefits are affected by the changes to the tax treaty?

A2. The benefits that are affected are those that are provided under Title II of the U.S. Social Security Act. These include retirement, survivor, and disability benefits. Rail-road retirement benefits that are provided under Tier 1 of the Railroad Retirement Act are also affected.

Q3. How do the changes affect the taxation of these benefits?

A3. Under the previous treaty rule which was effective January 1, 1996, the U.S. withheld a non-refundable tax equal to 25.5% of the benefits that it paid to a Canadian resident who is not a U.S. citizen or resident alien. Canada did not tax these benefits and therefore did not allow the tax that was withheld to be used as a credit on the recipient's Canadian tax return. Canada did require that the benefits be included in the recipient's net income, but allowed an equal amount to be deducted in calculating the recipient's income that is subject to Canadian tax. The inclusion in the recipient's net income affects federal non-refundable tax credits and entitlements, as well as provincial tax credits that are determined in part by reference to a person's net income for a year.

Under the changes, the U.S. will stop withholding tax. The benefits that are received are taxable in Canada. However, only 85% of the benefits that are received in a year will be subject to Canadian tax. This means that, while the entire benefit that a recipient receives in a year still has to be included in the recipient's net income for the year, 15% of that amount can be deducted in calculating the recipient's income that is subject to tax for the year.

Q4. What happens for 1996 and 1997?

A4. The changes apply back to January 1, 1996, when the U.S. began withholding the 25.5% non-refundable tax. Accordingly, these benefits are now taxable in Canada for 1996 and 1997. However, for 1996 and 1997, this change will not cause recipients of U.S. benefits to pay more tax than that which was withheld by the U.S. government and determined by Revenue Canada on 1996 and 1997 correctly assessed returns.

This means, for example, that the Canadian tax that will apply to a recipient for 1996 will not be greater than the total of the Canadian tax that was determinable under our domestic tax laws before the tax treaty changes took effect, and the U.S. tax that was withheld under the treaty rules that previously existed for 1996.

Q5. Which country will refund to me my 1996 tax that was withheld by the U.S.?

A5. Your 1996 U.S. tax will come to you through the Government of Canada. It will be based on tax information provided by the United States Government.

Q6. When will Revenue Canada issue me my refund for the 1996 U.S. withholding tax that I paid?

A6. Revenue Canada expects to begin issuing refunds for the 1996 U.S. tax paid in early 1998. You will not have to apply to us to get your refund. We have obtained information from the U.S. government that should enable us to refund the appropriate amount of tax to all affected individuals.

Q7. How much will my 1996 refund be?

A7. We are not able to determine at this time what your refund will be. However, if the inclusion of 85% of the U.S. benefits in your 1996 taxable income does not raise that income above the total of your non-refundable tax credits for 1996, you should get back all of the tax that was withheld by the U.S. Similarly, if the inclusion increases your 1996 taxable income to a level above the total of your 1996 non-refundable tax credits, you will get back less than the total tax withheld. Depending on the province in which you live, there will be an income level at which no refund of U.S. tax will result. Provided that we assessed the correct amount of U.S. social security benefits on your 1996 return, you will not in any case be required to pay more tax for 1996.

Q8. Will I have to apply to Revenue Canada to get back my money for 1996?

A8. Affected individuals do not have to apply to Revenue Canada. We have obtained from the U.S. government a complete list of Canadian residents who received U.S. social security benefits on which U.S. tax was withheld. This list includes complete details of the gross amount of the payments that were made as well as the U.S. tax that was withheld.

Q9. Do I have to supply any paperwork when adjustments start?

A9. Revenue Canada intends to minimize contact with recipients when adjustments start to be processed. However, situations will arise where Revenue Canada will have to contact a recipient or their representative before it can process the required adjustment. For example, it may be necessary to contact a recipient who filed his or her 1996 return electronically, if we cannot determine whether, or on which line of the return, the U.S. social security benefits were included as income.

Q10. How should I complete my 1997 tax return now that the changes are law in Canada?

A10. You have to report as income on line 115 of your 1997 return the full amount of the U.S. social security benefits that you received. This amount includes the U.S. tax that was withheld from your benefits. Remember to convert to Canadian dollars the amount you report as income on your return.

The tax treaty changes provide that 85% of the U.S. social security benefits will be taxable in Canada. However, they also provide that the Canadian tax that is payable for 1997 based on these changes will not be more than the combined amount of tax that would have been payable in Canada and the U.S. if the changes had not applied to 1997. As Revenue Canada computer systems are not designed to calculate tax in this manner, you should still claim a deduction on line 256 of your return for the full amount of U.S. social security benefits that you reported as income. Once we receive information from the U.S. regarding 1997 social security benefits paid to Canadian residents, if it is beneficial, we will process reassessments to the 1997 returns of affected individuals to recalculate the Canadian tax for 1997. At that time, we will refund to affected individuals the U.S. withholding tax that they are entitled to based on the tax treaty changes. These adjustments cannot be processed until the 1997 returns of affected individuals are assessed, and we receive the necessary information from the U.S.

Q11. Can I claim a credit on my 1997 tax return for the U.S. withholding tax that I paid on my 1997 U.S. social security benefits?

A11. No. You cannot claim this tax as a credit when you file your return. However, if we determine that it is beneficial under the new tax treaty provisions to adjust your 1997 return later in 1998, you will be given full credit for that tax, and you will receive a refund for whatever amount you are entitled to.

Q12. When can I expect a refund for the U.S. withholding tax that I paid in 1997?

A12. The information from the U.S. necessary to determine whether the treatment under the new tax treaty provisions is more beneficial will not be available to us until late 1998. Refunds will be processed quite soon after we receive this information.

Q13. As the changes to the Treaty are retroactive to January 1, 1996, will I receive interest on the amount Revenue Canada refunds to me?

A13. The ordinary interest that applies to any refund of an overpayment of tax will apply. This means that interest will be paid from June 15, 1997, in the case of the 1996 year, and from June 15, 1998, in the case of the 1997 year. This interest will apply up to the day on which the refund is paid for the particular year. In addition, to recognize the fact that tax was withheld from January of each year, a special payment of $50 will be added to each year's refund. This special payment will be made in lieu of interest for the period from January of the particular year until June 14 of the following year.

Q14. When will the U.S. stop withholding tax from my U.S. social security benefits?

A14. The U.S. government will stop withholding tax on the social security benefits it pays to a Canadian resident by March 1998. Any U.S. tax that has been withheld on benefits in respect of the 1998 year will be refunded thereafter by the U.S Social Security Administration with your normal monthly benefit payments.

Q15. What happens for future years now that the treaty changes have been formally approved?

A15. 85% of the U.S. social security benefits received in a year by a recipient will be subject to Canadian tax at that recipient's applicable tax rate for the year. This will mean that some recipients will pay less Canadian tax than they would pay in combined Canadian and U.S. tax if the previous rules had been maintained. It also means that high income recipients will probably pay more. However, each situation is dependent on a particular recipient's taxable income for a year.

In all cases, every recipient will pay less tax under the changes than they would if they were receiving Canadian social security benefits. This is because those changes exempt 15% of all U.S. social security benefits from tax while Canadian social security benefits do not enjoy such an exemption.

The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.

While every effort has been made to ensure the information provided herein is accurate and timely, no decision should be made or action taken on the basis of this information without first consulting a Coopers & Lybrand professional. Should you have any questions concerning the information provided herein or require specific advice, please contact your Coopers & Lybrand advisor, or: David W. Steele, Coopers & Lybrand, 145 King Street West, Toronto, Ontario M5H 1V8 Canada on Fax: 1-416-941-8415 or E-mail:
David W. Steele
145 King Street West
Toronto, Ontario  M5H 1V8
Fax:    1-416-941-8415
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