Subject to any potential treaty relief, Canadian tax residents are taxed in Canada on their worldwide income. This would include, for example, pensions received from a foreign country, even if they exclusively relate to services rendered outside Canada while a non-resident of Canada. When an individual moves from Switzerland to Canada for retirement, they need to consider how Canada will tax their Swiss pensions.
Canadian Taxation of Pension Withdrawals
The Canadian rules for pension withdrawals, and earnings within pensions, are complex, and may not necessarily match how Switzerland taxes such pensions. It is thus important to know the different tax treatments of different components of the Swiss pension system. As described below, while payments under Pillars 1 and 2 are taxed under the Canadian regime for “pensions”, Pillar 3 payments are often taxed under a separate regime for “trusts”. This article will address the Canadian taxation of Pillar 1 pensions. We will address Pillar 2 and Pillar 3 Swiss Pension taxation in another article.
The Swiss Pension System
The pension system in Switzerland is generally made up of three Pillars.
Pillar 1 (AHV/DI/EL) covers old-age and survivors’ benefits, as well as disability and loss of income insurance. It is administered by the Swiss government and is funded by mandatory contributions by employers and employees, as well as self-employed persons and persons not engaged in employment. It is also partly funded by general government revenues. Withdrawals are generally limited to reaching retirement age.
Pillar 2 is a partly mandatory and partly voluntary occupational benefits insurance regime, that provides supplementary old age, disability, and death benefits in addition to the AHV/DI plan. (It also provides some additional non-pension benefits such as accident insurance.) It is administered by the employer, and it is funded by both employer and employee contributions. The mandatory portion is based on a certain salary threshold; coverage in excess of such threshold would be part of the voluntary portion. Withdrawals are generally limited to reaching retirement age, except for certain limited circumstances.
Pillar 3 is a voluntary pension regime, that supplements the first two pillars. There is both a tied (3a) and a flexible (3b) component. The tied component has restrictions on contribution amounts as well as withdrawals prior to a set retirement age but provides for Swiss tax deductions on contributions. Further, earnings are exempt from Swiss income tax. Tax is fully paid, however, on a withdrawal. It is generally funded exclusively from employee contributions.
As mentioned, this article will only address Pillar 1 of the three pillars. It also does not discuss pensions that accrued in part when the employee may have been a tax resident of Canada.
Canadian Taxation of Swiss pensions
Canadian Taxation of undistributed earnings and gains within the Swiss Government Pension Plan
The taxation of undistributed earnings and gains accrued during a tax year depends on whether the pension plan itself is to be treated as tax resident in Canada (and therefore itself taxable in Canada on its worldwide income).
To answer this, we first need to determine the legal status of the pension. In Canada, pensions are generally structured as trusts, with the pension plan custodian or administrator acting as trustee and the participants being beneficiaries. While the common law concept of a “trust” may not necessarily apply in a civil law country like Switzerland, the Canadian tax authorities (“CRA”) can still apply trust concepts if they find that the parties have similar obligations and rights to those found in common law trusts.
It is highly likely that the Swiss government-administered plan in Pillar 1 would NOT be considered a trust (foreign social security regimes are generally not viewed as trusts). It is thus fairly reasonable to conclude that annual income earned within Pillar 1 would NOT be taxable to the participant if not distributed.
Canadian Taxation of distributions from the Swiss Government Pension Plan
Absent the application of the exceptions described below and Tax Treaty relief, Canada fully taxes 100% of distributions received from a foreign pension plan by a tax resident of Canada. This includes both government-controlled state pension plans, as well as employer-controlled company pension plans. Canada may provide a foreign tax credit for Swiss tax paid on the same income
This applies to Swiss pension plans even if all the services were rendered before they became Canadian residents, and even to the extent of funds that accrued before such date.
Exceptions to Canadian Taxation of Swiss Pension Plans
Under Canadian Domestic tax law - there are only three exceptions to the taxation of Swiss pension distributions in Canada.
The first is the extent to which there were contributions made to the plan by the employee while a Canadian tax resident; they can withdraw such employee contributions tax-free.
The second is where the funds withdrawn are transferred to a Canadian registered retirement savings plan (RRSP), for lump-sum transfers that relate to services rendered by the recipient or their spouse while they were non-residents of Canada. In such a case, the CRA allows an offsetting deduction for the portion of the eligible withdrawal that was transferred to the RRSP. Note that eventual distributions from the RRSP would be subject to Canadian tax. So this exception provides for a deferral of Canadian tax but does not consider Swiss taxation.
The third exception is for arrangements that did NOT have any direct employer contributions to them, but either had exclusively employee contributions (ex many Pillar 3 plans), or were rollover plans where funds were transferred (before the individual became a Canadian resident) from an employer plan to a personal pension scheme. In these cases, the Canadian “pension” rules don’t apply, such that withdrawals are not treated as taxable pension income. (Instead, the arrangement could be treated as either a personal account or a trust, and the annual income or gains earned within the trust may (or may not) be taxable in Canada).
Pillar 1 pensions do have employer contributions made to them, so they would be treated as “pensions” in Canada, such that withdrawals from Pillar 1 pensions will be fully taxable to the Canadian resident participant (in the absence of the first two exceptions).
The Canada- Switzerland tax treaty
While domestic Canadian tax legislation first determines the taxation of Swiss pensions received by Canadian residents, it can be overridden by the provisions of the Canada-Switzerland tax treaty (the “Treaty”).
Unfortunately, Article 18 of the Treaty only provides for an exemption for pensions related to government service, and war or other military pensions (which are not covered by this article), and therefore treaty relief does not apply to Pillar 1 Swiss pension distributions.
While annual earnings and gains realized and accrued within a Pillar 1 pension plan are not taxable. Distributions or withdrawals from Pillar 1 Swiss pension plans are taxable in Canada for Canadian tax residents receiving these pensions.
If you are a Canadian contributing to a Swiss Pension plan and planning to return to Canada or a Canadian Tax resident (regardless of Citizenship) receiving Swiss Pension Distributions and would like more information regarding the above, please contact us at info@trowbridge.ca or visit our website at www.trowbridge.ca/contact.