Taxation of German Pensions

I just got a phone call from a client telling me that Germany is now taxing pensions.  Who knew?  I sure didn’t, but that is not unusual since I have never dealt with German pensions in the past.  So here is the problem.  Until recently (read yesterday) everyone getting a German pension did not have to pay income tax in Germany on the amounts received.  The problem is they did have to pay tax in Canada on it if they were a Canadian resident.  The Germans in their infinite wisdom decided to change their legislation to be effective for tax years starting in 2005.  Now they have sent out reassessment notices dating back to 2005 asking for payment on all the back years.

Let’s count the problems Canadians collecting German pensions now have.  First, tax returns go statute barred after 3 years from the date they are assessed. Two, taxes on personal income are based on when amounts are received and paid.  Three, personal taxes are also based on a matching principle, which means tax paid should be associated with the income from which it was attributable.  Four, international transactions go statute barred after six years from the date of assessment.  Five, international transactions are subject to tax treaties.  I won’t go any further, but you get the idea.  Tax was paid on these pension amounts in Canada (the same is true if you live in most other OECD countries) and now they are being taxed again (double taxation).  There are two key things to know about tax treaties.  One, their primary purpose is to set out rules as to who gets first right of taxation on income amounts, and the second is avoid double taxation of the same amounts.

Simply put tax treaties state that pensions are taxed first in the issuing country and that the country of residence (where you live) gets to tax it as well, but must allow for a foreign tax credit.  This has been over simplified, but is essentially true.  So now that these pensions are being double taxed, and Germany has right of first taxation, how do you claim your foreign tax credit in Canada?  I don’t have the answer yet but I am going to propose some possibilities as to how it can be handled.  Once I have dealt with the client I have I will provide an update.

Potential solution #1 – Claim the foreign tax credit on 2011 return

The reason this appears as number one is that it is the easiest, and it makes sense.  The assessments just came out in 2011 and will be paid to the German government in 2011.  From a common sense point of view it just makes sense to claim the foreign tax credit in the year the amount is paid.  The problem is that this tax amount relates to income reported in prior years.  I suspect, but won’t know until May 2012, that CRA will say that “this is not the proper way to do it” for the reason stated above, namely the tax relates to income of other taxation years.

Potential solution #2 – Claim the foreign tax credit on return income was reported

Under this solution you would have to go back and amend the individual returns that the income was reported on.  That would mean amending 2005, 2006, 2007, 2008, 2009, and 2010.  Did I mention that tax returns usually go statute barred after 3 years?  So 2005 goes statute barred in 2009.  Oh yeah but international transactions go statute barred after 6 years, so 2005 goes statute barred in 2012 (return was filed and assessed in or around April 2006).  But that is only if CRA agrees that pension income qualifies as an international transaction.

Addendum (November 30th, 2012)

To date there has been no response from the CRA on the tax filings indicated in the above.  As soon as I have something new to report on this issue I will update it in a new blog.  Given that CRA are slower than a glacier, I may be retired or dead before I can provide an update.  I will duitifully leave this task in my will for my heir to follow up on.  No I am not a senior citezen (only in mid fourties), but if you have a time machine handy let me know.