The Queen v. Rumack, 92 DTC 6142, [1992] 1 CTC 57 (FCA)

Hugessen, J.A. (Stone and Heald, JJ.A., concurring):—This appeal raises the issue of the proper income tax treatment to be given certain types of lottery winnings. Traditionally such winnings have always been exempted from income tax, being treated as" windfalls”, i.e., of a capital nature. [1] The question here is to know whether the same exemption should be accorded where the winnings themselves take the form of a stream of income.

The matter arises in this way. In 1978, the respondent was the holder of the winning ticket in a lottery organized by the Ontario Association for the Mentally Retarded. The ticket on its face described the game as a “cash for life lottery". The front of the ticket also stated: “ first prize $1,000 each month for life". There were other prizes, some of which consisted of smaller monthly life payments. On the back of the ticket the following text appears:

Lifetime prizes are funded by Life Annuities purchased by the Association, and are guaranteed for a minimum of 20 years. Lifetime prize payments to start at age 18 or older and commence approximately 30 days after Winners’ declarations. All proceeds go to aid the Ontario Association for the Mentally Retarded. Check your newspaper or" Cash for Life” ticketseller for winning numbers after the draw date.

In the course of the 1979 taxation year, the only one directly in issue on the present appeal, the respondent received 12 monthly payments of $1,000 each. These were paid to her by the Sun Life Assurance Company from which the Ontario Association for the Mentally Retarded had purchased an annuity on the respondent's life with a guaranteed period of 20 years. The single premium of $135,337.75 was paid by the Association which remained the owner of the annuity. The respondent's name appears as payee but the Association as owner retained the right to revoke or change the payee at any time prior to the death of the annuitant.

Following the end of the 1979 taxation year, Sun Life issued to the respondent a T-4A form showing that the sum of $8,155.20 was to be included in her income for the year. The balance of the $12,000, being $3,844.80, represented the capital portion of the payments and was deducted pursuant to paragraph 60(a) of the Act. The respondent did not include any part of the payments received from Sun Life in her return for 1979 and the Minister, in due course, assessed her for income tax in respect of the sum of $8,155.20. An objection and an appeal to the Tax Court of Canada were both unsuccessful, but a further appeal by way of an action in the Trial Division of this Court succeeded. Hence, the present appeal.

The relevant provisions of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act") are as follows:

40. (2) Notwithstanding subsection (1),

(f) a taxpayer's gain or loss from the disposition of

(i) a chance to win a prize, or

(ii) a right to receive an amount as a prize, in connection with a lottery scheme is nil;

52. (4) Where any property has been acquired by a taxpayer at any time after 1971 as a prize in connection with a lottery scheme, he shall be deemed to have acquired the property at a cost to him equal to its fair market value at that time.

56. (1) Without restricting the generality of section 3, there shall be included in computing the income of a taxpayer for a taxation year,

(d) any amount received by the taxpayer in the year as an annuity payment except to the extent that the payment is otherwise required to be included in computing his income for the year;

60. There may be deducted in computing a taxpayer's income for a taxation year such of the following amounts as are applicable:

(a) the capital element of each annuity payment (other than a superannuation or pension benefit, a payment under a registered retirement savings plan, a payment under a registered retirement income fund, a payment under an income-averaging annuity contract or a payment of an annuity paid or purchased pursuant to a deferred profit sharing plan or pursuant to a plan referred to in subsection 147(15) as a revoked plan”) included in computing the taxpayer's income for the year, that is to say,

(i) if the annuity was paid under a contract, an amount equal to that part of the payment determined in prescribed manner to have been a return of capital, and

(ii) if the annuity was paid under a will or trust, such part of the payment as can be established by the recipient not to have been paid out of the income of the estate or trust;

248. (1) “annuity” includes an amount payable on a periodic basis whether payable at intervals longer or shorter than a year and whether payable under a contract, will or trust or otherwise;

In my view, the respondent is taxable upon the lottery proceeds.

As I indicated at the outset, lottery prizes have traditionally been exempted from income tax in Canada. Originally, this was not as a result of any declared policy or legislative provision in the Income Tax Act. Instead, it was simply a consequence of the fact that income tax was only imposed upon income from a source. Lottery winnings did not have the character or quality of income and could not be traced to any source which might be identified as income producing. They were described as "windfalls" which, as I have indicated above, was simply another way of saying that they were receipts of a capital nature.

With the introduction of capital gains tax in Canada in 1972, it became necessary to deal with the possibility that lottery winnings which were not income might nonetheless attract tax as capital gains. Clearly, a policy decision was reached that they should not be so taxed and the result was the enactment of paragraph 49(2) (Ç and subsection 52(4) above, both of which appear in Subdivision c of Division B of Part I : "Taxable capital gains and allowable capital losses".

The learned judge of the Trial Division was of the view that each monthly payment of $1,000 received by the respondent fell within what he called the "exempting provision" in subsection 52(4) and was therefore free from income tax. With respect, I think he was wrong.

In my view, subsection 52(4) simply cannot be of any assistance to the respondent. As previously indicated it is found in the subdivision of the Act particularly devoted to the matter of capital gains; it does not purport to deal with whether or not the payments received were to be treated as income. The very words of subsection 52(4) are cast in the language of capital gains talking as they do of a deemed cost of the acquisition of property.

Even if, as the learned judge of the Trial Division seems to have thought, each monthly payment of $1,000 was a prize acquired by the respondent in connection with the lottery scheme, a proposition as to which I have some difficulty as appears below, that still does not avail to make the payments exempt from income tax if in fact they have the quality of income. Many income payments are "acquired" by a taxpayer, in the sense of coming into his possession, at a cost to him equal to their fair market value; obvious examples are salaries, fees, royalties and the like. The fact that the taxpayer has given value for what he gets has never, however, as far as I know, served to deprive income payments of their character as such or to make them non-taxable.

Furthermore, and as suggested in the preceding paragraph, I do not think that one can properly characterize each $1,000 monthly payment as "a prize” within the meaning of subsection 52(4). I have already quoted the lottery ticket which describes the "first prize" as being “$1,000 each month for life”. Surely on any ordinary use of language this is not to be regarded as 240 or more separate prizes of $1,000 each, but rather as a single prize consisting of a guaranteed income stream for 20 years or more. This is confirmed by the text on the back of the ticket which indicates that each lifetime prize is to be funded by the purchase of a life annuity.

By its very nature a stream of payments of $1,000 monthly for life has the character and quality of income. Some of the features strongly indicative of that character in my view are the following: the payments are periodic, regular, certain, foreseeable, expected and enforceable; they are also to endure for the payee's lifetime and, subject only to that limitation, are inexhaustible. The fact that their present value is significantly less than their minimum face value over time shows that they contain a large component based upon interest or the productivity of money.

The source of the income constituted by the stream of payments is the contractual obligation undertaken by the Association at the time the respondent purchased the winning ticket. More immediately it is the annuity contract purchased by the Association from Sun Life for the respondent's benefit and in order to discharge its obligation to her. If it cost the Association $135,337.75 to meet its contractual obligation to her at the time she turned in her winning ticket in 1978, that is also surely the value of the prize which she won.

The respondent acquired through a lottery scheme a prize consisting of a stream of payments of $1,000 a month for life. That prize had a value of $135,337.75, and as such is clearly one which is intended to be covered, and is covered by the provisions of subsection 52(4). It is a “windfall” of a capital nature and is therefore not taxable as income. Since it is deemed to have been acquired by her at a cost equal to its fair market value, i.e., $135,337.75, it also does not attract capital gains tax.

The monthly payments received by the respondent are, however, an entirely different matter. It is true that each payment comes to her as a consequence of her having won a prize of a value of $135,337.75, but no payment or group of payments is itself the prize. The prize is the lifetime guaranteed stream of payments, each of which is composed, in large measure, of the income resulting from the tax exempt capital value of the prize. If she had won a lump sum and invested it there can be no doubt that the income from such investment would be taxable in her hands; only the capital would be free of tax by the operation of subsection 52(4). Here, the investment of the capital value of the prize was in effect compulsory, forced on her by the rules of the game itself, but that surely cannot change the result.

What the respondent has received in 1979 are 12 payments of $1,000 each. Those payments have been made under an annuity as that term is defined in subsection 248(1) above. As such they have the character of income and are required by paragraph 56(1)(d) to be included in computing the taxpayer's income. By the terms of paragraph 60(a) there may be deducted therefrom the amounts determined in prescribed manner to be a return of capital. Those amounts totalled $3,844.80 in 1979. The balance of $8,155.20 was taxable income and was properly assessed as such.

I would allow the appeal with costs, set aside the judgment of the Trial Division, and dismiss the action with costs.

Crown's appeal allowed.