26 June 2002 External T.I. 2001-0068035 - ANNUITY FROM RETIREMENT ARRANGEMENT

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Taxation of annuities acquired under retirement arrangements.

Position: General comments provided

Reasons: Detailed information must be provided in order to determine tax consequences.

XXXXXXXXXX 2001-006803
W. C. Harding
June 26, 2002

Dear XXXXXXXXXX,

Re: Annuity acquired under United Kingdom Occupational Pension Scheme Rules

This is in reply to your letter of January 11, 2001, in which you requested a technical opinion on behalf of your client in respect of the taxation of an annuity acquired under United Kingdom ("UK") pension legislation, while he was a resident of the UK. We also acknowledge our previous telephone conversations (XXXXXXXXXX/Harding) during which we discussed the problems in providing general comments in respect of a factual situation, and, in particular, at a time when proposals to amend the legislation pertaining to migration of taxpayers and foreign property income were outstanding. As noted below some concerns still exist in respect of the proposed rules for foreign investment entities.

Written confirmation of the tax implications inherent in particular situations may only be provided by this Directorate when the transactions involved are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in the Canada Customs and Revenue Agency ("CCRA") Information Circular 70-6R5 dated May 17, 2002. Where the particular transactions are completed, the enquiry should be addressed to the relevant District Taxation Office. We are, however, providing the following comments that relate to the possible application of the Income Tax Act (the "Act") in a situation where an individual becomes a resident of Canada after the individual acquires ownership of, or an interest in a deferred annuity contract as a consequence of the individual's participation in one or more foreign pension or retirement plans. These comments are general in nature and are not binding on the CCRA.

Our Comments

A person, who holds an interest in an annuity, may be subject to a number of provisions of the Act at, or subsequent to, the time the person immigrates to Canada. Accordingly, in order to determine which provisions will apply, a number of factors must be established. Furthermore, because there is a number of provisions of the Act that may apply depending on the particular facts, it is difficult to provide any general answers in respect of a particular situation until all of the facts have been established. For example, in a situation such as the one described above it would be necessary, as a minimum, to establish the following facts:

1. Was the annuity acquired under the terms of one or more arrangements designed to provide a "pension" for purposes of the Act? For example, in order for an arrangement to be a "pension plan", it must be an arrangement to provide a pension to an employee, usually for life, under which an employer of the employee, or a government, has made contributions. If employer contributions are made, it may be a pension plan and could also be an employee benefit plan (an "EBP"). On the other hand, if employer contributions are not made under the terms of the plan, it will not be a pension but may be some form of employee savings or thrift plan. Interpretation Bulletin IT-502 Employee Benefit Plans and Employee Trusts discusses this later type of arrangement

2. Who owns the annuity? While an employee may be the annuitant of an annuity, the employee, the employer or the custodian/trustee of the arrangment may be the legal owner of the annuity itself. Ownership of the annuity will be a factor in the determination of such things as the application of paragraph 254(a) of the Act and the possible application of section 12.2 or 94.2 of the Act. In basic terms, a person is normally taxable on amounts received out of a pension plan. Paragraph 254(a) of the Act generally provides that if an individual acquired an annuity out of a pension plan before July 31, 1997, the value of the annuity will not be included in the person's income at that time the annuity is acquired and all amounts received by the individual out of the annuity will be included in the person's income when the amounts are received. Similar provisions in subsection 147.4 of the Act apply to annuity contract acquisitions, amendments and substitutions that occur after July 30, 1997. In general terms, section 12.2 of the Act provides that income accrued under an annuity must be included in income on an annual basis while section 94.2 provides, in respect of annuities, that an amount must be included in the income of the holder of a foreign annuity on an annual basis unless an amount is reported as income accrued under the annuity in accordance with section 12.2 of the Act.

In this respect, we also note that, in some circumstances, an employer may be a residual beneficiary of surplus funds not used to provide other benefits under an annuity contract to an individual. The consequences of this provision may be of significance with respect to the ownership of an annuity.

3. Is the annuity contract a deferred annuity contract acquired by the employer to fund an unregistered pension plan and, if so, is it an insurance policy or an administrative services contract? CCRA generally takes the view that where an insurer assumes the risk under an insurance policy, the policy will not be an EBP as that term is defined in subsection 248(1) of the Act. However, where the insurer is acting as a custodian under an administrative services contract the arrangement will generally be considered to be an EBP.

We note that in the situation described above, the annuity was acquired with funds transferred from another arrangement. By definition, an EBP is established when an employer, or someone not dealing at arm's length with the employer, makes contributions to another person who will then make one or more payments to or for the benefit of an employee, former employee or a person with whom the employee or former employee does not deal at arm's length. It must therefore follow that a payment by a custodian or trustee of a pension scheme cannot establish an EBP unless the trustee is not dealing at arm's length with the employer. However, see the comments in 4 below.

4. What were the terms and conditions of the plan (or plans) by virtue of which the annuity or annuities were acquired? A pension plan may provide for the funding of pension benefits with an annuity. If this is the case, as described above, paragraph 254(a) of the Act may have application to the payment of amounts used to acquire the annuity and the subsequent payment of amounts under the annuity. Alternatively, the acquisition of the annuity may be as a consequence of the application of the legislation of the foreign jurisdiction, as that legislation was written at the time of the purchase of the annuity contract, and not as a consequence of the terms of the plan. For example, in the United States, an individual may use amounts received on a tax-deferred basis from a pension plan to acquire an annuity which qualifies as an individual retirement account (an "IRA"). However, this annuity may not be subject to paragraph 254(a) of the Act. This was established in Abrahamson, 91 DTC 213 (TCC). In that case, the taxpayer established an IRA with funds transferred from his employer's pension plan. The court held that the taxpayer was entitled to withdraw a lump sum amount from the pension plan and was entitled, under U.S. law, to transfer this amount to an IRA. Furthermore, the court took the view that the proceeds of the IRA were neither a payment of, nor in satisfaction of, a superannuation or pension benefit within the meaning of subparagraph 56(1)(a)(i) of the Act nor were they deemed to be such a payment under the provisions of paragraph 254(a) of the Act, since the IRA had not been entered into purporting to create, establish, extinguish or be in substitution for the taxpayer's right to an amount out of his U.S. employer's plan.

On the other hand, if the plan was an EBP but not a pension plan, then the consequences detailed in IT-502 Employee Benefit Plans and Employee Trusts in respect of the purchase of annuities would be applicable in determining when amounts received under the annuity would be taxable.

5. What is the date of the employee's immigration to Canada? It is of note that the legislation pertaining to taxation of property held on migration was amended in 2001 with effect after October 1, 1996. Because of the changes, the exact date of a person's immigration could be critical to the application of these provisions.

To summarize the above factors, a deferred annuity contract may be treated under Canadian tax law, subject to any applicable income tax convention, as an annuity contract owned by the annuitant. Alternatively, it may be considered that the annuitant has an interest in an annuity held by another person who may be the employer or former employer of the annuitant, or by a custodian of an EBP or some other arrangement. Furthermore, the annuity contract may provide the annuitant with a right to receive an annuity payment, a pension benefit, or in some circumstances, employment income. However, an explicit determination of these factors may only be determined where all of the particular facts are known.

As indicated above, in general terms, when paragraph 254(a) of the Act applies to the acquisition of an annuity, the annuitant will not be considered to have received a taxable benefit at the time the annuity contract is provided to the employee. However, the provision does not provide any rules on the taxation of the annuity and, in particular, whether the income accrued under the contract will be subject to tax under subsection 12.2(1) or otherwise. Furthermore, it is of note that the provisions of draft subsection 94.2(10) of the Act could have application to the contract. Under this provision, the annuity could be subject to the proposed foreign investment property rules if amounts are not reported under section 12.2 of the Act. In our view subsection 254 was originally enacted to provide that amounts received out of pensions that were used to acquire annuities should only be taxed upon receipt of the annuity payments. However, it also appears that subsection 94.2(10) of the Act, in conjunction with section 12.2 of the Act may also apply to such annuities. Accordingly, given your concern that an annuity received as a consequence of an individual's participation in a foreign pension scheme may be inappropriately taxed, you may wish to refer this matter to the Department of Finance for their consideration in the finalization of the proposed legislation.

We trust that these comments will be of assistance to you

Yours truly,

Roberta Albert, CA
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch