17 February 2003 External T.I. 2003-0000605 - CHARITABLE GIFT ANNUITIES

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:

Tax implications of charitable gift annuities issued after December 20, 2002

Position:

Provided general comments on the taxation of annuity contracts and the application of the draft gifting legislation in determining the eligible amount of a gift.

Reasons: Legislation and draft legislation.

XXXXXXXXXX 							2003-000060

February 17, 2003

Dear XXXXXXXXXX:

Re: Charitable Gift Annuities

This is in reply to your facsimile of January 29, 2003 in which you requested our views on the tax implications when an individual purchases an annuity contract from a registered charitable organization ("charity") after December 20, 2002.

Specifically, you asked us to consider an example where a 80-year male donor contributes $100,000 to the charity and the charity agrees to make annual annuity payments of $7,700 to the donor for as long as the donor lives with no guarantee period. To fund the charity's obligation to make the annuity payments, the charity purchases from a commercial annuity issuer an annuity on the donor's life containing the same terms but with a 10-year guarantee period. The cost of this annuity to the charity is $69,875. You note that the cost of a commercial annuity with no guarantee period that provides annual payments of $7,700 to the donor would be $52,300. You would like confirmation that the charity may issue a donation receipt of $47,700 and that the annual taxable portion of the annuity payments is $1,162.50.

Our comments

As you are aware, we announced the withdrawal of the administrative position in Interpretation Bulletin IT-111R2, Annuities Purchased From Charitable Organizations, in Income Tax Technical News No. 26, effective for annuities issued after December 20, 2002. As a result, the taxation of annuities issued by charities after that date is governed by the rules in the Income Tax Act (the "Act") based on the nature of the arrangement between the donor and the charity. Where an individual enters into a contract with a charity under which the individual pays a specified amount to the charity in order to receive annuity payments from the charity for life or for a guarantee period, such a contract would constitute an annuity contract.

An annuity contract may be subject to accrual taxation under subsection 12.2(1) of the Act. Under this provision, the amount by which the accumulating fund of the policyholder's interest exceeds the adjusted cost basis to the policyholder of that interest is required to be included in the policyholder's income on an annual basis. The accrual rules in section 12.2 of the Act are discussed in detail in Interpretation Bulletin IT-87R2, a copy of which can be obtained on the Agency's website at www.ccra-adrc.gc.ca. Subsection 12.2(1) of the Act does not apply to certain life insurance policies including a prescribed annuity contract ("PAC").

The term PAC is defined in subsection 304(1) of the Income Tax Regulations (the "Regulations"). Generally, an annuity contract issued by a charity could qualify as a PAC pursuant to paragraph (c) of that definition if the following conditions are satisfied:

1. The annuity payments under the contract have commenced in the taxation year or a preceding year.

2. The contract was issued by a registered charity.

3. The holder of the contract is an individual.

4. The holder is the annuitant under the contract and throughout the taxation year the holder dealt at arm's length with the charity.

5. The terms and conditions of the contract require that:

a) all payments made out of the contract be equal annuity payments made at regular intervals but not less frequently than annually;

b) the annuity payments made out of the contract continue for a fixed term or for the life of the holder;

c) where the annuity payments are to be made over a guaranteed or fixed term, the guaranteed or fixed term cannot extend beyond the time at which the holder would attain the age of 91 years.

6. No loans exist under the contract and the holder's rights under the contract cannot be disposed of otherwise than on the holder's death.

7. No payments can be made out of the contract other than as permitted by section 304 of the Regulations.

8. None of the terms and conditions provide for any recourse against the charity for failure to make any payment under the contract.

9. The holder has not notified the charity in writing before the end of the taxation year in which the annuity payments under the contract commenced that the contract is not to be treated as a PAC.

The above list is not exhaustive and we caution that a determination of whether a particular annuity contract is a PAC would require a review of the terms and conditions of the contract having regard to the PAC definition in subsection 304(1) of the Regulations as well as the other provisions in the Regulation including subsection 304(2) of the Regulations which sets out certain exceptions to the PAC definition.

Where the annuity contract between the donor and the charity qualifies as a PAC, the annuity payments will be included in the recipient's income under paragraph 56(1)(d) of the Act and the recipient may claim a deduction for the capital element under paragraph 60(a) of the Act. The capital element of each annuity payment is determined in prescribed manner as a return of capital in section 300 of the Regulations. Briefly, subsection 300(1) of the Regulations provides that the capital element of each annuity payment is the proportion of the annuity payment that the adjusted purchase price of the taxpayer's interest in the contract is of the total of the payments expected to be made under the contract. For this purpose, pursuant to paragraph 300(2)(a) of the Regulations, the 1971 Individual Annuity Mortality Table is to be used in cases where the continuance of the annuity payments depends in whole or in part on the survival of an individual. Pursuant to paragraph 300(2)(b) of the Regulations, the "adjusted purchase price" of an annuity contract is defined by reference to the "adjusted cost basis" of the contract to the taxpayer, as that term is defined in subsection 148(9) of the Act if it were read without reference to the deduction available under paragraph 60(a) of the Act. The adjusted purchase price will generally be equal to the amount paid to acquire the contract. Accordingly, when this amount is divided by the total of the payments to be made under the terms of an annuity contract for a term of years certain, or, in the case of a contact under which the continuation of the payments depends in whole or in part on the survival of an individual, the total of the payments expected to be made, a constant proportion is calculated which, when applied to each annuity payment, will determine the capital element of that payment.

You asked for our comments on the application of the gifting provisions in the draft legislation released on December 20, 2002 to your example. Pursuant to draft subsection 248(30) of the Act, the eligible amount of a gift is the excess of the fair market value of the property transferred to a qualified donee over the amount of the advantage provided to a donor. Draft subsection 248(31) of the Act provides that the amount of the advantage is generally the value of any property, service, compensation or other benefit received or obtained by the donor. In your example, the advantage provided to the donor is an annuity that provides annual payments of $7,700 for the life of the donor with no guarantee period. Therefore, if the cost of a commercial annuity with the same terms is $52,300, the amount of the advantage is $52,300. Since this amount does not exceed 80% of the amount paid to the charity, the charity may issue a tax receipt for an eligible amount of $ 47,700 ($100,000 minus $52,300). We note that the cost to the donor of the annuity is $52,300 pursuant to draft subsection 248(33) of the Act.

Regarding the taxation of the annuity payments in your example, if we assume that the arrangement between the donor and the charity is an annuity contract that qualifies as a PAC, the charity would need to calculate the capital element of each annuity payment. If the adjusted purchase price of the donor's interest is $52,300 and the total of the expected payments is $61,600 based on a life expectancy of 8 years according to the 1971 Individual Annuity Mortality Table ($7,700 X 8), the capital element of each annuity payment is $6,537.50 ($7,700 X $52,300/$61,600). Accordingly, the taxable portion of each annuity payment to the donor is $1,162.50 ($7,700 minus $6,537.50). The charity is required to prepare a T4A slip reporting the annual taxable portion of $1,162.50.

Finally, we note that where a charity funds its obligation to make annuity payments by purchasing an annuity contract from an insurer, the annuity contract purchased by the charity is a separate transaction. It has no bearing on the tax implications to the donor although we have been advised that the cost of the annuity contract to the charity may, in some cases, be the same as the cost to the donor where the terms and conditions of the two annuity contracts are identical. From the donor's perspective, it is the arrangement between the donor and the charity that will determine the tax implications to the donor.

We trust that our comments will be of assistance to you. However, as stated in paragraph 22 of Information Circular 70-6R5, this opinion is not a ruling and consequently is not binding on the Agency in respect of any particular situation.

Yours truly,

F. Lee Workman
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings directorate
Policy and Legislation Branch