28 April 2004 External T.I. 2003-0046241E5 - German tax-exempt life insurance plan

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.

Principal Issues: Whether lump-sum payment from German tax-exempt life insurance plan is taxable in Canada?

Position: Question of fact, but likely to be taxable under 56(1)(a) or 56(1)(j).

Reasons: Not enough details to make a determination.

XXXXXXXXXX 2003-004624
S. E. Thomson
April 28, 2004

Dear XXXXXXXXXX:

Re: German Tax Exempt Life Insurance Plan

This is in reply to your email of October 29, 2003 in which you ask for our views on the taxation of a lump-sum payment from the above plan. We apologize for the delay in responding to your query.

Your client was resident and employed in Germany and had contributed to the government pension plan. In 1969, he opted out of that plan, and into a new private program sponsored by a German life insurance company. The plan is referred to as a "tax exempt life insurance plan". The taxpayer is now a resident of Canada, and can either take a lump-sum withdrawal from the plan or can buy an annuity at age 65. A lump-sum withdrawal would be tax-exempt in Germany. You would like to know if the receipt of the lump-sum withdrawal would be taxable in Canada.

OUR COMMENTS

Since your question involves an actual taxpayer and a factual situation, we are unable to definitively reply to your question until we have had the opportunity to review all the facts and related documentation. Such a review is conducted by the relevant tax services office where the query relates to a completed transaction, or by this directorate where the arrangement is the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5 Advance Income Tax Rulings. We nevertheless offer the following general comments regarding the relevant provisions of the Income Tax Act (the "Act") that may apply. Since these comments are general in nature, they may or may not apply in your situation and are not binding on the Canada Revenue Agency.

The taxation of the lump-sum withdrawal as described above would depend on whether the amount is received out of or under a superannuation or pension fund or plan, or whether the amount is simply the proceeds from the disposition of an interest in a life-insurance policy owned by the taxpayer. We would have to examine the plan to determine if it was a superannuation or pension fund or plan, a life insurance policy, or some other type of arrangement.

Pension

If the lump-sum payment to be received at age 65 is an amount received out of or under a superannuation or pension fund or plan, the Canadian resident taxpayer must include the entire lump-sum payment in income by virtue of subparagraph 56(1)(a)(i) of the Act. This is the case whether or not the funds are brought to Canada, since a Canadian resident taxpayer is taxed on his worldwide income.

Whether or not the lump-sum payment is an amount received out of or under a superannuation or pension fund or plan is a question of fact. Generally, we consider a plan to be a superannuation or pension fund or plan where contributions have been made to the plan by or on behalf of an employer or former employer of an employee in consideration for services rendered by the employee and the contributions are used to provide an annuity or other periodical payment on or after the employee's retirement in consideration for his or her employment services. In some cases, a plan may be considered a superannuation or pension plan where amounts have been contributed by a government.

The Canada-Germany Tax Agreement (the "Treaty") would not prevent Canada from taxing the lump-sum pension payment. Paragraph 1 of Article 18 of the Treaty provides that periodic or non-periodic pensions and other similar allowances shall be taxable only in the country of residence (Canada), although they may also be taxed by the country of source (Germany) if certain conditions are met. The fact that Germany will not tax the lump-sum payment does not affect Canada's right to tax.

Life Insurance Policy

If the taxpayer acquired an interest in a life insurance policy in substitution for his rights under a superannuation or pension fund or plan such that paragraph 254(a) of the Act applied, the comments above under "Pension" would generally apply. However, if the lump-sum payment is not an amount received from a superannuation or pension fund or plan, but is simply the proceeds of disposition of an interest in a life insurance policy owned by the taxpayer, he will be taxed in Canada on the excess of the "proceeds of the disposition" over his "adjusted cost basis" of the interest, by virtue of subsection 148(1) and paragraph 56(1)(j) of the Act. The adjusted cost basis, as computed in subsection 148(9) of the Act, is essentially the cost to the taxpayer of the policy, adjusted for certain items such as premiums paid under the policy and any amount of accrued income previously included in computing the policyholder's income. If the taxpayer became resident in Canada after 1992, the cost of the policy to the taxpayer may be affected by the rules in paragraph 128.1(1)(c) of the Act, under which the taxpayer is deemed to have acquired the life insurance policy on becoming resident in Canada at a cost equal to the policy's fair market value at that time. Again, the Treaty would not prevent Canada from taxing the gain on the disposition of the life insurance policy.

Note that your client may have been required to report income accrued on the insurance policy on an annual, or possibly triennial, basis by virtue of section 12.2 of the Act. For more information on these rules, see Interpretation Bulletin, IT-87R2, Policyholders' Income from Life Insurance Policies, available on our website at www.ccra-adrc.gc.ca. Furthermore, your client may have been required to report the existence of the life insurance policy for years after 1997 by virtue of section 233.3 of the Act. For more information, search for the term "foreign reporting" on our website.

Note also that for years that begin after 2002, subsection 94.2(11) of the Act, as proposed in the draft legislation released on October 30, 2003, may apply to the life insurance policy. A discussion of these rules is beyond the scope of this letter.

We trust that we have been of some assistance.

Yours truly,

Olli Laurikainen, C.A., Manager
for Director
International & Trusts Division
Income Tax Rulings Directorate