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: What requirement is there relating to the disposition of a "prescribed annuity contract" ("PAC")? Can a PAC be terminated before death of the annuity holder and if so, what are the tax consequences?
Position: To qualify as a PAC, the terms and conditions of the annuity contract must not provide for the disposition of the annuity other than on death of the annuity holder. It is possible to amend the terms of an annuity that originally qualified as a PAC, to provide for the disposition of the annuity prior to the death of the annuity holder, however the amendment will result in the annuity no longer qualifying as a PAC. Generally, the contract will be deemed to have been disposed of at the time it ceases to qualify as a PAC and any policy gain arising from the disposition must be included in the annuity holder's income.
Reasons: The legislation.
XXXXXXXXXX 2004-005541
Alison Campbell
February 12, 2003
Re : Prescribed Annuity Contracts ("PAC's")
We are responding to your request of January 8, 2004, for our comments on a document which discusses section 304 of the Regulations to the Income Tax Act (the "Regulations"). The document you provided does not appear to be one issued by the Canada Revenue Agency ("CRA"), but rather an insurance industry publication that discusses PAC's. While we do not comment on the accuracy of third party documents we can provide you with some general information on PAC's which we hope will be of assistance to you.
The Income Tax Act (the "Act") provides for the tax consequences related to various types of insurance products, including annuities. The tax consequences to holders of annuities under the Act, will depend on whether the particular annuity contract is a "PAC". In general, an annuity contract that does not qualify as a "PAC" for purposes of the Act, will be subject to the annual income accrual taxation rules in section 12.2 of the Act, whereas an annuity that does qualify as a "PAC" is subject to taxation on a portion of annuity payments received in accordance with subsection 56(1) and paragraph 60(a) of the Act. In order to qualify as a "PAC" for purposes of the Act, an annuity contract must satisfy the list of conditions that are found in section 304 of the Regulations. For your reference, an electronic version of the Act and the Regulations can be found on the Department of Justice's website.
Among many other requirements in section 304 of the Regulations, one of the conditions which must be met for an annuity contract to qualify as a PAC is found in clause 304(1)(c)(iv)(D) of the Regulations. That condition requires that a holder's rights in the annuity contract not be disposed of otherwise than on the holder's death. Notwithstanding the condition in clause 304(1)(c)(iv)(D) of the Regulations, there is no provision in the Act or the Regulations which specifically prevents the renegotiation of the terms of a PAC such that it would no longer qualify as a PAC. If the circumstances indicate that the parties to a PAC arrangement contemplated at the time the annuity was issued, that the terms would subsequently be renegotiated such that the conditions in section 304 of the Regulations would no longer met, it is our view that the annuity may have never qualified as a PAC.
In the situation where a PAC is terminated and the commuted value is paid to the holder, it is our view that a disposition has occurred. Accordingly, subsection 148(1) of the Act would apply to include in the holder's income for the year of disposition the excess of the proceeds of the disposition over the adjusted cost basis of the annuity contract.
Your questions relating to section 304 of the Regulations, seem to have arisen in connection with a structured settlement. The Canada Revenue Agency has a published interpretation bulletin, IT-365R2, "Damages, Settlements and Similar Receipts, paragraph 5 of which deals with structured settlements. In this regard, we would note that the CRA's position in paragraph 5 of IT-365R2, sets out conditions relating to the annuity which must be satisfied in order the arrangement to be considered a "structured settlement". The interpretation bulletin is not, however, predicated on the annuity qualifying as a PAC as defined in section 304 of the Regulations.
While our comments above are not binding on the CRA in respect of any particular fact situation, we do hope that are comments are of assistance to you.
Yours truly,
F. Lee Workman
Manager
Financial Institutions Section
Income Tax Rulings Directorate
Policy and Planning Branch
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