11 January 2005 External T.I. 2004-0085091E5 - US Lottery Winnings - Taxation

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 US lottery prize, which is paid as XXXXXXXXXX annual payments, is taxable when received by a Canadian resident

Position: A portion of the payments will be taxable

Reasons: the payments represent an annuity that is not a prescribed annuity and would be taxable under the accrual rules in section 12.2

2004-008509
XXXXXXXXXX T. Harris
(613) 957-2114
January 11, 2005

Dear XXXXXXXXXX:

Re: Taxation of Lottery Winnings from a US Lottery

We are writing in response to your e-mail of July 9, 2004, regarding the above-noted subject. In particular, you have described the following situation:

Father is a US citizen and resident who won a state lottery prize in XXXXXXXXXX. The total prize was US $XXXXXXXXXX, payable in XXXXXXXXXX equal annual instalments of US $XXXXXXXXXX. There was no option to take the prize immediately in one lump sum, nor was the prize to be paid in the form of an annuity. The payments are transferable to Father's estate and/or beneficiaries on his death.

For estate planning purposes, Father would like to determine the Canadian taxation of the lottery payments should he name his Canadian resident child ("Child") as a beneficiary.

Our Comments

The particular situation outlined in your letter appears to relate to a factual one involving a specific taxpayer. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. However, we are prepared to offer the following general comments that may be of assistance.

As noted in your letter, subsection 248(1) of the Income Tax Act (the "Act") defines an "annuity" to include "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." Consequently, in our view, any payments made by the state lottery to Child would be considered to be an annuity payment and will be included in Child's income.

Based on the information provided in your letter, it would not appear that the annuity will qualify as a prescribed annuity contract as described in section 304 of the Income Tax Regulations (the "Regulations"). Consequently, the amount to be included in the Canadian recipient's income is determined according to the provisions of section 12.2 of the Act. For these purposes, subsection 138(12) of the Act provides that a life insurance policy includes an annuity contract. As noted in paragraph 3 of Interpretation Bulletin IT-87R2 Policyholder's Income from Life Insurance Policies, the expressions "accumulating fund" and "adjusted cost basis" are relevant to the determination of the amount to be included in income under subsection 12.2(1) of the Act. The meaning of these expressions is also explained in that paragraph of IT-87R2. In addition, the accrual rules under section 12.2 of the Act are described in paragraphs 4 and 5 of IT-87R2.

Although Father is not resident in Canada and, therefore, not taxable in Canada on any non-Canadian source income, it would first be necessary to consider the tax consequences resulting from the receipt of the annuity to Father as if he were resident in Canada.

Subsection 52(4) of the Act provides that the cost of property acquired as a prize under a lottery is equal to its fair market value at the time that it is acquired. As noted in paragraph 3(a) of Information Circular 89-3 - Policy Statement on Business Equity Valuations, it is the opinion of the Canada Revenue Agency (the "CRA") that fair market value means "the highest price, expressed in terms of money or money's worth, obtainable in an open and unrestricted market between knowledgeable, informed and prudent parties acting at arm's length, neither party being under any compulsion to transact." In the case of an annuity, the fair market value will generally be the present value of the payments to be received under the annuity and not the aggregate face value of the payments as suggested in your submission.

In the circumstances where the annuity is not a prescribed annuity contract, Father would be deemed, pursuant to paragraph 148(2)(b) of the Act, to have disposed of the annuity at the time of his death for proceeds of disposition equal to the accumulating fund of the annuity immediately before the time of death. Pursuant to paragraph 148(2)(c) of the Act, Child would then be deemed to have acquired the annuity at a cost equal to the accumulating fund of the annuity immediately after the time of death. The accumulating fund would need to be provided by the issuer of the annuity.

It is our understanding that such lottery prizes are subject to taxation in the US. Consequently, under subsection 126(1) of the Act, Child may be entitled to claim a credit for any non-business-income tax paid to the US or the state; however, the credit cannot exceed the Canadian tax otherwise payable on Child's non-business income from the US.

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

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch

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