8 December 2004 External T.I. 2004-0105071E5 - Deferred annuity paid from a U.K. pension

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 are the tax consequences if a Canadian resident receives a deferred annuity contract (on the wind-up of a pension) in satisfaction of benefits accumulated in a U.K. pension in respect of services rendered before the annuitant became a resident of Canada?

Position: The value of the contract will be taxable at the time it is issued. The contract will also be subject to annual taxation under section 12.2 of the Act. There may also be a mismatch of the timing of U.K. tax and Canadian tax if any U.K. tax is exigible.

Reasons: The Canada- U.K. treaty does not provide any specific relief (so paragraph 110(1)(f) of the Act does not apply). The domestic provisions of the Act will apply to the receipt of the annuity contract and its continued holding.

XXXXXXXXXX 								2004-010507
W. C. Harding
December 8, 2004

Dear XXXXXXXXXX:

Re: Deferred Annuity Contract received on a Pension Wind-up

This is in reply to your electronic correspondence of November 25, 2004, concerning the taxation of a Canadian resident who receives an "individual buy-out contract" on the wind-up of a U.K. Occupational Pension Scheme.

We thank you for providing us with the Inland Revenue's manual IR12 (2001) entitled Occupational Pension Schemes Practice Notes ("IR12") to assist us in preparing our reply.

Written confirmation of the tax implications inherent in particular transactions can be provided by this Directorate where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advanced Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, any inquiries should be addressed to the relevant tax services office. However, we are prepared to provide the following comments that may be of assistance to you. Please note that these comments are general in nature and are not binding on the Canada Revenue Agency ("CRA"). All publications referred to herein can be accessed on the CRA website at the following address: http://www.cra-arc.gc.ca/formspubs/menu-e.html.

You describe a situation where an individual was employed in the United Kingdom and, as part of that employment, participated in an employer's money purchase pension scheme. At a point in time, several years ago, the employee resigned from the employment. He later emigrated to, and become a resident of, Canada. At the time of his termination, the full amount of the funds held in his pension account was retained in the pension scheme to be used, in accordance with the terms of the plan, to provide a pension to the employee at his normal retirement age. The amount was not transferred to another employer's plan or out to a personal pension arrangement.

The individual has now been advised that the pension plan will be wound-up and that distributions will be made to the members in accordance with paragraph 14.5 of IR12, through the provision of individual buy-out contracts with insurers. In essence, the cash equivalent of each employees' balance in the plan will be used to purchase a specific deferred annuity contract for each employee.

In the U.K., as long as an individual buy-out contract continues to meet the requirements laid out in the provisions of IR12, income earned in the contract is not subject to U.K. tax on a current basis. Rather the payments out of the contract are subject to taxation in the normal way, at normal retirement age.

Our Comments

In our view, the receipt of the individual buy-out contract will result in the receipt of an amount out of the pension plan, equal to the fair market value of the buy-out contract, and this amount must be included in the recipient's income at the time of its receipt, in accordance with subparagraph 56(1)(a)(i) of the Income Tax Act (the "Act"). In our view, paragraph 254(a) of the Act cannot apply to the acquisition of the individual buy-out contract as it was not acquired prior to July 31, 1997. Furthermore, the provisions of section 147.4 of the Act cannot apply as the pension is not a registered pension plan and the contract will not be acquired to replace a contract to which paragraph 254(a) applies.

It is also our view that an individual buy-out contract held by a Canadian resident will be subject to the annual accrual rules set out in subsection 12.2(1) of the Act as the contract will not be a prescribed annuity contract as described in subsection 304(1) of the Income Tax Regulations. However, as it will be subject to subsection 12.2(1) of the Act, it will not be subject to the provisions of either paragraph 56(1)(d) or 60(a) of the Act.

With respect to the application of the Canada-U.K. Income Tax Convention, in our view, neither paragraph 1 nor 2 of Article 17 of the Convention will preclude the taxation by Canada of the pension receipt or the annuity in the manner described above. We also note that the treaty does not preclude the taxation by the U.K. of non-periodic pension payments or annuity payments made to residents of Canada. Furthermore, it is of note that if the U.K. does tax the payments, it may not be possible to obtain the full benefit of the Canadian tax credits that might be available in respect of those taxes due to the mismatch in the timing of the taxation by each country.

As discussed during our telephone conversation of December 8, 2004 (XXXXXXXXXX/Harding), we agree that, in the circumstances described, paragraph 60(j) of the Act would apply to allow a deduction in computing a taxpayer's income for a year, if a lump sum amount were to be paid out of the U.K. pension, included in the taxpayer's income for the year, and contributed to an RRSP under which the taxpayer was the annuitant.

We trust our comments will be of assistance to you.

Yours truly,

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

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