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Principal Issues: [TaxInterpretations translation]
1. On the anniversary date of an annuity contract, should the loss of value on an investment with a stock market return be taken into account in determining the accumulated fund?
2. When is income determined under subsection 12.2(1) to be included in the adjusted cost base?
2. In the taxation year following the year in which an amount is included in income under subsection 12.2(1).
1. Impossible to determine without the contract.
2. Legislative analysis.
L. J. Roy, CGA
September 19, 2006
Subject: Annuity contract
This is in response to your letter of December 5, 2005, to our Tax Services Office in XXXXXXXXXX, which asked us to respond to you directly.
You have described a situation of an individual who acquired a deferred annuity contract on August 25, 2005, for $75,000. An amount of $50,000 was invested in a certificate of deposit bearing interest at 3.5% and maturing on September 30, 2007. The remaining $25,000 was invested in a stock market return investment maturing on September 30, 2007, and redeemable prior to maturity. On August 25, 2006, the stock market investment was redeemed for $24,144 and a cheque for the same amount was issued to the individual.
In this situation, you asked whether on the anniversary day of the annuity contract, i.e., August 24, 2006, the loss in value on the stock market return investment should be considered in determining the accumulating fund. In addition, you wish to know when the income determined under subsection 12.2(1) is to be included in the adjusted cost basis.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act.
The situation you have indicated in your submission appears to relate to an actual situation involving a specific taxpayer. As stated in Information Circular 70-6R5, the determination of whether a completed transaction has received appropriate tax treatment is first made by our Tax Services Offices following a review of all the facts and documentation, which is generally done as part of an audit engagement. However, we can offer the following general comments that may be helpful to you. These comments may, however, under certain circumstances, not apply to your particular situation.
The determination of the tax consequences for the holder in the above situation can only be made after a review of all the facts and terms of the annuity contract.
Subsection 12.2(1) provides that a taxpayer who in a taxation year holds an interest in an annuity contract, acquired after 1989, other than a prescribed annuity contract, on any anniversary day of the policy must include in computing income for the taxation year the amount by which the accumulating fund on that day in respect of the interest in the policy exceeds the adjusted cost basis to the taxpayer of the interest in the policy on that day.
In calculating the accumulating fund of an interest in an annuity contract issued by a life insurer, reference should be made to paragraph 307(1)(b) of the Income Tax Regulations (the "Regulations"). Under that paragraph, the accumulating fund at any particular time is the greatest amount that could be determined at the particular time in respect of the policy by the life insurer pursuant to paragraph 1401(1)(c) of the Regulations multiplied by the taxpayer's proportionate interest in the policy. For that purpose, it is assumed, inter alia, that the life insurer's taxation year ended on the particular day. The amount determined under paragraph 1401(1)(c) of the Regulations is generally the greater of
- the cash surrender value of the policy at the end of the year less the aggregate of all amounts payable in respect of a policy loan outstanding at the end of the year in respect of the policy;
- the amount by which the present value at the end of the year of the future benefits provided by the policy exceeds the present value at the end of the year of any future modified net premiums in respect of the policy and outstanding policy loans at the end of the year in respect of the policy.
For this purpose, the terms "benefit", "modified net premium" and "cash surrender value" are defined in subsection 1408(1) of the Regulations.
In the situation you have described, for the purposes of subsection 12.2(1), the accumulated fund should be calculated as of August 24, 2006. However, the question of whether the loss in value on the stock market return investment should be considered in determining the accumulated fund as of August 24, 2006, cannot be determined without examining the contract.
A policyholder of a life insurance policy who disposes of an interest in the policy is required, inter alia, to include in computing income under subsection 148(1) and paragraph 56(1)(j) the amount by which the proceeds of disposition of the policyholder's interest in the policy that the policyholder is entitled to receive in the year exceeds the adjusted cost basis to the policyholder of that interest immediately before the disposition.
Subsection 148(4) provides a special rule for computing the holder's income from the disposition of a part of a policyholder’s interest in an annuity contract. By virtue of that subsection, the adjusted cost basis attributable to the portion of the interest is equal to the proportion of the adjusted cost basis of the policyholder's entire interest in the contract immediately before the disposition determined by the ratio of the proceeds of the disposition to the accumulating fund of the entire interest immediately before the disposition.
Subsection 148(4) does not apply to a partial disposition arising from the declaration of an amount received as a policy dividend or a policy loan made under the policy.
Subsection 148(9) defines the "adjusted cost basis" to a policyholder at a particular of the policyholder’s interest in a life insurance policy. The description of D in the definition provides, inter alia, for the addition of the total of all amounts each of which is an amount in respect of the policyholder’s interest in the policy that was, pursuant to section 12.2, included in computing the policyholder’s income for any taxation year ending before that time.
In a situation where there is a disposition of an interest in a policy immediately after the anniversary day of the same taxation year, we are of the view that the adjusted cost basis immediately before the time of disposition would not include the amount included in income pursuant to subsection 12.2(1) for the year.
These opinions are not advance decisions and, as stated in paragraph 22 of Information Circular 70-6R5 of 17 May 2002, are not binding.
Financial Sector and Exempt Entities Section
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
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