29 September 2009 External T.I. 2008-0286071E5 - Non-registered annuity

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 to the employee when the employer purchases a non-registered annuity in the year of the employee's retirement to top-up the employee's pension?

Position: Only general comments provided.

Reasons: The tax consequences will depend on the nature of the arrangement. Generally, where an employer arranges the funding of the top-up by purchasing an annuity contract in the name of the employee and provided that the purchase of the annuity represents the payment of a pension benefit, the fair market value of the annuity would be included in the employee's income under subparagraph 56(1)(a)(i). Depending on the terms and conditions of the annuity contract, the annuity payments received by the employee are to be included in the employee's income either under section 12.2 or paragraph 56(1)(d). Where the employer acquires an interest in the annuity contract, the arrangement will likely be an RCA. The employee is to include payments out of the RCA in income in the year received pursuant to paragraph 56(1)(x) and the lump sum used by the employer to acquire the interest in the annuity contract would not be taxed in the hands of the employee.

XXXXXXXXXX  						2008-028607
S. Bernards
September 29, 2009					

Dear XXXXXXXXXX :

Re: Non-registered annuity

This is in response to your letter of July 11, 2008 requesting our views concerning a situation where an employer moved from a defined benefit pension plan to a defined contribution pension plan. At that time, a select group of employees were identified as having a potential loss of pension income as a result of the change from a defined benefit pension plan to a defined contribution pension plan. The employer agreed to provide these members with additional funds should the combined pension from the two plans be less than what the members would have received under the defined benefit pension plan if the members had only been members of the defined benefit pension plan from enrolment to retirement. You have requested our views on the tax implications to these employees should the employer make a lump-sum payment to acquire a non-registered annuity at the time of retirement to top-up the combined pension to the employees.

The situation outlined in your letter appears to relate to a factual one involving a specific taxpayer. 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. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the Internet at http://www.cra-arc.gc.ca. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.

Our Comments

The tax implications to the employees will vary depending on which provisions of the Income Tax Act (the "Act") apply to the situation described. In order to determine which provisions are applicable, a number of facts must be established.

You advise that where there is a shortfall, the employer will acquire an annuity to top up the pension the employee will receive under the pension plans. It is not clear from the limited information provided whether the employer or employee will own the annuity.

While an employee may be the annuitant of an annuity, the employee, the employer or the custodian/trustee of the arrangement may be the legal owner of the annuity itself.

Employee owned annuity

Generally, where an employer promises to pay an amount in the future, the employee would not be taxed on that amount until received. On the other hand, where an employer arranges the funding of the payments through an annuity contract purchased in the name of the employee, the employee would be subject to taxation in the year it is purchased by the employer. If the purchase of the annuity contract represents the payment of a pension benefit, the fair market value ("FMV") of the annuity contract would be included in the employee's income at the time of purchase under subparagraph 56(1)(a)(i) of the Act. It is a question of fact what the FMV of the annuity contract is. The amount will be subject to taxation at the tax rates applicable to the employee at that time.

With regard to the annuity payments, such payments will be included in income under either section 12.2 or paragraph 56(1)(d) of the Act. Generally, section 12.2 of the Act applies to an interest in a life insurance policy, last acquired after 1989, other than an interest in a policy that is an exempt policy or a prescribed annuity contract ("PAC"). Under subsections 248(1) and 138(12) of the Act, a life insurance policy is defined to include an annuity contract. The definitions of exempt policy and PAC are found in sections 306 and 304 of the Income Tax Regulations (the "Regulations"), respectively. To determine whether a particular annuity contract is or is not a PAC, one has to review the terms and conditions of the contract to see if the contact meets the requirements specified in section 304 of the Regulations.

Where subsection 12.2(1) of the Act is applicable, the income inclusion for a particular taxation year under the life insurance policy is generally based on the excess of the policy's "accumulating fund" (as defined in section 307 of the Regulations) each year over its "adjusted cost basis" (as defined in subsection 148(9) of the Act). The accumulating fund is essentially a measure of the accumulating investment growth or build-up over time. The adjusted cost basis is essentially the cost of the policy adjusted for certain items such as premiums paid under the policy and any amount of income previously included in computing the policyholder's income. As discussed in Interpretation Bulletin IT-87R2, Policyholders' Income from Life Insurance Policies, the determination of the accumulating fund and the adjusted cost basis of a policy generally requires information that is available only in the accounts of the issuer of the policy.

If an annuity contract qualifies as a PAC, annuity payments received by the taxpayer from or out of the PAC would be included in computing the income of the taxpayer under paragraph 56(1)(d) of the Act. A deduction for the capital element of the annuity payment would be allowed under paragraph 60(a) of the Act. The capital element is that portion of the payment determined in section 300 of the Regulations to have been a return of capital.

Employer acquired interest in an annuity contract

If an employer has acquired an interest in an annuity contract as a means of funding an unregistered arrangement to provide supplementary retirement benefits, the arrangement will likely be a retirement compensation arrangement ("RCA").

An RCA is defined in subsection 248(1) of the Act as generally being an arrangement under which payments are made by an employer of a taxpayer to a custodian in connection with benefits that are to be received by a person on, after or in contemplation of any substantial change in the services rendered by the taxpayer, the retirement of the taxpayer, or the loss of an office or employment of the taxpayer, subject to certain listed exclusions. An insurance policy is specifically excluded from the definition of an RCA. However, where an employer has acquired an interest in a life insurance policy as a means of funding a plan or arrangement to provide retirement benefits, subsection 207.6(2) of the Act generally deems the employer to be the custodian of an RCA and the interest in the policy to be subject property of the RCA.

An employer may only deduct amounts paid in the year as a contribution to an RCA where the amounts are reasonable and the contribution must be made in respect of services rendered by an employee or former employee. Any contributions to an RCA are subject to a special 50% refundable tax pursuant to Part XI.3 of the Act. Where a contribution is made to an RCA for the purposes of paying a life insurance policy premium, the employer will need to contribute an amount equal to twice the policy premium to enable the custodian to withhold and remit the tax and to pay the policy premium.

Pursuant to subparagraph 6(1)(a)(ii) of the Act, an employer's contributions to an RCA are excluded from taxation as employment benefits, but any amounts received by an employee out of an RCA must be included in the employee's income in the year of receipt pursuant to paragraph 56(1)(x) of the Act. The amount included in the employee's income will be subject to taxation at the tax rates applicable to the employee at that time.

Detailed explanations concerning the tax treatment of an RCA can be found in T4041, Retirement Compensation Arrangement Guide, including any withholding, remitting and reporting requirements. The Guide also discusses life insurance policies, including annuities, qualifying as RCAs.

We hope our comments will be of assistance.

Yours truly,

Jenie Leigh
For Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch