18 August 1989 Income Tax Severed Letter 5-7806 - Taxation of deferred annuities

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.

Dear Sirs:

This is in response to the questions raised in your letter dated March 28, 1989 and in our telephone conversation XXX Ahmed) of June 20, 1989 relating to the application of various provisions of the Income Tax Act (the "Act") to the situation described below.

• 1. An individual, Mr. X., became a holder of a deferred annuity which represents an interest in an annuity contract described in paragraph 12.2(3)(b) of the Act (a "pre-1982 annuity") at a time when he was a resident of Canada for purposes of the Act.
• 2. Before 1985, Mr. X ceased to be a resident of Canada while the 1982 annuity contract was still a deferred annuity, i.e. payments had not begun under the annuity contract. You are of the view that the accrual rules in sectoin 12.2 of the Act do not apply to Mr. X in respect of such annuity contract while he is not a resident of Canada.
• 3. Mr. X is considering becoming a resident of Canada.

You have raised the following questions:

• 1. What is the effect of Mr. X becoming a resident of Canada in respect of his interest in the annuity contract and, in particular, will the issuer of the annuity (the "Issuer") be suject to reporting requirements in respect thereof?
• 2. Will the annuity contract qualify as a prescribed annuity contrat, within the meaning of section 304 of the Income Tax Regulations (the "Regulations"), after such time as payments commence thereunder?
• 3. If payments under the annuity contract commence when Mr. X is not a resident of Canada for purposes of the Act, is the Issuer subject to reporting or withholding requirements under the Act in respect of such payments?

Opinions

As your questions appear to relate to an actual fact situation and proposed events, your request should hvae been the subject of an advance income tax ruling. The procedures and the requirements for requesting an advance income tax ruling are set uot in Information Circular 70-6R issued December 18, 1978. We are, however, able to offer the following general comments relevant to a situation similar to the one described above.

The opinions contained herein are based on the current provisions of the Act. They do not consider the proposed amendments to the Act contained in Bill C-28 which received first reading in the House of Commons of Canada on June 20, 1989. In addition, they do not consider the effect of any relevant income tax convention.

In general, a non-resident of Canada who holds an interest in an annuity contract is not subject to Part I tax nor to the accrual rules contained in section 12.2 of the Act nor would the non-resident be subject to withholding under Part XIII in respect of that accrued income. We note, however, that there may be situations where a non-resident holds an annuity contract as part of its business carried on in Canada, in which case it may be subject to Part I tax on the accrued income.

Upon Mr. X becoming a resident of Canada he would become subject to the rulescontained in section 12.2 of the Act and, in particular, subsection 12.2(3). We have assumed Mr. X would not elect to report income on an annual basis pursuant to subsection 12.2(4) of the Act.

In general terms, subsection 12.2(3) of the Act requires an individual who holds an interest in certain annuity contracts including pre-1982 annuities (the annuity contract in this case is assumed not to be one excluded from the accrual rules by paragraphs 12.2(3)(c) to (e) of the Act or by subsection 12.2(7) of the Act) to report as income on a triennial basis an amount which represents investment income which has accrued in respect of the annuity. Basically, for a deferred annuity, the amount which must be reported as income on each third anniversary, within the meaning of paragraph 12.2(11)(b) of the Act (referred to as a "reporting date"), is the excess of the accumulating fund, within the meaning of section 307 of the Regulations, over the aggregate of the adjusted cost base ("ACB") of the annuity, within the meaning of paragraph 148(9)(a) of the Act. Note that the amount of "unallocated income accrued before 1982" as determined under sectin 305 of the Regulations, has been given special "grandfathered" status, and is not taxed under this calcualtion.

A taxpayer's ACB of an interest in a pre-1982 annuity includes the cost of such interest and generally is increased by any amount included in the taxpayer's income by virtue of Part I of the Act, and by the portion of an amount paid to him which was subject to non-resident withholding tax by virtue of paragraph 212(1)(o) of the Act. In this case, the cost of Mr. X's interest in the pre-1982 annuity would not be increased upon his becoming a resident of Canada because the deemed acquisition rules in subsection 48(3) of the Act do not apply to interests in pre-1982 annuities and because none of the disposition rules contained in section 148 of the Act would apply. Also, Mr. X would not have reported income in respect of the annuity contract while he was a non-resident under section 12.2 or paragraphs 56(1)(d.1) of the Act since the accrual rules were not applicable thereto, nor would he have paid any withholding tax under paragraph 212(1)(o) of the Act since no annuity payments were;made to him. Therefore, at the time of the initial reporting date for Mr. X as a resident of Canada, the ACB of his interest in the pre-1982 annuity will not reflect the investment income which has notionally accrued thereon.

The accumulating fund on such reporting date in respect of the pre-1982 annuity will, however, reflect the investment income which has notionally accrued in respect of the pre-1982 annuity. Thus, the income inclusion required by subsection 12.2(3) of the Act will reflect the investment income which has notionally accrued on the pre-1982 annuity since January 1, 1982 including such notional amount relating to the time that Mr. X was a non-resident of Canada.

The initial reporting date for Mr. X's pre-1982 annuity would be December 31, 1990 assuming he becomes a resident of Canada in 1989 or 1990 The information filing obligation of the issuer of the policy for such reporting date and each subsequent reporting date is contained in subjection 201(5) of the Regulations.

The definition of "prescribed annuity contract" is contained in section 304 of the Regulations. Whether a particular annuity contract meets the requirements of this definition is a question of fact upon which we are unable to comment. However, the fact that a holder of an interet in an annuity contract was at one time a non-resident of Canada should not affect its qualification as a prescribed annuity contract.

By virtue of paragraph 212(1)(o) of the Act, a resident of Canada who makes a payment under an annuity contract to a non-resident is generally obliged to withhold 25% (subject to reduction by a tax treaty) of the amount that would, if the non-resident were a resident of Canada, be required to be included in computing his income and would not be deductible in such computation. The amount of such income inclusion would be determined by the application of one or more of paragraphs 56(1)(d), (d.1) of 60(a) depending on the partiuclar circumstances. One exception to the above is that no withholding tax is applicable if the annuity was issued in the course of carrying on a life insurance business in a country other than Canada.

The normal procedural provisions for withholding on payments to non-residents (see Part XIII of the Act) and the reporting requirements contained in subsection 202(2) of the Regulations, i.e. filing forms NR4-NR4A, would apply to payments made by a resident of Canada to a non-resident under a pre-1982 annuity.

The opinions herein are provided pursuant to the practice set out in paragraph 24 of Information Circular 70-6R.