6 March 1991 Ministerial Correspondence 903374 F - Deferred Annuity Plan

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.

903374

Subject: Your File Number: HDB-8199-6 Deferred Annuity Plan

We are writing in response to your memorandum of November 27, 1990 concerning the treatment for tax purposes of withdrawals from deferred annuity plans by a resident of the United States of America.  It is our understanding that the original request was initiated by the taxpayer through the Kitchener District Office and subsequently forwarded to your division for comments.

We are unable to comment directly on the tax consequences which would result from any of the alternative courses of action indicated by the taxpayer as we are not in possession of sufficient facts to render a determinative opinion.  Such an opinion would, generally, be provided only in the form of an advance income tax ruling in respect of a definite proposed transaction.

We would, however, offer the following general comments relative to the taxation of annuities in these types of situations, but would caution that these comments may or may not be applicable to any particular situation depending upon the facts of that situation.

Included with your memorandum were copies of two annuity contracts purchased by the taxpayer from two companies which each carry on an insurance business in Canada.  The purchaser of the annuities was a non-resident of Canada at the time the annuities were purchased and continues to be a non-resident as of the present time.  A review of the annuity contracts would appear to indicate that they are both "life annuity contracts" as that term is defined in section 301 of the Income Tax Regulations (the "Regulations") and that annuity payments have not, as yet, commenced.  We would further note that, pursuant to paragraph 138(12)(f) of the Income Tax Act (the "Act"), a "life insurance policy" includes an annuity, however, pursuant to paragraph 138(12)(g) of the Act, neither of the pertinent annuity contracts constitutes a "life insurance policy in Canada".

In a situation in which a non-resident person is the annuitant under an annuity contract, paragraph 212(1)(0) of the Act requires that person to pay tax on every amount paid or credited to him in respect of "a payment under an annuity contract... to the extent of the amount in respect of his interest in the contract that, if the non-resident person had been resident in Canada throughout the taxation year in which the payment was made, would be required to be included in computing his income for the year...".  Accordingly, it must be determined if, in circumstances similar to those presented, a person who was resident in Canada throughout the particular year would be required to include an amount in computing income for the year and, should the question be answered in the affirmative, that amount would be subject to the provisions of paragraph 212(1)(0) with respect to a non-resident person.

Subsection 148(1) of the Act requires a taxpayer to include in computing income for the year in respect of the disposition of an interest in a life insurance policy including an annuity, the amount by which the proceeds of disposition of that interest to which the policyholder, or annuitant, became entitled to receive in that year exceed the adjusted cost basis of that interest.  We would note that, pursuant to subparagraph 148(9)(c)(i) of the Act, a "disposition" of an interest in a life insurance policy includes a "surrender" of that interest.  Accordingly, a situation in which a taxpayer withdraws some or all of his funds from an annuity in a lump sum could be considered to be a surrender and, therefore, a disposition of all or a part of his interest in the annuity as the case may be.  In such a case, the proceeds of disposition are, generally, readily determinable and would be equal to the funds received from the insurer.  The adjusted cost basis, however, is somewhat more difficult to determine in the case of a life annuity because such contracts contain elements of life insurance and the cost base must be adjusted for, inter alia, mortality gains and losses pursuant to subparagraphs 148(9)(a)(v.1) and (xi) of the Act respectively.  Because these amounts are functions of assumptions made by the insurer at the time the contract was originally purchased, the adjusted cost basis is normally calculated by the insurer and reported to the policyholder with such calculations being subject to verification by the department.  Where there is a partial surrender of the interest in the annuity, i.e. where only some of the funds are withdrawn, subsection 148(4) of the Act is applicable to prorate the entire adjusted cost basis of the annuity to the portion of the funds withdrawn.  The result of this proration is that there would always be an income element where a portion of the funds are withdrawn from the annuity to the extent that the accumulating fund of the annuity exceeds the adjusted cost basis.  We would also note that, as an extension of this result, it is not possible to withdraw only the capital element of an annuity upon a partial surrender of the contract.

Where the policyholder is resident in Canada, the income amount as calculated above is included in the determination of his taxable income for the year pursuant to subsection 148(1) and paragraph 56(1)(j) of the Act.  Where the policyholder is not resident in Canada, paragraph 212(1)(0) is applicable to require the non-resident to pay a tax of 25% of the amount of the annuity income included in the payment, subject to any reduction in the rate of tax pursuant to an applicable tax convention.  In the case of a resident of the United States of America, the applicable convention is the Canada-United States Income Tax convention, 1980.

Article XVIII of that convention deals with Pensions and Annuities and paragraph 4 of the article defines an annuity for purposes of the convention as a "stated sum paid periodically at stated times during life or during a specified number of years.... but does not include a payment that is not a periodic payment".  Accordingly, a payment made pursuant to a surrender or partial surrender of an annuity is not within the ambit of Article XVIII as it is not a periodic payment.

Paragraph 1 of Article XXII of the convention, however, states that "items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State, except that if such income arises in the other Contracting State it may also be taxed in that other State."  It is our opinion that any income arising upon the surrender, or partial surrender as the case may be, of the annuity constitutes income of the non-resident person arising in Canada and, consequently, this article of the Convention allows Canada to tax the income.  The income would be taxed pursuant to paragraph 212(1)(0) of the Act and, as Article XXII of the Convention does not provide for a preferential rate of tax, the tax payable pursuant to paragraph 212(1)(0) would be 25% of the income amount.

Your memorandum further addresses four hypothetical situations proposed by the taxpayer in relation to his interest in the deferred ("life") annuity contracts.  Although we are prepared to provide general comments with respect to these situations, we would, again, note that such comments are not to be construed as a binding ruling as the situations are purely hypothetical.

The first three situations, being the exchange of the deferred annuity for a deferred annuity with another company, the withdrawal of a lump sum from an annuity prior to annuitization or the transfer of a deferred annuity to the children of the annuitant prior to annuitization, would all have the same result as noted above in that there would be a surrender, or partial surrender as the case may be, of the interest in the contract.  Accordingly, the income element attributable to the portion of the annuity surrendered would be recognized at that time and, to the extent that the holder of the interest is resident in the United States of America, would be subject to tax in Canada at the rate of 25% pursuant to paragraph 212(1)(0) of the Act.  We would again note that for Canadian income tax purposes it is not possible to withdraw only the capital element of an annuity.  Further, with respect to the third situation wherein the annuity would be transferred to the children of the policyholder, we would note that subsection 148(8) of the Act which provides for a "rollover" of an interest in a life insurance policy to children of a policyholder is not applicable to an annuity.  The fourth situation deals with the treatment of the annuity upon the death of the policyholder.  In general terms, the previously discussed rules apply insofar as the policyholder is deemed by paragraph 148(2)(b) of the Act to have disposed of his interest in the annuity contract immediately prior to his death.  Accordingly, it would be at that time at which any accrued income would be realized by the policyholder and, again the Part XIII tax provisions would be applicable.

There is, however, a slight modification to this provision with respect to an interest in a life annuity contract entered into after November 16, 1978 and before November 13, 1981.  Subsection 148(1.1) provides that the income amount will be included in the income of the beneficiary in such a case rather than in the income of the policyholder as noted previously.  A determination of the country of residence of the beneficiary would be required to determine any tax consequences in such circumstances.

We trust our comments are of assistance to you.

for DirectorFinancial Industries DivisionRulings Directorate