27 June 1994 Internal T.I. 9407976 - DEFERRED AND PRESCRIBED ANNUITY CONTRACTS

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

DOCUMENT TYPE:

Head Office Memo - 940797

Principal Issues:

1. Whether or not the conversion of a deferred annuity contract ("DAC") into a prescribed annuity contract ("PAC") defined in section 304 of the Income Tax Regulations constitutes a disposition of the DAC.

2. XXXXXXXXXX

Position TAKEN:

1.Generally such a conversion would not trigger a disposition of the DAC. However, the final determination is to be made by Audit.

2. XXXXXXXXXX

Reasons FOR POSITION TAKEN:

1.This is a question of fact and has been referred back to Audit.

2. XXXXXXXXXX

	Head Office	Head Office
	Audit Technical Support	Rulings Directorate
	Industry Specialist Services	Michèle Trotier
(613) 957-8953
      Attention:  Blair Chisholm
		940797

Conversion of deferred annuity contracts ("DAC")
into prescribed annuity contracts ("PAC")

This is in reply to your memorandum dated March 28, 1994 and the memorandum dated March 11, 1994 from Stan Trevor of the Scarborough District Office wherein he requested our comments in respect of the tax implications relating to the annuitization of a DAC including the conversion of a DAC into a PAC as defined in section 304 of the Income Tax Regulations ("Regulations") and
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Unless as otherwise stated all references to statute are to the Income Tax Act S.C. 1970-71-72, c.63 as amended consolidated to June 10, 1993 (the "Act").

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we will provide you with our general comments dealing with the income tax implications of the annuitization of DAC including the conversion of DAC into PAC.

The Act deals specifically with the annuitization of a life insurance policy (other than an annuity contract) in certain circumstances but not specifically with respect to the annuitization of an annuity contract.

Subsection 148(6) of the Act deals with a life insurance policy (other than an annuity contract) last acquired before December 2, 1982 where the policyholder becomes entitled to receive all of the proceeds under the policy in the form of an annuity contract or annuity payments. It deems the annuity contract or annuity payments not to be proceeds of disposition of an interest in the policy. This provision certainly infers that there could otherwise have been a disposition of such a life insurance policy. The conversion of a life insurance policy (other than an annuity contract) acquired after December 1, 1982 into an annuity contract or annuity payments could therefore trigger a disposition of such a policy but the Act does not deal specifically with this issue.

Subparagraph 148(9)(c)(viii) of the Act provides only that an annuity payment is not a disposition of a policy. It previously only dealt with annuity payments from life annuity contracts. It now applies to any annuity payments including those from term-certain annuities. Annuity payments are subject to tax as they are received pursuant to paragraph 56(1)(d) and to the application of paragraph 60(a) of the Act.

Subparagraph 148(9)(c)(x) of the Act provides that where an individual becomes entitled to receive all of the proceeds under a life insurance policy (other than an annuity contract), which is an exempt policy as defined in section 306 of the Regulations, in the form of an annuity contract or annuity payments and the individual is totally and permanently disabled any transaction or event by which the individual became entitled to the proceeds would not be considered to be a disposition of the policy. This provision again infers that where the individual is not totally and permanently disabled there could be a disposition of the policy.

Paragraph 148(10)(d) of the Act deems, except as otherwise provided, a disposition not to have occurred with respect to "an interest in a life insurance policy (other than an annuity contract) as a result only of the exercise of any provision (other than a conversion into an annuity contract)". Consequently, this provision does not prevent the annuitization of a life insurance policy (other than annuity contract) to be treated as a disposition of the life insurance policy. On the other hand, the legislator has specifically excluded an annuity contract from the application of this provision and that of subparagraph 148(9)(c)(x) described above thereby leading us to believe that the legislator considered the annuitization of an annuity contract would generally not result in the disposition of an annuity contract. An annuity contract is by its nature a contract which usually provides for the cash surrender value of the contract to be paid out in the form of annuity payments.

While as a practical matter this may be wrong it has been our understanding that the terms and conditions of a DAC would generally provide for its annuitization without any new annuity contract being issued and the DAC would therefore continue in existence as long as the annuity payments are to be made. Consequently, there should not be a disposition of the DAC at the time the annuity payments commence. This seems to have been what Allan Macnaughton was referring to on page 935 of his 1983 article entitled New Income Tax Rules for Holders of Life Insurance Policies and Annuities in Volume 31 No 6 of the Canadian Tax Journal where he indicated that "if a deferred annuity becomes a PAC when the payments start, the income accrued since the last third anniversary will be taxed over the pay out period because the commencement of payments under an annuity does not constitute a disposition."

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Where the terms of the PAC are consistent with those provided for in the DAC we would not have thought that a disposition of the DAC would occur at the time of its conversion into a PAC if the issuance of a separate annuity contract was simply a matter of renumbering the DAC.

Where the insurer transfers the funds from a DAC to a new and separate annuity contract it then becomes a question of fact as to whether or not there has been a disposition of the original DAC.

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It was suggested that it is possible that a PAC may contain assumptions including interest rates different from those in respect of the original DAC and that this may perhaps be sufficient to cause a disposition of the DAC when it is converted into a PAC since the modifications to the DAC may be so fundamental in nature to cause a disposition of the DAC. If this is the case we would be inclined to agree that a disposition would occur. On the other hand if the issuance of a separate annuity contract was simply a matter of renumbering the DAC then it should not trigger a disposition of the original contract. Similarly, as noted above, even if the PAC is evidenced by a separate contract if the DAC contained provisions setting out what the assumptions would be during both the accumulation and the pay out periods and the PAC was consistent with such assumptions the conversion of the DAC to a PAC arguably should not result in a disposition of the DAC.

In summary, the annuitization of a DAC including its conversion into a PAC which is made pursuant to the terms and conditions of the DAC should not result in a disposition of the DAC. Nevertheless, it is possible that the annuitization of a DAC may result in the disposition of the DAC as indicated above. This is question of fact which can only be determined by reviewing each particular case.

We trust that the above information will be of some assistance.

Section Chief
Financial Institutions
Financial Industries Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch