19 June 1997 External T.I. 9705105 - U.S. ANNUITIES RECEIVED AS DAMAGES

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.

Principal Issues:

1.Where a taxpayer immigrating to Canada has a right to receive payments under an annuity, would paragraphs 128.1(1)(b) and (c) apply to deem the taxpayer to have disposed of and then reacquired that right at its fair market value immediately before immigration?

2.Whether payments received under two U.S. annuities as part of an out-of-court settlement are subject to tax in Canada.

3.Whether the accrual rules in section 12.2 will apply to a taxpayer who has a right to receive payments under an annuity but is not the owner of the annuity contract.

Position:

1.Generally, a right to receive income would constitute "property" as defined in subsection 248(1). Since paragraphs 128.1(b) and (c) apply to each property of a taxpayer who becomes resident in Canada (with exceptions), a right to receive payments under an annuity would appear to be subject to those provisions.

2.Question of fact. Only provided general comments.

3.Subsection 12.2(1) applies to a taxpayer who holds an interest in a life insurance policy. This is a factual determination. If subsection 12.2(1) is not applicable, paragraph 56(1)(d) may apply as it applies to any amount received by a taxpayer as an annuity payment subject to certain exceptions.

Reasons:

1.Wording of paragraphs 128.1(1)(b) and (c) and the definition of "property" in subsection 248(1).

2.Unable to comment on specific situation without all of the relevant documentation.

3.Factual determination.

XXXXXXXXXX                                    		5-970510

Attention: XXXXXXXXXX

June 19, 1997

Dear Sirs:

Re: Tax Treatment of Damages

This is in reply to your letter of February 20, 1997 concerning the Canadian income tax treatment of two United States (U.S.) annuities payable to an individual, A, who is considering immigrating to Canada. You advise that as part of an out-of-court settlement A's former employer agreed to make a cash payment and fund two annuities. The agreement specified that the first annuity was compensation for personal injuries and the second annuity was compensation for all other damages, including punitive, pre-judgment and post-judgment interest. You note that the owner of the two annuities is A's former employer and the owner has the right to designate the payee to whom benefits are payable under the annuity. However, absent a specific direction from the owner, all the payments under the two annuities will be made to A.

The situation you described in your letter appears to relate to an actual fact situation and we are unable to consider such situations in a general letter of opinion. To the extent that you require assistance in determining the tax treatment with regard to a completed transaction, you should contact the appropriate district tax services office and provide them with the full particulars of your client's situation (including copies of any relevant documentation). To the extent that you require confirmation of the tax consequences of proposed transactions, your request should be the subject of a request for an advance income tax ruling. However, we can provide you with the following general comments which may or may not be applicable to the situation described in your letter.

Deemed disposition/acquisition rules

Section 128.1 of the Income Tax Act (the "Act") provides rules that will apply where a taxpayer becomes resident in Canada. Pursuant to paragraph 128.1(1)(b) of the Act, such a taxpayer will generally be deemed to have disposed of each property owned by the taxpayer, other than certain types of property listed in subparagraphs 128.1(1)(b)(i) to (iv) of the Act, for proceeds equal to its fair market value at the time that is immediately before the time the taxpayer becomes resident in Canada. Paragraph 128.1(1)(c) of the Act then deems the taxpayer to have reacquired the property at a cost equal to the deemed proceeds.

The term "property" is defined in subsection 248(1) of the Act to include a right of any kind whatever. Given this broad definition, it would appear that a right to receive payments would constitute property for purposes of the Act. Since paragraph 128.1(1)(b) of the Act applies to each property owned by a taxpayer and paragraph 128.1(1)(c) of the Act applies to each property that is subject to paragraph 128.1(1)(b) of the Act, it is our view that a right to receive payments under an annuity would generally be subject to the deemed disposition/acquisition rules in paragraphs 128.1(1)(b) and (c) of the Act.

Tax treatment of damages

As indicated above, the Department is unable to address your specific concerns with regard to the taxability of any payments received under the two U.S. annuities without a complete understanding of A's situation, including a review of the relevant documentation. However, the comments contained in IT-365R2, Damages, Settlements and Similar Receipts, reflect the Department's general position on the tax treatment of amounts received out of claims for damages for personal injury.

Paragraph 2 of IT-365R2 indicates that all amounts received by a taxpayer that qualify as special or general damages for personal injury will be excluded from income. However, an amount which can reasonably be considered to be income from employment rather than an award of damages will not be excluded from income. We note that it is not necessary that an award of damages for personal injury be paid in a lump sum in order to be non-taxable. As indicated in paragraph 3 of IT-365R2, an award of damages for personal injury that decrees that it be paid in periodic payments is not considered to be an annuity contract and such periodic payments are not considered to be annuity payments for the purposes of the Act. Consistent with these comments, where an award of damages is payable in periodic payments to the taxpayer under a structured settlement as described in paragraph 5 of IT-365R2, the periodic payments will not be taxable. However, where a taxpayer becomes entitled to a lump sum in respect of a damages claim and the amount is used by the taxpayer to acquire an annuity contract, the resulting payments received by the taxpayer will be regarded as being annuity payments. These payments would be subject to the provisions of section 12.2 and paragraphs 56(1)(d) and 60(a) of the Act.

With regard to the taxability of an award for punitive damages, we would advise that such a determination can only be made having regard to the facts of the particular situation. If the award for punitive damages relates to personal injury, the award will generally be treated in the same manner as an award in respect of damages for personal injury.

Where an amount in respect of damages for personal injury includes or is augmented by pre-judgment interest, the Department's position as set out in paragraph 4 of IT-365R2 is that such interest is not income to the recipient. However, post-judgment interest is taxable and must be included in income.

Annuity

Your last query concerns the application of section 12.2 of the Act should the payments under the two U.S. annuities be subject to tax in Canada. Subsection 12.2(1) of the Act requires the amount of accrued income on certain life insurance policies including annuity contracts to be included in income on an annual basis. This subsection applies to a taxpayer who holds an interest in a life insurance policy. While the term "an interest in a life insurance policy" is not defined in the Act, it refers to an ownership interest. It is a question of fact whether or not a taxpayer has an ownership interest in an annuity contract.

In the situation described in your letter, A is not the owner of the two U.S. annuities. Nevertheless, it is still possible that A may have an ownership interest in an annuity contract to which subsection 12.2(1) of the Act is applicable. This would depend on whether the rights and obligations created under the agreement between A and A's former employer are such that the agreement itself constitutes an annuity contract. In general, where a taxpayer enters into a contract with another party and under that contract the taxpayer has a right to receive an annuity and the other party is obligated to provide an annuity to the taxpayer, the contract may well constitute an annuity contract notwithstanding that the annuity might be funded with an annuity contract issued by a third party. We note that the Federal Court of Appeal in Her Majesty The Queen v. Miriam Rumack, (1992) 1 C.T.C. 57, held that a lottery prize of $1,000 per month for life funded by an annuity purchased by a charity was taxable to the recipient as annuity payments under paragraph 56(1)(d) of the Act and that the capital element of such payments was deductible under paragraph 60(a) of the Act notwithstanding that the charity remained the owner of the annuity contract. The court's conclusions seem to suggest that it viewed the ticket as a contractual obligation undertaken by the charity to provide a stream of payments and that this contractual obligation constituted an annuity contract in which the recipient held an interest.

We note that depending on the nature of the obligation imposed on A's former employer under the settlement agreement, it is also possible that A may have an interest in a debt obligation. To the extent that A holds an interest in an "investment contract" as defined in subsection 12(11) of the Act, the provisions of subsection 12(4) of the Act may be applicable.

In circumstances where subsections 12.2(1) and 12(4) of the Act do not apply, paragraph 56(1)(d) of the Act may apply to require certain amounts received as annuity payments to be included in the income of a taxpayer for a taxation year. The definition of "annuity" in subsection 248(1) of the Act is very broad and includes periodic payments whether payable under a contract, will or trust or otherwise. Given this definition and the broad wording of paragraph 56(1)(d) of the Act, it is our view that annuity payments received by a taxpayer may be subject to tax under paragraph 56(1)(d) of the Act even if the taxpayer is not the owner of an annuity contract. However, the taxpayer will not be entitled to a deduction under paragraph 60(a) of the Act in such circumstances since there is no basis to allow this deduction if the taxpayer does not have an interest in an annuity contract.

Finally, we note that where a transaction concerns a payment arising in the U.S. and made to a resident of Canada, reference will have to be made to the provisions of the Canada-U.S. Income Tax Convention (1980) which generally override the provisions of the Act.

While we hope that our comments are of assistance to you, they do not constitute an advance income tax ruling and therefore are not binding on the Department in respect of a specific situation.

Yours truly,

Chief
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch