12 March 1998 External T.I. 9733755 - US TAX 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.

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:

Does section 12.2 apply where an individual owns a deferred annuity contract issued by a U.S. insurance corporation?

Position:

Yes

Reasons:

Section 12.2 clearly applies although there may be relief under the Canada-U.S. Tax Convention should paragraph 7 of Article XVIII be applicable.

XXXXXXXXXX 973375

March 12, 1998

Dear XXXXXXXXXX:

Re: US Tax Deferred Annuities

This is in reply to your letter of December 15, 1997. You are inquiring about the income tax implications under the Canadian Income Tax Act (the "Act") where an individual owns a deferred annuity contract that was issued by a foreign insurance corporation in the following situation.

In your letter you state that you are a Canadian resident individual, who also happens to be a citizen of the United States of America ("US"), and that you plan to invest in a flexible annuity product issued by a US corporation (the "US Tax Deferred Plan"). You indicate that a taxpayer is not subject to income taxes in the US on the income accumulating in the US Tax Deferred Plan until such time when withdrawals are made from the US Tax Deferred Plan. You also indicate that withdrawals from the US Tax Deferred Plan cannot begin prior to time the individual reaches age 59 1/2. In addition you indicate that you file both Canadian and US income tax returns annually.

Your question is whether the taxation of the annual accumulating income earned under the US Tax Deferred Plan can be deferred in Canada until such time as these amounts are subject to taxation in the US.

General Comments

Where a taxpayer holds an interest in a life insurance policy , other than a life insurance policy described in paragraphs 12.2(1)(a), (b) or (c) of the Act, the taxpayer will be required to accrue income on such a policy on an annual basis. The term "life insurance policy" is defined in subsections 248(1) and 138(12) of the Act to include an annuity contract. While the term "interest in a life insurance policy" is not defined in the Act it generally refers to an ownership interest. Where subsection 12.2(1) of the Act applies, the amount of the accrual is based on the excess of the policy's "accumulating fund", as defined in section 307 of the Regulations to the Act, over its "adjusted cost basis", as defined in subsection 148(9) of the Act.

Where an individual who is resident in Canada owns an interest in an annuity issued by a foreign entity, as mentioned above, it remains a question of fact as to whether such a contract is considered to represent a foreign pension, employee benefit or some other type of retirement arrangement under the Act and whether the individual can be considered as the owner of the particular annuity (see brief discussion below). Pursuant to paragraph 4 of Article XVIII of the Convention, "annuity" is defined in to mean, "...a stated sum paid periodically at stated times during life or during a specified number of years, under an obligation to make the payments in return for adequate and full consideration (other than services rendered), but does not include a payment that is not a periodic payment or any annuity the cost of which was deductible for the purposes of the taxation in the Contracting State in which it was acquired." The term "pensions" is also defined in paragraph 3 of Article XVIII of the Convention to include any payment under a superannuation, pension or other retirement arrangement, Armed Forces retirement pay, war veterans pensions and allowances and amounts paid under a sickness, accident or disability plan, but does not include payments under an income-averaging annuity contract or any benefit referred to in paragraph 5."

Therefore, while it remains a question of fact as to whether a particular deferred annuity would be considered to be an annuity or a pension for the purpose of the Convention, the Convention does not automatically supersede the application of section 12.2 of the Act to a deferred annuity. We refer you to Interpretation Bulletin IT-87R2, Policyholder's Income From Life Insurance Policies dated February 15, 1996 if you require a more complete explanation of the accrual rules under section 12.2 of the Act. A copy of which is enclosed for your information.

Paragraph 7 of Article XVIII of the Convention may apply in certain situations to provide relief where one country requires current recognition of income for tax purposes but the other country defers taxation until such income is received. For this paragraph of the Convention to apply the individual must be "...a citizen or resident of a Contracting State and a beneficiary of a trust, company, organization or other arrangement that is a resident of the other Contracting State, generally exempt from income taxation in that other State and operated exclusively to provide pension, retirement or employee benefits...". This rule provides a mechanism whereby an individual, assuming the above criteria are met, may be allowed to elect to defer taxation under rules established by the competent authority of that State with respect to income accrued but not distributed under that plan or any plan substituted for such a plan. This rule was primarily intended to apply to Canadian resident beneficiaries of IRAs and US resident beneficiaries of RRSPs for example.

The foregoing comments are intended as a general discussion only which may or may not be relevant to the fact situation described in your letter. While we hope 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.

We are returning the brochure which you kindly forwarded to us for our review.

Yours truly,

F. Lee Workman
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch