11 August 2010 External T.I. 2010-0375511E5 - Taxation of annuity received from Switzerland

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.

Principal Issues: 1) Is a guaranteed annuity of $XXXXXXXXXX received in respect of an annuity contract purchased from a life insurance company in Switzerland taxable as income to the Canadian resident or is it a return of capital? 2) Is the bonus annuity, representing interest earned, considered pension income or investment income earned in Canada?

Position: 1) The tax treatment of the payments received from an annuity contract depends on the type of contract, which cannot be determined based on the information provided. Generally, annuity payments representing a return of capital are not taxed. 2) Investment income earned on the principal from the annuity contract is generally considered income from property. Whether it is also be considered as "eligible pension income", for the pension credit provided for in subsection 118(3) of the Act or the ability to split eligible pension income with the individual's spouse or common-law partner under section 60.03, is a question of fact.

Reasons: Interpretation of the relevant provisions of the Act.

XXXXXXXXXX 							2010-037551
								T. Posadovsky, CMA
							 	(613) 952-8283
August 11, 2010

Dear XXXXXXXXXX :

Re: Taxation of Annuity Payments Received from Switzerland

We are writing in response to your email of July 20, 2010, in which you requested our comments concerning the income tax consequences to a Canadian resident taxpayer who receives quarterly payments from an annuity contract purchased from a life insurance company located in Switzerland.

According to your email, your client paid a premium of $XXXXXXXXXX up front in return for a guaranteed annuity of $XXXXXXXXXX per annum, paid up to the date of the individual's death. In addition to the guaranteed annuity, which you indicated is a return of the individual's premium, there is a bonus annuity paid annually representing investment income earned. The amount of the bonus annuity is variable each year depending on investment performance. All annuity payments are subject to a 15 per cent withholding tax.

Specifically, you wish to know: (1) is the guaranteed annuity of $XXXXXXXXXX taxable as income to the Canadian resident or is considered a return of capital? (2) Is the bonus annuity considered investment income or pension income?

Written confirmation of the tax implications inherent in a particular transaction is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Our Directorate also provides non-binding technical interpretations at no charge with respect to hypothetical scenarios. As the circumstances outlined in your letter relate to a specific situation involving a particular taxpayer, your inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to offer the following general comments, which may be of assistance.

Our Comments

Article 18 of the Canada-Switzerland Income Tax Convention, signed on May 5, 1997, addresses the taxation of pensions and annuities arising from a source located in Switzerland. In the case of periodic annuity payments (except lump-sum payments arising on the surrender, cancellation, redemption, sale or other alienation of an annuity, and payments of any kind under an annuity contract the cost of which was deductible, in whole or in part, in computing the income of any person who acquired the contract), the withholding tax imposed by the Swiss tax authority is 15 per cent of the gross amount of the payment(s).

For Canadian income tax purposes, annuity income is generally included in a Canadian resident's income under either section 12.2 or paragraph 56(1)(d) of the Act, depending on the type and structure of the annuity contract. Under subsections 248(1) and 138(12) of the Income Tax Act (the "Act"), a "life insurance policy" is defined to include an "annuity contract". Therefore, any reference to a life insurance policy should be taken to include an annuity contract unless otherwise indicated.

Section 12.2 applies to an interest in a life insurance policy, last acquired after 1989, other than: (a) an interest in a policy that is an exempt policy, or (b) a prescribed annuity contract ("PAC"). Pursuant to section 306 of the Income Tax Regulations ("ITR"), an exempt policy does not include an annuity contract, so this exception does not apply to your situation. There is a third exception in paragraph 12.2(1)(c), but this applies only to contracts acquired before December 2, 1982.

Subsection 12.2(1) of the Act requires that the amount by which the "accumulating fund", as defined in section 307 of the ITR, exceeds the "adjusted cost basis", as defined in subsection 148(9) of the Act, of each interest in a life insurance policy is to be included in computing a taxpayer's income annually on the "anniversary day", as defined by subsection 12.2(11) of the Act, of the contract. In other words, any increase in the value of the policy holder's contract, accrued up until the anniversary day of the policy, must be included in computing a taxpayer's income in the taxation year in which the anniversary occurs.

The treatment of a PAC, as defined in section 304 of the ITR, is quite different from that of annuity contracts which are not PACs. If the contract at issue is in fact a PAC, subsection 12.2(1) would not apply and all payments received by the taxpayer from or out of the PAC would be included into income under paragraph 56(1)(d) of the Act.

However, a deduction for the capital element of the payments would be allowed under paragraph 60(a) of the Act. The capital element means that part of the payment determined in section 300 of the ITR to have been a return of capital. In other words, the income is taxed on a receipt basis not on the accrual basis, even though the ultimate tax result is more or less the same as that if the annuity contract was not a PAC.

In answer to your first question, whether or not an annuity contract is subject to section 12.2 or excluded under one of the exceptions is a question of fact that must be determined taking into account the terms of the contract and any relevant circumstances. Likewise, to determine whether a particular annuity contract is a PAC and subject to paragraph 56(1)(d), or is not a PAC, one has to review the terms and conditions of the contract to see if they meet the requirements in section 304 of the ITR. We are not in a position to determine whether the annuity contract is, or is not, a PAC; however, under both situations, an individual is generally not taxed on the return of capital from an annuity contract. For additional information on this topic, please refer to Interpretation Bulletin IT-87R2, Policyholders - Income from Life Insurance Policies, available on our website at www.cra-arc.gc.ca.

Further, your client may qualify for a foreign tax credit ("FTC") in respect of the 15 per cent withholding tax on the gross payments from the annuity. This credit is a deduction from Canadian income tax otherwise payable claimed in respect of income or profits tax paid to a foreign country. However, it is a question of fact whether your client would qualify for a FTC in his particular circumstances. For more information, please refer to IT-270R3, Foreign Tax Credit, available on our website.

Your second question concerns whether the bonus payments, which you characterized as interest earned on the invested capital in the annuity contract, is considered pension or investment income. The characterization of income from an annuity is a question of fact; however, if you are asking this question in relation to the pension credit provided for in subsection 118(3) of the Act, or the ability to split eligible pension income with the individual's spouse or common-law partner under section 60.03, then the payments must meet the definition of "eligible pension income" in subsection 118(7) of the Act. Eligible pension income is defined as either "pension income" received in a taxation year by an individual who is 65 years of age or older, or "qualified pension income" received in a taxation year where an individual is under 65 years of age.

Accordingly, if your client is 65 years of age or more in the taxation year, and the annuity payments are included into income under section 12.2 or paragraph 56(1)(d) of the Act, such income would be considered "pension income" under either paragraph (b) or subparagraph (iv) of the definition, respectively, and would therefore meet the definition of "eligible pension income" for the purposes of subsection 118(3) or section 60.03 of the Act. If your client is not yet 65 years of age in the taxation year, then the annuity income in your situation does not meet the definition of "qualified pension income" and therefore it is not "eligible pension income" for the purposes of subsection 118(3) or section 60.03 of the Act. This is because the annuity payments were not received as a consequence of the death of a spouse or common law partner, or in respect of a superannuation or pension plan.

The taxation and characterization of foreign-based annuity payments are complex issues and the terms and conditions of a particular annuity contract must be examined in detail before a determination can be made with respect to the tax treatment of any payments received. For this reason, we would advise you or your client to discuss this matter with a Canadian tax advisor specializing in the taxation of foreign annuities or life insurance products if you require more specific advice or information relating to your client's particular fact situation.

We hope that our comments will be of assistance.

Yours truly,

Randy Hewlett
Manager
for Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch