28 July 1995 External T.I. 9514955 - DEFERRED ANNUITIES ISSUED IN THE UNITED STATES

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:

Income tax implications in Canada with respect to a tax sheltered annuity contract issued in the United States.

Position TAKEN:

Reviewed accrual rules and taxation of annuity payments when received.

Reasons FOR POSITION TAKEN:

It is a question of fact which provisions may apply. Must consider actual contracts and also treaty implications.

                       		                	951495
XXXXXXXXXX		                                 Michèle Trotier

July 28, 1995

Dear XXXXXXXXXX:

Re: U.S. Tax Deferred Annuities

This is in reply to your letter of December 17, 1994 which has been transferred to our Directorate from Revenue Canada International Audits Division on June 1, 1995. The situation you described in your letter appears to relate to an actual situation and we cannot express opinions on specific transactions. However, we offer the following general comments.

You are enquiring about the income tax implications in Canada to a Canadian resident with respect to a tax sheltered annuity contract issued in the United States ("U.S.") under the provisions of subsection 403(b) of the Internal Revenue Code which is not annuitized. You have advised that the annuity was issued in either 1976 or 1983 and is described as a single premium deferred annuity or a flexible payment annuity under a tax deferred retirement plan. You also advised that it is not an individual retirement account.

All references to statute are to the Canadian Income Tax Act and, where specified, the regulations thereunder.

It is our understanding that tax sheltered annuities under subsection 403(b) of the Internal Revenue Code may act to provide pensions to the employees of certain organizations. We do not know whether or not the annuity you are referring to in your letter would be such an annuity nor do we know which entity or individual would be the owner of this annuity. We note that any payment from such an annuity which relates to pension income will be included in the taxpayer's income by virtue of paragraph 56(1)(a) and the portion thereof that represents a return of the taxpayer's

contributions to the tax sheltered annuity which relates to pension income will be exempt from income tax in Canada in accordance with paragraph 1 of Article XVIII of the Canada-United States Tax Convention ("Convention"). The offsetting deduction is provided under paragraph 110(1)(f). The particular annuity contract must be reviewed to determine the nature of the payments to be made from it.

Section 12.2 refers to a life insurance policy which pursuant to subsections 248(1) and 138(12) includes an annuity contract. Section 12.2 will apply to the taxpayer who holds an interest in the contract. This determination can only be made upon the review of the particular contract. Depending on when the annuity was last acquired, it will either be subject to annual or triennial accrual taxation upon the taxpayer becoming a Canadian resident. We note that Article XVIII of the Convention does not supersede section 12.2 with respect to an annuity contract except as described above.

The amount to be included in income pursuant to section 12.2 is generally the amount by which the "accumulating fund" (see section 307 of the Income Tax Regulations) at the relevant time exceeds the "adjusted cost basis" (see subsection 148(9) of the Act) at that time. The accumulating fund is essentially a measure of the accumulating investment growth or build-up over time. The adjusted cost basis is essentially the cost of the annuity contract and, among other things, is increased by any amount in respect of the annuity which has previously been included in the holder's income under Part I of the Act or taxed under Part XIII of the Act.

Where the annuity contract was last acquired after 1989, subsection 12.2(1) is relevant and requires annual accrual; otherwise subsection 12.2(3) applies and requires triennial accrual, subject to an election in subsection 12.2(4) to accrue annually. (Triennial accrual under subsection 12.2(3) can be affected where a premium that was not fixed before 1990 is paid after 1989. Pursuant to subsection 12.2(8), such a premium is deemed to have been paid to acquire a separate annuity contract at the time of payment, which thus being last acquired after 1989, would be subject to subsection 12.2(1),(ie. annual accrual).

The general application of both the annual and triennial accrual rules for annuity contracts in the case of immigration to Canada is discussed below.

Section 128.1 which is applicable for the 1993 and subsequent taxation years provides that there will be a deemed acquisition of a life insurance policy, which includes an annuity contract, upon immigration at a cost equal to its fair market value at that time. This is intended to provide that the accrued income accumulated prior to the holder immigrating to Canada will not be subject to tax in Canada. The comments that follow are on the basis that subsection 128.1 is applicable.

Contract Last Acquired After 1989 - Subsection 12.2(1)

Where subsection 12.2(1) is relevant, it requires an income inclusion in each year of the amount by which the accumulating fund on the "anniversary day" (defined in subsection 12.2(11)) occurring in the year exceeds the adjusted cost basis on that day. The first year in which this would apply in the case of immigration would be the year in which the first "anniversary day" occurs upon becoming a resident, based on the application of section 114 as discussed below. (This would likely be the year of immigration or the following year.)

Upon the first application of subsection 12.2(1), the accumulating fund would reflect the build-up to date, including the period while a non-resident, while the adjusted cost basis at that time would reflect the fair market value at the time of immigration. The annuitant would thus be subject to tax in respect of the build-up accumulated during the period while a resident upon the first application of subsection 12.2(1).

In the case of a taxpayer who immigrates to Canada in a particular year, paragraph 114(a) includes world income for the period while a resident. If the period of Canadian residence in the year of immigration includes the contract's anniversary day, subsection 12.2(1) will apply to require the income inclusion in the year of immigration. If the contract's anniversary day in the year of immigration was prior to the commencement of the period of Canadian residence, subsection 12.2(1) would not apply until an anniversary day first occurs while a resident (presumably the year following immigration).

Contract Last Acquired Before 1990 - Subsection 12.2(3)

Where subsection 12.2(3) applies in respect of an interest in an annuity contract last acquired prior to 1990 (but see NOTE 2 below), the required income inclusion occurs in the year of each "third anniversary" of the contract (see paragraph 12.2(11)(b) as it applies to contracts acquired before 1990). The amount to be so included is the excess of the accumulating fund on that date over the adjusted cost basis on that date (see NOTE 1 below). Thus, the build-up during the period while a non-resident (see NOTE 1 below) would not be taxed in Canada. (Note that if a third anniversary does occur in the year of immigration, it is, by definition, December 31 of such year and therefore will necessarily occur in the period of Canadian residence for purposes of paragraph 114(a)).

NOTE 1:In the case of a contract acquired before December 2, 1982, subsection 12.2(3) provides an adjustment to exclude from accrual taxation "unallocated income accrued in respect of the interest before 1982" as determined under section 305 of the Regulations. (This will be taxed in future years once annuity payments commence.)

NOTE 2:There is a complete exemption from accrual taxation under section 12.2 in the case of certain annuity contracts last acquired before December 2, 1982. Subsection 12.2(7) as it applies to contracts last acquired before 1990, sets out the conditions which must be met such as, among other things, the owner of the annuity contract not being able to require the repayment, acquisition, cancellation or conversion of his interest in the contract. (Annuity payments under such contracts are taxable on a receipt basis pursuant to paragraphs 56(1)(d) and 60(a))

Other Comments

Whether or not the annuity payments will be taxed in Canada when received pursuant to paragraph 56(1)(a) or (d) of the Income Tax Act can only be determined upon the review of the particular annuity contract.

The foregoing is intended as a general discussion of the major provisions of the Act and Regulations which could be relevant in the type of situation described in your letter. In any specific situation, the particular facts would of course be relevant in determining the manner in which these and any other provisions might apply. We recommend that you contact our Audit Insurance Specialist, Mr. George Pottage at 519-895-3305, who can assist you in reviewing your particular annuity contracts and in determining the related tax implications.

We have attached copies of subsection 148(9) of the Income Tax Act and sections 305 and 307 of the Income Tax Regulations as you requested. We have tried to respond to all the queries raised in your letter. However, you will note that we have not made references to the Part numbers as they were listed in your letter because of the manner in which we have responded to your queries. If you need to clarify certain points please do not hesitate to contact Michèle Trotier at 613-957-3494.

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.

Yours truly,

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

c.c. International Tax Directorate