Principal Issues: Can "contingent interest" for a deferred annuity with guaranteed values and an index-linked bonus payable only on maturity be excluded from the determination of the tax reserve and from the amount of income required to be reported prior to maturity?
Position: Unable to conclude without a thorough review of the circumstances.
Reasons: See response.
CLHIA Conference - May 26, 2005
Question 10
Index-linked Deferred Annuities
Financial institutions have found that certain types of index-linked products are popular with consumers. For example, banks issue GICs the return on which is linked in some way to a stock market index. The CRA has indicated that contingent benefits on an index-linked bank GIC are not taxed until receivable (see RID documents 2001-0076265, 2001-0079875, 9406155).
An insurer could offer a similar investment product in the form of a deferred annuity with guaranteed values and an index-linked bonus payable only on maturity. However, from a policyholder perspective, to achieve parity of treatment with the index-linked GIC, the holder should not be subject to tax annually in respect of similar "contingent benefits".
Under subsection 12.2(1), a taxpayer holding a life insurance policy other than an exempt policy or a prescribed annuity contract must include in computing income annually the "accumulating fund" in excess of the adjusted cost basis. "Accumulating fund" is defined for this purpose in subparagraph 307(1)(b)(ii) of the Regulations by reference to the insurer's reserves determined under paragraph 1401(1)(a) or (c). Finally, this last provision refers, essentially to the greater of the cash surrender value and the excess of the present value of future benefits over the present value of future modified net premiums.
It may be argued that the index-linked bonus falls outside the definition of "benefit" in subsection 1408(1), which is relevant to the determination of the reserve under paragraph 1401(1)(c), since paragraph (e) of the definition provides that a "benefit" does not include "any other amount under the policy that was not specifically provided for by the insurer in determining a premium for the policy".
Questions
(a) Would the CRA agree that contingent "interest" for a deferred annuity with guaranteed values and an index-linked bonus payable only on maturity may therefore be excluded from the determination of the tax reserve and, as a result, from the amount of income required to be reported prior to maturity?
(b) If the CRA does not agree, is there any other statutory basis for excluding such amounts from the reserve, and ultimately the amount of accrued income required to be reported prior to maturity?
(c) If the CRA does not agree that such amounts may be excluded from the reserve, will the Department of Finance recommend an amendment to the Regulations so that life insurance companies can offer deferred annuities with index-linked contingent bonuses payable at maturity with tax effects to investors similar to those currently available with respect to comparable GICs offered by banks?
Agency's Response
(a) We are unable to confirm that the contingent "interest" for a deferred annuity with guaranteed values and an index-linked bonus payable only on maturity may be excluded from the determination of the tax reserve without a thorough review of the circumstances.
There may be other elements related to the deferred annuity policy and related to the underlying investments such as a portion of the expected gain from the underlying investments, guarantee costs, acquisition costs, investment expenses and/or administration expenses that have been provided for by the insurer in determining the premium for the policy. As such, these elements would qualify as a "benefit" as defined in subsection 1408(1) of the Income Tax Regulations and therefore we would argue that the "present value of future benefits" in respect of these deferred annuity policies would be included in the MTAR calculation. At this point, we are not convinced that it is appropriate to separate the contingent "interest" benefit from the aforementioned other benefits in applying the definition of "benefit" in subsection 1408(1) of the Income Tax Regulations, but instead consider it more appropriate to consider all benefits under the policy in the aggregate.
(b) There is no other statutory basis for excluding such amounts from the reserve. As the deferred annuity product in question qualifies as a "life insurance policy", then the normal policyholder taxation rules would apply thereon.
Finance's Response
The Department of Finance recognizes the importance of equitable and fair treatment of taxpayers. Consequently, it would be willing to review this matter in more detail. However, an amendment to paragraph (e) of the definition of "benefit" in Regulation 1408(1) would be considered only where appropriate and only where the terms of the contingent benefits as expressed in the annuity contract are sufficiently similar to those specifically set out in the indexed-linked GIC as set out in RID documents 2001-0076265, 2001-0079875, 9406155. Finance would not support any amendment that would result in inappropriate tax deferral.