16 June 1989 Ruling 73791 F - Annuity Agreement with a Registered Charity

SUBJECT: Annuity Agreement with a Registered Charity

This is in reply to your memorandum and enclosures of March 30, 1989 concerning the tax treatment of annuity payments received by an elderly taxpayer form a registered charity.

19(1)

19(1)  with reference to "IT-111 Bulletin, Regulation 300(2)(a)(iii) Published June 27, 1983" (sic).

Interpretation Bulletin IT-111R applies to situations where an individual makes an irrevocable contribution of capital to a charity in exchange for immediate guaranteed payments to the individual for life at a specified rate depending on life expectancy.  where the individual pays more for the annuity than the total amount expected to be received as annuity payments (using the table provided in IT-111R), the Department is prepared to take the view that the excess of the purchase price over the amount from tax payable in respect of a gift to the extent allowed by subsection 118.1(3) of the Act.  No portion of any annuity payment is taxable in the hands of the individual in these circumstances because of the deduction under paragraph 60(a) of the capital element of the annuity payments as determined by Part III of the Income Tax Regulations (the "Regulations").

19(1)

However, the use of a trust-type arrangement, rather than a contract -type arrangement, has raised a number of additional issues that have had to be addressed.  The first of these issues is that under the terms of the Trust, the charity has not received an immediate gift to which it has the legal title.  The Trustee has the legal title , while the charity has the equitable title or interest.  While the Trustee and the charity are the same entity, nevertheless the capital amount settled by the taxpayer is subject to the terms of the Trust and the charity has no use of the capital until such time as the taxpayer dies and the trust is terminated, This raises the question of whether or not the taxpayer has created a life tenancy in favour of the charity.  Unfortunately, the trust document is less than clear on this point.

If there is a gift of the residual interest to the charity, Interpretation Bulletin IT-226 would appear to apply.  IT-226 states that an inter vivos gift of a residual interest to a registered charity con be a charitable donation for purposes of subsection 118.1(3) of the Act.  The value of the residual interest must be determined and in this case, we believe that the value would be the same as that determined under IT-111R.  However, paragraph 4 of IT-226 states that where the residual interest is not reasonably ascertainable, such as when the life tenant has the right to encroach on the capital, the charitable donation will not be allowed.  Under the Trust, there is a right to encroach on the capital, to the extent necessary to meet the annuity payments when the income is insufficient.

We have discussed this question informally with Legal Services. There is no doubt that an inter vivos trust exists.  Although not precise, the wording in the trust document can support an interpretation that the taxpayer has made a gift of a residual interest to the charity.  Despite the fact that there is a right of encroachment on the capital, it is strictly limited, and notwithstanding paragraph 4 of IT-226, the value of the residual interest can reasonably be determined, using the approach in IT-111R.  We are therefore of the opinion that the charity can properly issue a charitable donation receipt for income tax purposes to the taxpayer in the amount of 19(1) 

We now turn to the issue of the tax treatment of the annuity payments received by the taxpayer.  As noted earlier, IT-111R states that because of the deduction available under paragraph 60(a) of the Act as calculated under Part 111 of the Regulations, where the amount donated to the charity is greater than the expected return, the entire annuity payment is considered are turn of capital and therefore is not taxable.  However, subparagraph 60(a)(i), which refers to calculating the amount deductible in prescribed manner, refers only to an annuity "paid under a contract".  Subparagraph 60(a)(ii) states that "if the annuity was paid under a will or trust" then the amount deductible is "such par of the payment as can be established by the recipient no to have been paid out of the income of the estate or trust".  since paragraph I(1) of the Trust clearly indicates that the annuity payments are to be paid from income, it would appear that subparagraph 60(a)(ii) of the Act would deny any deduction to the Taxpayer (except to the extent that the payment contained a portion paid out of capital).  The payments would then be taxable under paragraph 56(1)(d).

In the alternative, it may be that the relevant taxing provision is found in paragraph 104(13)(a) of the Act.  This paragraph taxes, in the hands of a beneficiary, that portion of the income that is earned by a trust which has been paid out tot the beneficiary and for which the trust claimed a deduction under subsection 104(6) or (12) of the Act.  We express no opinion as to whether the annuity payments in this case are subject to tax under paragraph 56(1)(d) or under paragraph 104(13)(a) of the Act as we believe the result is the same in either case.

We have also considered whether subparagraph 75(2)(a)(i) of the Act has any application in this case. This subparagraph provides that where property is held by a trust on condition that it may revert to the person from whom it was received, any income or loss form the property is attributed back to that person.  It is our opinion that the word "revert" in subparagraph 75(2)(a)(i) of the Act was not intended to apply to the kind of situation under review here. We do not consider the taxpayer's right to receive payments (or a portion thereof) out of capital, to the extent necessary to make up any insufficiency in income, to be a reversionary interest.  The taxpayer only has a right of encroachment on the capital, and a very limited on at that.

As for the Trust itself, it is subject to tax on its income under subsection 104(2) minus any deduction taken under paragraph 104(6)(b) of the Act for the annuity payments to the taxpayer.

Our opinion is that, based on strict legal and technical criteria, the above interpretation is the correct one.  However, there are other arguments mitigating against such an approach.

19(1)

There is also the question of whether there is anything to be gained by requiring the Trust to file a return when it is likely that its income will be nil, by virtue of the deduction under paragraph 104(6)(b) of the Act.  Given the amount of the annuity payments, it is unlikely the trust will earn any excess income.

In addition, there is some support in IT-111R for a more lenient approach.  Paragraph 1 of IT-111R states that irremovable contributions of capital to a charity in return for immediate guaranteed payments tot he individual for life "are considered to be annuity contracts for purposes of the Income Tax Act".  We could take the administrative position that in this case the trust shall be considered tot be a contract.

Should you decide that a strict technical interpretation is not warranted in this case, we nevertheless suggest that the Trustee/charity be informed that your decision is based solely on the circumstances of this particular case.  Furthermore, they should be advised that the use of a trust raises income tax implications that do not arise by the use of a contract, and could have likely for the purpose of protecting the taxpayer's interest, but as can be seen, it raises other difficulties.

We trust the above is of assistance to you.

B.W. DathDirectorSmall Business and General DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch