| 922736 | |
| B.G. Dodd | |
| (613) 957-3495 |
October 29, 1992
HALIFAX DISTRICT OFFICEHEAD OFFICERulings Directorate
Att: E.W. Caseley
International Audit
Deferred Annuity of a Non-resident Moving to Canada
This is in reply to your memorandum of September 10, 1992 with which you enclosed a copy of a letter dated July 21, 1992 from 24(1). All references to statute are to the Income Tax Act and, where specified, the regulations thereunder.
As we understand it, the concern is with the tax treatment in the case of a non-registered deferred annuity owned by a non-resident of Canada (the "annuitant"), who had no taxable income earned in Canada while a non-resident, where the non-resident moves to Canada. The specific question is whether all the untaxed interest accrued to date becomes taxable in the year in which the annuitant becomes a Canadian resident. You indicate that your reading of subsection 12(4) suggests that this would be the case.
As our reply is somewhat lengthy, we summarize the major points as follows:
- accrual taxation in respect of annuities is provided by section 12.2 rather than subsection 12(4);
- depending on when the annuity was last acquired, it will either be subject to annual or triennial accrual taxation upon becoming a Canadian resident;
- the investment growth in the annuity which accrued prior to becoming a Canadian resident will be taxed on a lump sum basis upon becoming a resident, there being no provision in the Act similar to subsection 48(3) in the case of annuities;
- whether such taxation occurs in the year of immigration to Canada or in a succeeding year depends on a number of factors;
- it may be possible to amend a deferred annuity contract so that it qualifies as a "prescribed annuity contract" which would then be excluded from accrual taxation (payments would have to commence immediately and taxation would be on a receipt basis with a deduction for the capital element).
DISCUSSION
We note initially that subsection 12(4) provides for accrual taxation of interest on an "investment contract", as defined in paragraph 12(11)(a), whereas accrual taxation in the case of an annuity contract is provided for in section 12.2. In this respect, section 12.2 refers to a "life insurance policy" which, pursuant to subsection 248(1) and paragraph 138(12)(g), includes an annuity contract.
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 paragraph 148(9)(a) 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.
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 is discussed below.
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 paragraph 12.2(11)(b)) 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 no previous Canadian taxation in respect of the annuity. The annuitant would thus be subject to tax in respect of the build-up during the period while a non-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. (Paragraph 114(b) does not contemplate taxation of annuities in the period while a non-resident other than with respect to dispositions.) 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 be taxed in Canada on a lump sum basis but only in the year in which the first "third anniversary" occurs after becoming a Canadian resident. (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. (Annuity payments under such contracts are taxable on a receipt basis pursuant to paragraphs 56(1)(d) and 60(a).)
Other Comments
Although subsection 48(3) effectively excludes from Canadian taxation changes in the value of property which occur prior to becoming a Canadian resident by deeming an acquisition to occur upon immigration at a cost equal to fair market value at that time, this applies only to capital properties for purposes of subdivision c of division B of the Act. There is no provision in the Act which provides similar treatment in the case of annuity contracts.
24(1)
We note that an annuity contract which is a "prescribed annuity contract" ("PAC"), as defined in subsection 304 of the Regulations, is excluded from accrual taxation pursuant to either of paragraphs 12.2(1)(b) and 12.2(3)(b). Annuity payments under a PAC are taxed on a receipt basis under paragraph 56(1)(d) with a deduction in respect of the capital element pursuant to paragraph 60(a).
While a deferred annuity does not qualify as a PAC, it may be possible for the parties involved to amend such a contract so that it satisfies all the criteria set out in paragraph 304(1)(c) of the Regulations. If this can be done, one result would be that the annuity payments could no longer be deferred (per subparagraphs 304(1)(c)(i) and (iv) of the Regulations) so the annuitant would have to decide whether this would be a viable option.
It would be a question of fact in any particular situation whether amendments to an annuity contract would be so substantial as to result in a disposition of the original contract (in which case there may be an income inclusion under subsection 148(1)) and the acquisition of a new contract. It may be possible to accelerate the commencement of payments under a deferred annuity contract for the purpose of qualifying as a PAC without triggering a disposition of the contract for the purposes of section 148. For example, we have in one particular case agreed there would not be a disposition where a deferred annuity contract was to be modified along the following lines for the purposes of qualifying as a PAC:
- annuity payments would commence before the end of the current year, although the guarantee period would remain unchanged (except where the immediately following item applies);
- the guarantee period would not extend beyond the holder's 91st birthday;
- no loans could exist under the contract and the holder's rights under the contract could not be disposed of other than on his death;
- the holder's right to have the contract commuted would cease immediately before the first payment; and
- there would be no reduction in interest rates.
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 memorandum. 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 hope this will be of assistance.
for DirectorFinancial Industries DivisionRulings Directorate