ATTENTION J.L. Simard
Specialty Rulings Directorate A.G. Thornley 957-2130
January 6, 1987
RE: Non-registered deferred annuities
This is in reply to your memorandum dated September 26, 1986, with enclosed letter from XXX requesting information with respect to the insurance rules in section 148 and the insurance accrual rules in section 12.2 of the Income Tax Act (the "Act").
Our comments follow the point order of your questions.
Our Comments
1) The termination, in consequence of the death of the annuitant, of a life annuity contract that was entered into prior to November 17, 1978 does not result in a "disposition" for purposes of paragraph 148(9)(c) of the Act. Thus, the death benefit paid out of such a contract would not be taxable under subsection 148(1). In the example referred to, the XXX which is prior to the first third anniversary date of December 31, 1987, for contracts acquired before December 2, 1982 that is referred to in paragraph 12.2(11)(b) of the Act, thus the death benefit would include the entire proceeds of the contract to the date of death which, of course, is not taxable. Were the annuitant in the example to die after December 3, 1987, the above rules would still apply except that the income accrued since December 31, 1981 to December 31, 1987 would be reported in the taxpayer's 1987 taxation year pursuant to subsection 12.2(3) of the Act. The foregoing assumes that annuity payments were not being received.
2) If the annuitant were to die in 1989 as suggested in your memo and before annuity payments commence the foregoing would still apply (because there is no disposition) but the income earned after December 31, 1987 and up to the date of death, not being a third anniversary, would become part of the tax free death benefit.
3) The relief granted annuitants in respect of policies acquired prior to November 17, 1978, as outlined above, is only as a consequence of death. Where the owner of an annuity purchased prior to November 17, 1978 transferred into a new plan or contract in June 1981, as in your example and as a consequence he surrendered the old policy in order to acquire the new one he would have had, under the provisions of subparagraph 148(9)(c)(i), a disposition. Thus the taxpayer in your example would have lost his tax-free mortality gain status and his newly acquired annuity would become subject, in the event of a disposition, to the provisions of subsection 148(1.1) and subparagraph 148(9)(c)(iv.1) of the Act as it was purchased after November 16, 1978 and before November 13, 1981. The reinvesting in June 1983 into "the same old policy" would not be recognized. It would just be another transfer triggering yet another disposition. However, under both old contracts (acquired before December 2, 1982) his reporting date under the accrual rules would have been December 31, 1987 whereas under the new contract (acquired after December 1, 1982 i.e. in June, 1983) the first three year anniversary date will fall on December 31, 1986, being three years from the end of the calendar year of issue of the policy. (See paragraph 12.2(11)(b)).
Example 2 page 7 of XXX Information Circular. Contract acquired October 1978. Owner dies in 1988 before annuitizing.
4) As indicated in 1 above, the termination of a life annuity contract by reason of death during the accumulation period does not represent a disposition, provided that the contract was entered into before November 17, 1978. Accordingly, the entire proceeds would be exempt from income tax including the growth from December 31, 1987 to June 1988. However, the growth from December 31, 1981 to December 31, 1987 would have already been reported under the accrual rules in the owner's 1987 tax return, with no relief from tax on this amount being available in the year of death or at any other time.
If death occurs after the pre-November 17, 1978 contract vests and after annuity payments have begun, the beneficiary of the contract would step into the shoes of the original owner and would report income under the accrual rules as described previously or under the prescribed annuity contract (PAC) rules if the beneficiary is age 60 or older and meets the other PAC rules described in Regulation 304.
With respect to PAC's, if the annuitant under a policy acquired prior to November 17, 1978 elects and qualifies for PAC status according to the provisions of Regulation 304 before December 31, 1987, the income accrued from December 31, 1981 to the date of annuitization would not have to be reported in a lump sum but would be spread over the remaining life of the contract and would be taxed as received pursuant to paragraph 56(1)(d) and 60(a) of the Act. This statement is based on the assumption that the first annuity payments under the PAC would be made on or before December 31, 1987.
As you are basically in agreement with the conclusions set out in the XXX circular we have not commented on them other than as indicated. However, if you have specific questions arising from them now or in the future please write again providing your views and as much information as possible.
ORIGINAL SIGNED BY Wm. R. McColm
for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernment Affairs Branch