2014-0549941E5 Foreign issued deferred annuities

Principal Issues: 1) How is a foreign issued deferred annuity taxed when the non-resident holder of the annuity immigrates to Canada? 2) What are the Canadian tax implications of holding a foreign issued deferred annuity while the holder is non-resident?

Position: General Comments Provided

Reasons: See below

Author: Johnstone, Alexander
Section: ITA 12.2, 56(1)(d), 60(a), 138(12); ITR 304

XXXXXXXXXX

                                                2014-054994
                                                Alex Johnstone
                                                (613) 410-9134

July 9, 2015

Dear XXXXXXXXXX:

Re:  Foreign issued deferred annuities

We are writing in response to your letter dated September 29, 2014 and your email of March 12, 2015. Your initial question concerned the Canadian tax treatment of certain deferred variable annuities issued by a non-resident company that is a specialist provider of pensions and annuities. Since discussing the matter with us (XXXXXXXXXX/Johnstone), you have revised your question. You are now requesting our comments on the Canadian tax consequences of an individual holding a particular foreign issued deferred variable annuity while as a non-resident of Canada and on becoming a Canadian resident.

This technical interpretation provides general comments about the provisions of the Income Tax Act (the “Act”) and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. Accordingly, we are not able to provide substantive comments relating to the Canadian tax implications of holding the particular foreign investment product referenced in your correspondence as we have not reviewed the terms and conditions associated with that product. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.

Our comments

As you may be aware, Canada imposes tax on income based on an individual’s status as a resident or non-resident of Canada and not on his or her citizenship. Generally, if the individual is a resident of Canada, the individual is subject to tax in Canada on all of his or her income from all sources, including sources outside of Canada.  Non-residents are generally subject to Canadian income tax on most Canadian sourced income unless all or part of it is exempt under a tax treaty. Therefore, a foreign investment product held by a non-resident individual of Canada would not normally give rise to Canadian income tax consequences.

Note that our comments below provide a brief overview of the taxation of non-registered annuity contracts in Canada as well as the tax implications to a non-resident individual on becoming a resident of Canada.

Annuities are generally subject to tax in Canada under either section 12.2 or paragraph 56(1)(d) of the Act, depending on the type and structure of the particular annuity contract.  Under subsections 248(1) and 138(12) of the Act, a "life insurance policy" is defined to include an annuity contract. Therefore, any reference to a life insurance policy in the Act should be taken to include an annuity contract unless otherwise indicated.  It is to be noted that the residence of the issuer is not relevant in determining whether an annuity contract constitutes a life insurance policy for the purposes of the Act. Thus, an annuity contract issued by a non-resident can constitute a life insurance policy for Canadian tax purposes.

Annual Income Taxation

Pursuant to subsection 12.2(1) of the Act, where a taxpayer holds an interest in a life insurance policy, the taxpayer is required to accrue income on such a policy on an annual basis for each year that the taxpayer holds an interest in the policy, regardless of the amounts actually received under the policy. If the policy is an “exempt policy” or a “prescribed annuity contract” (“PAC”), annual accrual taxation will not apply.

If the annuity contract meets the requirements in section 304 of the Income Tax Regulations (“Regulations”) to qualify as a PAC, payments received by the taxpayer from or out of the PAC would be included into income under paragraph 56(1)(d) of the Act. However, a deduction for the capital element of such payments would be allowed under paragraph 60(a) of the Act. Since one such requirement is that the annuity payments must have commenced, a deferred annuity will not qualify as a PAC during the accumulation period.

Subsection 12.2(11) of the Act defines the term “exempt policy” to have the meaning prescribed by the Regulations. Pursuant to section 306 of the Regulations, an exempt policy does not include an annuity contract.

Where an interest in a life insurance policy is not a PAC or an exempt policy, in accordance with subsection 12.2(1) of the Act, the annual accrual to be included in income is the amount by which the accumulating fund (as defined in section 307 of the Regulations) exceeds the adjusted cost basis (“ACB”) (as defined in subsection 148(9) of the Act) for each interest in a life insurance policy calculated on the anniversary day of the policy. 

In general terms, the accumulating fund of a life insurance policy is a measure of the accumulated savings that have built up within the policy. The ACB is essentially the cost of the interest in the policy adjusted for certain items. One adjustment is that any accrual amount included in income in a year is added to the ACB. These amounts are generally computed by the life insurance company when the insurer is a resident of Canada, but they may not be available from foreign insurers.

Immigration to Canada

Individuals becoming resident in Canada are subject to paragraphs 128.1(1)(b) and (c) of the Act which provide that, for purposes of the Act, an individual is deemed to dispose of all of the individual’s property (with certain exceptions) for proceeds equal to fair market value prior to becoming resident in Canada. The property subject to the deemed disposition is then deemed to be reacquired by the individual for a cost equal to the proceeds of disposition. Very generally, the effect of this is that, for purposes of computing Canadian tax, an individual who becomes resident in Canada will have a cost base for most of his or her property that is equal to the fair market value of the property upon entering Canada. Property is defined in subsection 248(1) of the Act and would normally include an interest in a deferred annuity contract. However, the deemed disposition in paragraph 128.1(1)(b) of the Act does not apply to certain specified exceptions. One such exception is for property that is an “excluded right or interest” which is defined in subsection 128.1(10) of the Act. Paragraph (f) of the definition of “excluded right or interest” includes a right of the individual to receive a payment under an annuity contract.

In summary, the taxation and characterization of foreign issued investment products are complex issues. As such, we would advise you to discuss this matter with a Canadian tax advisor specializing in the taxation of foreign annuities or life insurance products if you require more specific advice or information relating to your particular fact situation.

We hope that these comments will be of assistance.

Yours truly,

Jenie Leigh
Manager
Financial Institutions Section
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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