2024-1005821C6 2024 CALU RT Q7 - PACs and Trusts

Principal Issues: If an inter vivos trust, other than a trust described in subclauses 304(1)(c)(iii)(A)(II) through (IV) of the Regulations purchases an annuity contract on the life of an individual beneficiary and under the contract the annuitant/trust beneficiary is appointed to be the payee, will that annuity contract qualify as a prescribed annuity contract pursuant to the interaction of paragraph 304(3)(a) and section 304 of the Regulations?

Position: The annuity contract would not qualify as a prescribed annuity contract.

Reasons: Only trusts described in clause 304(1)(c)(iii)(A) of the Regulations are a qualified holder of an annuity contract.

Author: 2024 CALU RT Q7 - PACs and Trusts
Section: 56(1)(d), 60(a), 148, Regulation 304

CALU Roundtable - May 2024

Question 7 – Prescribed Annuity Contracts and Trusts

A prescribed annuity contract (PAC) is a type of immediate annuity contract (i.e. payments have commenced) that is not subject to annual accrual tax reporting under subsection 12.2(1) of the Income Tax Act (the “Act”) by virtue of the exception set out in paragraph 12.2(1)(b) of the Act. Instead, annuity payments received in the year are included in the taxpayer’s income under paragraph 56(1)(d) of the Act and a deduction may be claimed by the taxpayer for a prescribed amount representing a return of capital under paragraph 60(a) of the Act and section 300 of the Income Tax Regulations (the “Regulations”). The terms and conditions to qualify for PAC status are set out in section 304 of the Regulations.

Pursuant to clause 304(1)(c)(iii)(A) of the Regulations, a holder of a PAC has to be an individual other than a trust except if the trust is a trust described in subclauses 304(1)(c)(iii)(A)(II) through (IV). However, paragraph 304(3)(a) of the Regulations states that, for purposes of Regulation 304, the annuitant under an annuity contract is deemed to be the holder of the contract where the contract is held by another person in trust for the annuitant. Subsection 304(4) of the Regulations defines the “annuitant” under an annuity contract to be a person who, at that time, is entitled to receive the annuity payments.

Question

If an inter vivos trust, other than a trust described in subclauses 304(1)(c)(iii)(A)(II) through (IV) of the Regulations purchases an annuity contract on the life of an individual beneficiary and under the contract the annuitant/trust beneficiary is appointed to be the payee, will that annuity contract qualify as a PAC pursuant to the interaction of paragraph 304(3)(a) and subsection 304(1) of the Regulations?

CRA Response

Generally, a holder of an annuity contract, acquired after 1989, that is not a PAC is subject to the annual accrual taxation rules under section 12.2 of the Act. However, where a taxpayer holds an annuity contract that is a PAC, an amount received by a taxpayer as an annuity payment under the PAC is included in the taxpayer’s income pursuant to paragraph 56(1)(d) of the Act, and the taxpayer is permitted a deduction under paragraph 60(a) of the Act equal to the amount of the capital element of the annuity payment, as computed under section 300 of the Regulations.

Section 304 of the Regulations defines a PAC for purposes of subsection 12.2(1) of the Act. In this regard, under paragraph 304(1)(c) of the Regulations, a PAC refers to an annuity contract that meets certain conditions. Among the conditions to be met, clause 304(1)(c)(iii)(A) of the Regulations requires each holder of the annuity contract be

(i) an individual (other than a trust),

(ii) a specified trust that is described in paragraph 104(4)(a) of the Act (i.e., an alter ego trust, joint spousal or common-law partner trust or post-1971 spousal or common-law partner trust),

(iii) a “qualified disability trust”, as defined in subsection 122(3) of the Act, for the year in which the annuity was issued, or

(iv) if the annuity is issued before 2016, a testamentary trust.

Moreover, under clause 304(1)(c)(iii)(B) of the Regulations, each holder of the annuity contract must be an annuitant under the contract and deal at arm’s length with the issuer.

Paragraph 304(3)(a) of the Regulations deems the annuitant under an annuity contract to be the holder of the contract where the contract is held by another person in trust for the annuitant. Subsection 304(4) of the Regulations defines an annuitant under an annuity contract as a person who is entitled to receive annuity payments under the contract.

In our view, absent paragraph 304(3)(a) of the Regulations an annuitant would not be considered to be the holder of the annuity contract as required by clause 304(1)(c)(iii)(B) of the Regulations. For example, under paragraph 304(3)(a) of the Regulations, a parent could hold an annuity contract for their child until they attain a specific age. Paragraph 304(3)(a) of the Regulations would deem the child to be the holder of the contract and, as such, would meet the requirements of clause 304(1)(c)(iii)(A) of the Regulations. In our view, the expression "in trust" in paragraph 304(3)(a) of the Regulations is more akin to a nominee and is not meant to include a trust not specifically referenced in clause 304(1)(c)(iii)(A), namely those identified in (ii) to (iv) above.

Steven Szilagyi
2024-100582
May 7, 2024

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