CANADA CUSTOMS AND REVENUE AGENCY INTERPRETATION BULLETIN NUMBER IT-508R DATE: February 12, 1996 SUBJECT: INCOME TAX ACT Death Benefits REFERENCE: Subparagraph 56(1)(a)(iii) and the definition of "death benefit" in subsection 248(1) (Also subsections 104(28) and 252(4), the definitions of "retiring allowance," and "superannuation or pension benefit" in subsection 248(1), and subparagraph 56(1)(a)(ii)) Application This bulletin cancels and replaces IT-508, Death Benefits - Calculation, dated June 30, 1987. It also cancels IT-301, Death Benefits - Qualifying Payments, dated April 6, 1976. Summary The purpose of the legislative provisions regarding death benefits is: - to ensure that amounts received as death benefits are included in the recipient's income; and - to allow an exclusion from income for up to $10,000 of the gross amount of death benefits attributable to a deceased taxpayer's service in an office or employment. This bulletin discusses some of the types of payments which qualify as the gross amount of a death benefit. The calculation of a death benefit is also explained in situations where qualifying payments are made over more than one taxation year or received from more than one office or employment. Discussion and Interpretation 1. In this bulletin, the term "gross amount" of a death benefit means the amount or amounts received by any taxpayer in a taxation year upon or after the death of an employee or former employee in recognition of that employee's or former employee's service in an office or employment. In general terms, a "death benefit" is the gross amount received by a taxpayer in a taxation year less an amount of up to $10,000 (see 9 to 12 below) and is included in the recipient's income under subparagraph 56(1)(a)(iii). As decided by the Tax Court of Canada in Gesina Hiltemann versus The Queen ([1986] 2 C.T.C. 2279, 86 DTC 1716), generally, the value of a benefit conferred on a taxpayer after the death of an employee or former employee, as a consequence of the employment relationship, is considered to be the gross amount of a death benefit. However, this does not apply to non-qualifying payments, as noted in 4 below. 2. Since there is no requirement that the payer be the employer, an amount received or receivable from a testamentary trust qualifies as the gross amount of a death benefit, if the payment received by the trust on or after the death of the employee is in recognition of the employee's service in an office or employment. Under subsection 104(28), if the gross amount of a death benefit received by a testamentary trust is paid or to be paid to a beneficiary of the trust, the amount is deemed to have been received by the beneficiary (and not received by the trust). Qualifying Payments 3. The following payments are considered to be the gross amount of a death benefit: - payments in recognition of the employee's service even though the payments continue for a long time on a periodic basis, or for the lifetime of the recipient, if they were made under an employer's fund or plan that is distinctly separate from certain plans such as a superannuation or pension fund or plan, a salary deferral arrangement, or a retirement compensation arrangement; and - payments in recognition of service of an employee who dies prior to retirement that represent a settlement of his or her accumulated sick leave credits to which the employee was entitled under the terms of the office or employment. Non-Qualifying Payments 4. The following payments are not considered death benefits: - a payment received out of a superannuation or pension fund or plan, and in general, payments received out of a salary deferral arrangement, or a retirement compensation arrangement upon or after the death of an officer or employee; - where an employee dies prior to retirement, a payment in respect of accumulated vacation leave; - a death benefit paid under the Canada or Quebec Pension Plan; - a payment representing deferred employment income that would have been taxable in the employee's hands under subsection 6(3) if the employee had not died; and - a payment representing overtime pay that would have been taxable to the employee under subsection 5(1) if the employee had received the amount before death. 5. If an employee ceased employment and was entitled to receive a retiring allowance (see the definition of retiring allowance in subsection 248(1)) but dies before the payment is made, the subsequent payment of the amount to a beneficiary of the deceased is included in the recipient's income under sub- paragraph 56(1)(a)(ii) as a retiring allowance. The tax treatment of a retiring allowance is discussed in the current version of Interpretation Bulletin IT-337, Retiring Allowances. If an employee dies while still employed by the employer, and that employee was contractually entitled to receive a retiring allowance upon retirement, the severance pay received by a beneficiary of the deceased, on or after the death of that employee, qualifies as the gross amount of a death benefit. 6. A benefit received on the death of an individual will not qualify as a death benefit unless it is reasonable to conclude that the benefit is in recognition of that individual's service in an office or employment. If no employer-employee relationship existed, the amount received by a beneficiary of the deceased will not be treated as a death benefit. Notwithstanding the existence of an employer-employee relationship, generally, amounts received out of or under a salary deferral arrangement, or a retirement compensation arrangement, do not qualify as death benefits. Public Servants of the Federal Government 7. Under Part II of the Public Service Superannuation Act, public servants of the Federal Government make contributions to the Public Service "Supplementary Death Benefit" Plan for which a specific account is established separate from the Superannuation Plan. Since this plan is in substance a group term life insurance plan, contributions thereto are not deductible in computing income nor are the benefits payable considered income as death benefits or otherwise. Superannuation or Pension Benefit 8. As provided in subsection 248(1), a "superannuation or pension benefit" includes any amount received out of or under a superannuation or pension fund or plan. This specific provision is considered to override the death benefit definition; thus payments from such funds or plans cannot qualify as death benefits in any circumstances. CALCULATION OF DEATH BENEFIT Qualifying Payment Received After 1992 Sole Beneficiary is Spouse 9. For 1993 and later taxation years, if a gross amount of a death benefit is received by a taxpayer who is the only person who both: - has received such an amount; and - is a "surviving spouse" (see 11 below) of the employee, paragraph (a) of the death benefit definition provides that the reduction allowed in computing the death benefit is the lesser of: - the gross amount received in the year by the surviving spouse; and - the amount, if any, by which $10,000 exceeds the total gross amounts received in prior years by the surviving spouse. Sole Beneficiary is not Spouse 10. If only one person (ex. a child of the deceased employee) receives a gross amount of a death benefit, and that person is not a surviving spouse of the deceased employee, paragraph (b) of the death benefit definition applies. Since the $10,000 exemption does not have to be apportioned to any other recipient, the calculation of the reduction would be the same as that shown in 9 above for a surviving spouse, except that the gross amount received by the recipient who is not the surviving spouse, would be substituted in the calculation. If more than one person receives a gross amount in respect of the same deceased employee, the apportionment rule (see 12 and 13 below) applies. Meaning of "Spouse" 11. In general, before 1993, the "spouse" of a taxpayer was a person of the opposite sex to whom the taxpayer was legally married. For 1993 and later years, since the extended definition of "spouse" in subsection 252(4) includes certain common-law spouses, it is possible that a death benefit can be paid to more than one individual who, for the purpose of that subsection, is considered to be a spouse of the deceased employee. For the purpose of the death benefit definition, a person is considered a "surviving spouse" of the deceased employee, only if that person is an individual who: - is a "spouse" of the deceased employee; and - is the only spouse who has received a gross amount of a death benefit in respect of the employee. More than One Spouse is a Beneficiary 12. In a situation where more than one spouse has received a gross amount, the calculation of the reduction from the gross amount of the death benefit received for each spouse would fall under paragraph (b) of the death benefit definition (see 13 below). In other words, the $10,000 exempt portion of the death benefit is divided between the spouses, in proportion to the amount each spouse receives. However, note that the total exempt portion of the death benefit for the spouses cannot exceed $10,000. If a gross amount of a death benefit is paid to: - two or more individuals who are considered to be spouses of the deceased employee; and - to an individual other than a spouse, paragraph (b) of the death benefit definition applies and the $10,000 exemption is divided between the recipients in proportion to the amount each received. Beneficiaries are Spouse and a Person other than a Spouse 13. If a gross amount is received by a taxpayer who is not the "spouse" (ex. a child of the deceased employee), and there is also only one spouse who is in receipt of a gross amount of a death benefit, paragraph (a) of the death benefit definition applies (see 9 above) to the "surviving spouse" and paragraph (b) of the death benefit definition provides that the reduction available to the other beneficiary is limited to the excess of $10,000 over the total gross amounts received by the "surviving spouse" in any taxation year. The allowable reduction to the other beneficiary is the lesser of: - the gross amount received in the year by the taxpayer, and - the amount determined using the formula: A multiplied by B divided by C where: A = $10,000 minus the total gross amount received by the "surviving spouse"; B = the gross amount received by the taxpayer; and C = the total of all gross amounts received at any time by all taxpayers other than the surviving spouse." See the example in 16 below for the calculation of death benefits paid to both the surviving spouse and a beneficiary other than the spouse (e.g. the child of the deceased employee). Death Benefit Paid over More than One Taxation Year 14. If the death benefit is paid over more than one taxation year, and the total gross amount paid to all of the taxpayers in the taxation year is less than the $10,000 exempt portion, the difference can be applied against the following years' payments, to the extent that there is any left. If gross amounts are received in more than one year as a consequence of a death, it may be necessary to reassess the income tax returns of individuals who received gross amounts in earlier years in respect of the death to reflect the effect, on the reductions available in the earlier years, of the amounts received in the later years. See the example in 16 below. Death Benefit Received from More than One Office or Employment 15. If gross amounts are received from more than one office or employment by any recipient, the gross amounts received in each year by each recipient are totalled and this total amount is used in the calculation of the allowable reduction as described in 9 and 13 above. In other words, $10,000 is the maximum amount that can be excluded from income under paragraphs (a) and (b) of the death benefit definition in respect of qualifying payments (see 3 above) from all sources received by the surviving spouse or other beneficiaries of a deceased employee in recognition of the employee's service from an office or employment. Example 16. The following example shows the calculation of the death benefit for a surviving spouse and a taxpayer who is not a surviving spouse. A surviving spouse and a child of a deceased employee receive gross amounts of $5,000 and $4,000, respectively, which are qualifying payments (see 3 above) from employment X during year 1. In year 2, the surviving spouse receives a gross amount of $3,500 from employment Y. As a result, the child's income tax return for year 1 has to be reassessed to reduce the reduction allowable to the child as a consequence of the payment of $3,500 to the surviving spouse in year 2. The surviving spouse and child are allowed the maximum reduction available under the death benefit definition in years 1 and 2. Calculation of reductions: Year 1 Surviving Spouse: The lesser of: - the amount received in year 1 = $5,000; and - $10,000 minus the gross amounts received in previous years ($0) = $10,000. In year 1, the exempt portion of the gross amount of the death benefit is $5,000. The death benefit required to be included in the income of the surviving spouse for year 1 is $0. Child: The lesser of: the amount received in year 1 = $4,000; and the excess ($10,000 minus $5,000) multiplied by $4,000 divided by $4,000 = $5,000. In year 1, the exempt portion of the gross amount of the death benefit is $4,000. The death benefit required to be included in the income of the child for year 1 is $0. Year 2: The surviving spouse receives a gross amount of $3,500 from employment Y. The calculation of the reduction for year 2 is as follows: Surviving Spouse: The lesser of: - the amount received in year 2 = $3,500; and - $10,000 minus the gross amounts received by the spouse in prior years ($10,000 minus $5,000 received in year 1) = $5,000. In year 2, the exempt portion of the gross amount of the death benefit for the spouse is $3,500. The spouse does not include any death benefit on his or her income tax return for year 2. Child: However, the child's income tax return for year 1 would have to be reassessed to reduce the reduction allowable to the child as a consequence of the payment of $3,500 to the surviving spouse in year 2. The revised maximum reduction available to the child in year 1 would be the lesser of: - the amount received by the child in year 1 = $4,000; and - the excess ($10,000 minus $8,500 received by the spouse in years 1 and 2) multiplied by $4,000 divided by $4,000 = $1,500 The child's revised exempt portion of the gross amount for year 1 would be $1,500. Therefore, the child includes a death benefit of $2,500 ($4,000 gross amount minus $1,500 exempt amount) in income in year 1. If you have any comments about matters discussed in this bulletin, please send them to: Director, Technical Publications Division Policy and Legislation Branch Revenue Canada 875 Heron Road Ottawa ON K1A 0L8 Explanation of Changes for Interpretation Bulletin IT-508R Death Benefits Introduction The purpose of the Explanation of Changes is to give the reasons for the revisions to an interpretation bulletin. It outlines revisions that we have made as a result of changes to the law, as well as changes reflecting new or revised departmental interpretations. Overview This bulletin deals with the calculation of the amounts subject to tax which a taxpayer may receive after the death of an employee in recognition of the employee's service in an office or employment. The revision of IT-508 was undertaken primarily to reflect an amendment to the Income Tax Act by S.C. 1994, c. 7 (former Bill C-92). It was also revised to reflect changes to the Income Tax Act by S.C. 1983 c.140 (former Bill C-139) and S.C. 1994 c.21 (formerly Bill C-27). This bulletin cancels and replaces IT-508, Death Benefits - Calculation, dated June 30, 1987. The comments on death benefits contained in Interpretation Bulletin IT-301 are incorporated into this bulletin, and consequently, IT-301 has been cancelled. The contents of this bulletin are not affected by any draft legislation released before December 11, 1995. Legislative and Other Changes Paragraph 1 (replaces former paragraphs 1 and 2) defines the term "gross amount" of a death benefit for the purposes of this bulletin. It also outlines the definition of "death benefit" in subsection 248(1), which was amended for 1993 and later years. New paragraph 2 incorporates some of the comments from former paragraph 1 and also discusses the provisions of subsection 104(28) regarding a gross amount of a death benefit received by a testamentary trust. New paragraph 3 incorporates the comments in former paragraph 2 of IT-301 regarding qualifying payments. New paragraph 4 reflects the discussion of non-qualifying payments in former paragraph 3 of IT-301. It also elaborates on other types of payments which are non-qualifying payments. New paragraph 5 briefly discusses the principal difference between a retiring allowance and a death benefit. New paragraph 6 outlines the requirement for the existence of an employee- employer relationship in the determination of whether a payment qualifies as a gross amount of a death benefit. New paragraph 7 incorporates the comments set out in former paragraph 5 of IT- 301, concerning death benefits paid to public servants of the federal government. New paragraph 8 incorporates the explanation regarding superannuation or pension benefits in former paragraph 6 of IT-301. New paragraph 9 (replaces former paragraph 3) outlines the amendment to the death benefit definition, applicable after 1992, as a consequence of the addition of the extended meaning of "spouse" in subsection 252(4), applicable after 1992. New paragraph 10 explains the calculation of a death benefit when the only individual who has received a qualifying payment is an individual other than the spouse, such as the deceased employee's child. New paragraph 11 briefly discusses the addition of the extended meaning of "spouse" in subsection 252(4), applicable after 1992, and the meaning of "surviving spouse" in the death benefit definition. New paragraph 12 explains the calculation of the death benefit where a qualifying payment has been paid to more than one individual who is considered to be a "spouse" of an employee at the time of death. Paragraph 13 (replaces former paragraph 4) relates to the calculation of the death benefit where qualifying payments have been made to a sole surviving spouse and to a beneficiary other than a spouse such as the deceased employee's child. New paragraph 14 explains how the death benefit is calculated if it is paid over more than one taxation year. Paragraph 15 replaces former paragraph 5. New paragraph 16 contains an example of a situation relating to paragraph 13. Former paragraph 4 of IT-301, which discussed the deduction for death benefits used to purchase an income-averaging annuity contract (IAAC), is no longer applicable. The addition of the definition of "qualifying payment" in former paragraph 61(4)(c), for purposes of an IAAC, effectively terminated the deduction available under subsection 61(1) for single payments, such as death benefits, paid after November 12, 1981, in consideration for an IAAC, since a "qualifying payment" generally only includes a single payment made before November 13, 1981.