Mike is driving me crazy. He won our office football pool and, just to rub it in, he's still carrying around the very large WaterStreet official football pool trophy as he walks by my office several times each day.
To make matters worse, he also won the Academy Awards pool this week. With the hockey playoff pool coming up shortly, I thought I'd try to settle him down; you know, scare him a bit by telling him I've sent a letter to the Canada Revenue Agency about his victories and that, in my view, the cash winnings should be taxable. Or are they? Here's a refresher on how the taxman views prizes from lotteries, pools and other contests.
A lottery is a scheme for distributing prizes by lot or chance among those who have purchased a ticket or a right to the chance. If any real skill or merit plays a part in distributing the prize, the scheme is not a lottery (the skill-testing question you've got to answer is not generally considered a real skill under Canadian tax law, so the lottery label may still apply).
You'll be glad to know that any prizes you win in a lottery are generally tax-free in Canada. If you win something other than cash, such as a house, car, or other things, the property you've won will have an adjusted cost base (ACB) equal to the fair market value of the property on the day you win it. Although you won't pay any tax on the prize itself, you might have a taxable capital gain if you sell the prize later for more than your ACB.
If you win a sizable amount, it's common to receive the prize over time – perhaps paid as a certain amount each month for life. Be aware that prizes paid out in this way – that is, as an annuity – will be partly taxable. I think of the decision in the case of The Queen v. Rumack (92 DTC 6142), where Ms. Rumack won $1,000 a month for life. The court admitted that the $135,338 used to purchase the annuity, which would pay Ms. Rumack $1,000 monthly, was a tax-free amount. But the annuity payments are partly a return of this tax-free capital, and partly interest on the capital. The court made it clear the interest portion is taxable.
I think Mike, from my office, would be shocked if the taxman came knocking on his door to collect tax on that $135 he won in our office football pool. Mike can relax. A "pool system" of betting is defined in the federal Athletic Contests and Events Pool Act as betting on any combination of two or more professional athletic contests or events. These differ from lotteries in that a degree of skill is involved in selecting the outcome of each event. Your only prize will be cash from the pool, and those winnings are not taxable.
If you receive a prize other than through a lottery or pool system, chances are it's simply a giveaway contest. These are contests where the prize is awarded wholly gratuitously. You didn't pay for any ticket, and you didn't earn the prize through any skill or merit. Like lotteries and pool bets, giveaways are also generally tax-free, unless the prize is received by virtue of your business or is received in respect of an achievement in a field of endeavour that you ordinarily carry on – in which case it could be taxable.
If you've won a prize from your employer, the news isn't all good. Regardless of the form of the prize (additional cash, additional pension benefits or other property, for example), the value of the prize will be taxable as employment income. The exception is where you've entered a lottery scheme in which employees make up a very small percentage of the total participants and you have no advantage over other participants. In this case, prizes won may be considered a lottery winning and are likely to be tax-free.
The Internal Revenue Service is not as kind to prize winners. Canadian residents who win U.S. prizes or awards, including gambling winnings, will pay a 30-per cent withholding tax to the IRS. If you've got provable gambling losses you can file a U.S. tax return – a 1040NR – to recover some of the tax you've paid to the United States. Don't expect to claim a foreign tax credit in Canada for any U.S. taxes paid on these winnings – it's not permitted.