After a tax-free win: why the interest is taxable and who the CRA taxes on it

The prize itself: the starting point

Whether a win is taxable is a separate question, and for most players the answer is no. This article starts after that answer. The CRA's Income Tax Folio S3-F9-C1 says at paragraph 1.16 that the amount or value of a prize received from a lottery scheme is not taxable as a capital gain or as income, unless it is income from employment, business or property, or an achievement prize.

Paragraph 1.17 adds two rules that matter later. Under paragraph 40(2)(f) of the Income Tax Act, no taxable capital gain or allowable capital loss results from the disposition of a chance to win. And under subsection 52(4), a winner in a lottery scheme is deemed to have acquired the prize at a cost equal to its fair market value. A cash prize therefore enters your hands at full value with nothing owing. From that point on, it is treated like any other money you hold.

What the money earns is income

The tax-free status attaches to the prize, not to what the prize produces. Put the winnings in a savings account, a GIC or a bond, and the interest is investment income. The CRA's page on line 12100, interest and other investment income, tells you to report interest paid or credited to you even if you did not receive an information slip, and notes that you may not receive a T5 slip for amounts under $50 but must still report the income. For GICs and similar investments, interest earned in each complete investment year has to be reported even though it is often only paid at maturity.

The folio has one specific case: where the prize is an annuity, paragraph 1.29 says the initial adjusted cost base of the annuity is its fair market value when acquired, and the income from it is taxed under the annuity rules.

Giving it to a spouse: attribution

The common next step after a large win is to share it. The same line 12100 page warns that special rules apply for income from property, including money, that one family member loans or transfers to another. Those rules are in sections 74.1 to 74.5 of the Income Tax Act.

Subsection 74.1(1) covers property transferred or lent, directly or indirectly, to or for the benefit of a spouse or common-law partner. Income or loss from that property is deemed to be income or loss of the person who transferred it, not of the spouse, for the period in the year when the transferor is resident in Canada. Subsection 74.2(1) does the same for taxable capital gains and allowable capital losses when the spouse later sells the property.

So the prize can be given to a spouse without tax on the gift itself, but the interest the spouse earns on it is reported by the winner. Splitting the money does not split the investment income.

Children: under 18 and adults

Subsection 74.1(2) applies a similar rule to a person under 18 who does not deal with the transferor at arm's length, or who is the transferor's niece or nephew. Income from property transferred or lent to them is attributed back until the year they turn 18. The capital gains rule in section 74.2 is written for spouses and common-law partners, not for minors.

An outright gift to an adult child is outside section 74.1, because subsection 74.1(2) stops at age 18. A loan is different. Under subsection 56(4.1), where an individual lends money to a non-arm's-length individual and one of the main reasons for the loan was to reduce or avoid tax, income from the lent property can be attributed to the lender. That rule has no age threshold.

Exceptions written into the Act

Section 74.5 sets out where attribution does not apply. Three are relevant after a win:

• Loans at the prescribed rate. Under subsection 74.5(2), attribution does not apply to income from lent property if interest was charged at no less than the lower of the prescribed rate at the time of the loan and the arm's-length rate, and interest for each year is paid no later than 30 days after the end of that year. Subsection 56(4.2) has the same test for 56(4.1). The CRA publishes prescribed interest rates by calendar quarter.
• The spouse's TFSA. Paragraph 74.5(12)(c) excludes property held in a TFSA or FHSA of which the spouse is the holder, to the extent the spouse has no excess TFSA or FHSA amount when the contribution is made.
• Spousal RRSP. Paragraph 74.5(12)(a) excludes a premium paid to an RRSP under which the spouse is the annuitant, to the extent the premium is deductible by the contributor.

A worked example

Hypothetical figures. A Canadian resident wins $200,000 in a provincial lottery. Nothing is reported for the prize. The winner gives $100,000 to their spouse and $50,000 to their 25-year-old daughter, and keeps $50,000. Each puts the money in a GIC, and in the first year the three GICs pay $4,000, $2,000 and $2,000 of interest.

• The winner reports $2,000 on their own GIC plus the $4,000 the spouse earned, because subsection 74.1(1) attributes it back: $6,000 in total.
• The spouse reports none of the $4,000.
• The daughter reports her $2,000. An outright gift to an adult is outside section 74.1.

If the daughter had been 16, her $2,000 would also go on the winner's return under subsection 74.1(2). If the spouse's share had gone into the spouse's TFSA within available room, the income on that portion would fall under the exception in paragraph 74.5(12)(c).

None of this changes the tax status of the prize. It only answers whose income the earnings are. Large wins also bring other decisions; the responsible gaming page covers limits and self-exclusion tools for anyone who keeps playing afterwards, and the top Canadian online casinos page lists sites that offer them.

This is a summary of the published CRA folio and the Act, not tax advice. A tax professional or the CRA can confirm how the rules apply to a particular family.