10 December 2002 Internal T.I. 2002-0175027 - SEGREGATED FUNDS CAPITAL GAINS AND CDA

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

Whether the non-taxable portion of a capital gain from a segregated fund policy can be added to a corporate policyholder's capital dividend account.

Position: Yes.

Reasons:

Pursuant to subsection 138.1(3), capital gains or capital losses of a segregated fund trust are deemed to be capital gains or capital losses of the policyholder. Accordingly, where the policyholder is a corporation, it is our view that the non-taxable portion of a capital gain can be added to its capital dividend account.

							December 10, 2002

KITCHENER/WATERLOO TSO				HEADQUARTERS
Financial Institutions Section
	Attention :  Judi Turek						J. Leigh
                   Business Enquiries					(613) 952-1505

							2002-017502

Segregated Funds and Capital Dividend Account

This is in reply to your e-mail of November 21, 2002 in which you requested our views as to whether the non-taxable portion of capital gains allocated to a corporate policyholder of a segregated fund policy can be added to its capital dividend account ("CDA").

A segregated fund policy issued by an insurer is subject to the provisions of section 138.1 of the Income Tax Act (the "Act"). For Part I purposes, paragraph 138.1(1)(a) of the Act deems the creation of an inter vivos trust and paragraph 138.1(1)(b) of the Act deems the property allocated to the segregated fund, and any income accrued thereon, to be the property and income of the segregated fund trust and not that of the insurer. Consequently, the provisions governing the taxation of trusts and their beneficiaries generally apply to a segregated fund trust. For the purposes of subsections 104(6), (13) and (24) of the Act, paragraph 138.1(1)(f) of the Act deems the income of the segregated fund trust to be amount that has become payable in the year to the beneficiaries under the trust. In addition, under subsection 138.1(3) of the Act, a capital gain or capital loss of a segregated fund trust on disposition of its property is deemed to be a capital gain or capital loss of the policyholder or other beneficiary and not that of the trust. Subsections 138.1(3.1) and (3.2) of the Act relate to changes to the capital gains inclusion rate.

With regard to the interaction between subsection 138.1(3) and the definition of CDA in subsection 89(1) of the Act, given that subsection 138.1(3) of the Act deems a capital gain or capital loss realized by a segregated fund trust to be a capital gain or capital loss of the policyholder, it is our view that the non-taxable portion of the capital gain or the non-deductible portion of the capital loss is to be included in computing a corporate beneficiary's CDA pursuant to paragraph (a) of the CDA definition.

As you have noted, prior to the addition of paragraph (f) to the CDA definition in 2001, it was our position that the non-taxable portion of capital gains of a trust other than a segregated fund trust could not added in computing a corporate beneficiary's CDA. Subsection 104(21) of the Act allows the trust to designate a portion of its net taxable capital gains for a taxation year as a taxable capital gain of a beneficiary of the trust. Unlike subsection 138.1(3) of the Act, subsection 104(21) of the Act does not deem the beneficiaries to have realized the entire capital gain themselves. However, as a consequence of paragraph (f) of the CDA definition, the non-taxable portion of capital gains distributed by a trust to a corporation may, within limits, be included in the corporation's CDA account. This paragraph is applicable to elections in respect of capital dividends that become payable after 1997.

We trust the above comments will be of assistance.

F. Lee Workman
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch