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 Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
Whether mortgages transfered by bank to trust were sold and therefore should be excluded from "loans" of the bank in determining provincial allocation under section 404 of the Regulations
Position:
Mortgages were sold to the trust and should not be included in "loans" of the bank for purposes of section 404 of the Regulations
Reasons:
Terms of the agreement transferring mortgage receivables from bank to trust
March 30, 2000
VANCOUVER TSO HEADQUARTERS
Tom Markota Alison Campbell
2000-000579
Sale of Mortgage Receivables and Section 404
of the Income Tax Regulations ("Regulations")
This is in reply to your letter of January 21, 2000, wherein you requested our views on a transfer of mortgage receivables from a bank to a trust and whether the mortgage receivables should be considered as "loans" of the bank for the purposes of the provincial allocation calculation in section 404 of the Regulations.
Paragraph 404(1)(b) of the Regulations provides that one factor in the determination of the allocation of income to a province is the amount of loans and deposits of a permanent establishment in a province. Mortgage receivables in respect of loans made by a bank would generally be included in the amount of loans used in the calculation under paragraph 404(1)(b) of the Regulations. In the situation you describe, the mortgage receivables of the bank are the subject of an agreement with a trust, (the trustee of which is a subsidiary of the bank), under which the mortgage receivables are transferred to the trust. The issue has come up as to whether the mortgage receivables are still loans of the bank, or are loans of the trust. To resolve this question, it is necessary to determine whether the transfer under the agreement is in fact a sale of the mortgage receivables to the trust, or does the agreement really result in a financing transaction under which the Bank remains the owner of the mortgage receivables. Whether or not the mortgage receivables have been sold to the Trust requires a determination as to whether the beneficial ownership of the mortgage receivables was transferred. The question of who is the beneficial owner of a property is a question of fact which must be determined on a case by case basis.
In determining whether property has been sold, there is substantial jurisprudence that indicates it is the change in beneficial ownership, and not simply change in legal title that is relevant. The beneficial owner of a property is considered to be the person in whom the substantial benefits and risks of ownership of the property rests. In the case of mortgage receivables, the benefits of ownership would generally include:
1) Entitlement to receive cash flows from the receivables.
2) Increase in the value of fixed-rate receivables due to interest rate declines.
3) Entitlement to sell receivables for consideration.
Under the terms of the Agreement provided to us, it appears that the payments by mortgagors (principal, interest, prepayment and early renewal penalties) will belong to the trust. Furthermore, the agreement clearly provides that the trust has the right to sell the mortgage receivables for consideration. The fact that the trust has agreed to give the bank the first right to purchase mortgage receivables that the trust wishes to sell, does not alter the fact that the trust has the right to realize fair market value consideration on the sale of the mortgage receivables. In our view, the substantial benefits of ownership rest with the trust.
The substantial risks associated with the ownership of mortgage receivables would generally include:
1) Losses resulting from debtor default.
2) Losses resulting from value of security when realized upon being less than outstanding principal and interest.
3) Decrease in value of fixed-rate receivables resulting from increases in interest rates.
Under the terms of the Agreement, it would appear that the bank does, in fact bear the substantial risks associated with the ownership of the mortgage receivables. If the mortgagor defaults, the bank agrees to repurchase the receivables from the trust, at the amount of the outstanding principal plus any accrued and unpaid interest at the time of repurchase. Therefore, if the debtor is unable to pay the balance of the receivable and if the value of the mortgaged property is insufficient to realize the full balance outstanding, the bank will be the one to incur the losses. The Agreement, however, also makes it clear that incorporated into the calculated purchase price of the mortgage receivables is a guarantee fee. This guarantee fee is paid by the trust to the bank to have the bank assume the risks associated with the mortgage receivables. In our view, there would be no reason for the trust to pay the bank to assume the risks unless the transfer of the mortgage receivables to the trust would otherwise result in the trust acquiring the risks of ownership. Therefore, it is our view that the risks of ownership of the mortgages must have been transferred to the trust under the Agreement, otherwise there would be no reason for the trust to agree to pay the bank a guarantee fee to assume the risks.
We considered the argument that for GAAP purposes, the mortgage receivables must be reported on the balance sheet of the bank, because the bank has the substantial risks associated with the ownership of the mortgage receivables. However, we are of the view that the financial statement reporting requirements are not determinative of whether there in fact has been a legal sale of the mortgage receivables to the trust. GAAP requires the bank to report the mortgage receivables on its financial statements because it has the substantial risks of ownership related to the mortgage receivables. We do not dispute that the bank has the risks of ownership related to the mortgages, but as stated above, these risks have been assumed in exchange for a guarantee fee paid by the purchaser of the mortgage receivables.
Finally, we considered the argument that for regulatory reporting purposes, the mortgage receivables are included in the calculations of the minimum capital requirements for the bank. The minimum capital requirements are based upon the risk exposure of the bank. We do not dispute that the bank has risk exposure that is related to the mortgages, but this exposure was assumed in exchange for a guarantee fee. The exposure does not exist because the mortgage receivables were never sold.
In reviewing the Agreement as a whole, it is our view that the parties made it clear that they intended the mortgage receivables to be legally transferred to the trust. It is stated clearly in subclause XXXXXXXXXX that the "XXXXXXXXXX". The agreement also requires that the trust is to pay the bank a guarantee fee in consideration for the bank agreeing to repurchase the Sold Mortgages in the circumstances described in the Agreement. The circumstances under which the Agreement provides for the bank to repurchase the sold mortgages, are those circumstances which would otherwise result in credit or interest rate losses to the trust, or to prevent the mortgagors from being aware that their mortgage has been sold to another party. The trust is also required, under the agreement, to pay the bank an administration fee for administrating the mortgages. If the parties did not intend there to be a sale of the mortgages, it is not clear to us, why the trust would pay a guarantee and administration fee to the bank in respect of mortgages still owned by the bank.
Based on the foregoing analysis of the information provided to us, we are of the view that the mortgage receivables were, in fact, sold to the trust by the bank and are not mortgage receivables of the bank. These mortgage receivables should therefore, we believe, not be included in the "loans" amount used in calculating the provincial allocation under section 404 of the Regulations.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Canada Customs and Revenue Agency's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version, or they may request a copy severed using the Privacy Act criteria, which does not remove client identity. Request for this latter version should be made by you to Mrs. Jackie Page at (613) 994-2898. A copy will be sent to you for delivery to the client.
We trust that our comments will be of assistance to you.
F. Lee Workman
Manager
Financial Industries Division
Income Tax Rulings Directorate
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