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: We are asked for comments on the application of the draft trust provisions set out in the notice of ways and means motion of June 5, 2000 (the draft legislation) to a proposed transfer of securities from the general segregated fund of a life insurance corporation to a newly created specific segregated fund of the same life insurance corporation established for the benefit of the same persons followed by a subsequent transfer of those securities from the specific segregated fund of that life insurance corporation to a newly-created specific segregated fund of a second life insurance corporation created for the benefit of the same persons. As a result of the subsequent transfer, the specific segregated fund of the first life insurance corporation would cease to exist.
Position: It is our view that the first step of the transaction would probably not constitute a qualified disposition as there would be a change in beneficial ownership that is not within the deeming rule set out in paragraph 107.4(2). The second step of the transaction may be within the exception set out in paragraph (f) of the proposed definition "disposition" in subsection 248(1). The transaction raises anti-avoidance issues in that it tries to achieve a rollover of interests indirectly that could not be achieved directly. Whether or not a qualified disposition of trust assets causes the policyholders to realize a disposition depends upon the formality of the transaction.
Reasons: In order for a transaction to constitute a qualified disposition, it is necessary that there be no change in beneficial ownership of the assets transferred. The proposed legislation provides a deeming rule that, in our view, would have very narrow application, as it requires that a beneficiary retain its proportionate interest in "each particular property" of the transferor trust. We note, in this respect, that a single share is a particular property for the purposes of the Act.
XXXXXXXXXX 2000-003268
R. Maley
Attention: XXXXXXXXXX
December 7, 2000
Dear Sirs:
Re: Request for Technical Interpretation
Section 138.1 of the Income Tax Act
Notice of Ways and Means Motion, June 5, 2000
This is in reply to your letters of June 19, 2000 and November 16, 2000 respecting the application of the draft trust provisions set out in the notice of ways and means motion of June 5, 2000 (the draft legislation) to certain transactions involving segregated funds.
In your letter of June 19, 2000, you set out descriptions of two types of arrangements and requested our views as to whether both or either arrangement would constitute a "qualified disposition" within the meaning defined in the draft trust provisions. These arrangements were:
1. A transfer of a portfolio of securities from a general segregated fund of one life insurance corporation to a general segregated fund of another life insurance corporation; and
2. A transfer of a portfolio of securities from a general segregated fund of one life insurance corporation to a newly-created specific segregated fund of the same insurance corporation created for the benefit of the specific persons.
You further requested our views as to whether the mix of assets transferred is relevant to whether such transfers would constitute qualifying dispositions and whether an administrative position such as that adopted Interpretation Bulletin IT-450 (Share for Share Exchange) respecting transfers of fractional interests in property would be applied to property transferred in qualifying dispositions.
In your letter of November 16, 2000, you varied your request, indicating that you were seeking comments on a particular two-step transaction. The two steps were:
1. A transfer of a portfolio of securities from the general segregated fund of a life insurance corporation to a newly created specific segregated fund of the same life insurance corporation established for the benefit of persons who had previously held an interest in the general segregated fund; and
2. A subsequent transfer of that portfolio of securities from the specific segregated fund of that life insurance corporation to a newly-created specific segregated fund of a second life insurance corporation created for the benefit of the specific persons who held interests in the transferring fund. As a result of the subsequent transfer, the specific segregated fund of the first life insurance corporation would cease to exist.
You requested our views on the following issues. First, you requested confirmation that the first step of the transaction would constitute a qualified disposition within the meaning of the draft legislation. Second, you requested confirmation that the first step of the transaction would not result in any disposition being realized by any policyholders of the general segregated fund of the first life insurer. Third, you requested confirmation that the second step of the transaction would not result in a disposition pursuant to paragraph 248(1)(f) of the definition "disposition" in the proposed legislation. Fourth, you requested confirmation that the second step of the transaction would not result in a disposition being realized by any policyholders of the specific segregated fund of the first insurer pursuant to subsection 248(25.1) of the draft legislation. Finally, you reiterated your question as to whether an administrative position such as that adopted Interpretation Bulletin IT-450 (Share for Share Exchange) respecting transfers of fractional interests in property would be applied to property transferred in qualifying dispositions.
Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance tax ruling request. Information circular IC 70-6R3 sets out the specific procedural and information requirements to be met to obtain an advance income tax ruling. Such information would also be required where the opinion requested is in respect of proposed legislation that has not yet been passed into law, if the request is in respect of a specific proposed transaction. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office.
However, we are prepared to provide the following general comments on the draft legislation which are not binding on the Canada Customs and Revenue Agency.
Paragraph (c) of the definition "disposition" in section 54 of the Act provides that a transfer of property to a trust is a disposition unless it does not result in a change in the beneficial ownership of the property. Under proposed amendments, section 54 will be repealed, effective after December 22, 1998 and replaced with a new definition in subsection 248(1). The new definition is similar to the old, however it does narrow the exception in respect of dispositions that do not involve changes in beneficial ownership. In order for such a transfer to not constitute a disposition, it is necessary that the transferee not have held any property immediately prior to the transfer and that the transferor cease to exist immediately after the transfer. In addition, where the transferor is a related segregated fund trust, the transferee must also be a related segregated fund trust.
In our view, the first of the two-steps described in your submission would result in there being a disposition of trust assets to the general segregated fund of the first insurer under the proposed definition in subsection 248(1) as there clearly would be a change in the beneficial ownership of the transferred property. It would, in our view, be possible to structure the second of the two steps in order to satisfy the exception in paragraph (f) of the proposed definition. If all criteria in that paragraph were satisfied, the second of the two steps would not result in a disposition of trust assets to the specific segregated fund of the first insurer for tax purposes.
Under the proposed trust rules set out in the notice of ways and means motion, a rollover will be available where there is a "qualifying disposition" of property to a trust. As a segregated fund is deemed to be a trust for the purposes of the Act, it is our view that a disposition to a segregated fund may be structured so as to constitute a "qualifying disposition".
The proposed definition "qualifying disposition" includes only dispositions that do not result in a change in the beneficial ownership of the property transferred. However, proposed subsection 107.4(2) provides that, under certain circumstances, a change in beneficial ownership will be deemed to not have occurred. These circumstances are those involving transfers of property occurring within a period that does not exceed one day and where the transferor receives no consideration for the disposition. Generally, in those circumstances there would be deemed to be no change of beneficial ownership where "as a consequence of the disposition, the beneficial ownership at the beginning of the period of each beneficiary under the transferor trust in each particular property of the transferor trust is the same as the beneficiary's beneficial ownership at the end of the period in the particular property that relates to the beneficiary's combined interest in the transferor trust and in the other trust or trusts". (Special rules apply in respect of trusts governed by a registered retirement savings plan or by a registered retirement income fund).
We have some concerns about the proposed wording of subsection 107.4(2). Subparagraph (a)(ii) of that provision refers specifically to "each particular property" and not to classes of identical properties. It may be noted that a single share is a particular property for the purposes of the Act (e.g. see the definition "property" in subsection 248(1) of the Act).
The basis for this concern may be more apparent where one is considering the application of the subsection to a trust holding several different types of property. For example, consider a trust having two beneficiaries with 30/70 proportionate interests. The trust has two types of property, shares having a fair market value (FMV) of $300 and an adjusted cost base of $100, and debt instruments having a FMV of $700. The interest of the 30% beneficiary could be satisfied by 30% of each of the shares and the debt, by all of the shares, or by 3/7 of the debt. However, if that beneficiary's interest is to be moved to another trust as a qualified disposition, it is necessary that the beneficiary's interest "in each particular property" at the beginning of the period in the transferor trust be the same as its interest in those particular properties at the end of the period under both of the transferor trust and the transferee trust. Thus, it would seem to be not sufficient, for example, to transfer all of the shares to the recipient trust in satisfaction of the beneficiary's interest, if the transfer is to constitute a qualifying disposition. The beneficiary held a 30% interest at the beginning of the period in each particular property of the transferor trust. At the end of the period, the beneficiary would hold, between the two trusts, a 100% interest in each of the shares and no interest in any of the debt.
The Department of Finance's technical note which were released together with the draft proposals included a very simple example. Unfortunately, it is difficult to extrapolate the policy intention from this example and we question whether subsection 107.4(2), as drafted, would apply to the example proposed. The example was as follows:
Subsection 107.4(2) provides a supplementary rule that applies for the purpose of paragraph 107.4(1)(a). Paragraph 107.4(2)(a) is designed to allow for the division of properties among trust in certain cases. Consider for example, the situation where 1,000 shares of ABC Corp. are held in trust A for beneficiaries X and Y. Assume that X has a 30 per cent interest in the trust and Y has the remaining 70 per cent interest. If 300 shares are transferred to trust B for X and the remaining 700 shares are transferred on the same day to trust C for Y, there has been no change in the economic interests of X and Y. Paragraph 107.4(2)(a) provides that, in these circumstances, the requirement in paragraph 107.4(2)(a) that there be no change in beneficial ownership is satisfied in the event that trust A receives no consideration. Consequently, assuming the other conditions under subsection 107.4(1) are satisfied, there would be a qualifying disposition of the 300 shares to trust B and another qualifying disposition of the 700 shares to trust C.
It is our view that subsection 107.4(2) would not apply to the example transaction because, before the transfer X has a 30% interest in each of the 1000 properties in the transferor trust. After the transaction has a 100% interest in 300 of the properties and a 0% interest in 700 of the properties.
It may be noted that subsection 107.4(2) would clearly have applied if all 1000 of the shares were treated as one particular property for the purposes of that subsection. However, the legislation does not seem to provide any authority for treating more than one property as a single property for the purposes of these provisions. Moreover, it is not clear from this example whether or not the intention behind the given example was to allow only for identical properties to be treated as a single property or whether it was intended that the transfer of any property having a FMV equal to the beneficiary's interest in the transferor trust could be a qualified disposition. In any event, our view is that the current provision would only apply where the beneficiary's interest in each particular property of the transferor trust were transferred to the transferee trust. This may be the case where the property held by the trust is severable.
It is recognized that some property, by its nature, may not be severed in proportion to a person's undivided interest therein. However, it is not the practice of the Canada Customs and Revenue Agency to adopt administrative positions in respect of draft legislation. Instead, we recommend that you relay these concerns to the Department of Finance for their consideration in advance of the proposals being adopted as final legislation.
Where qualifying dispositions do occur between segregated funds, the ramifications to the policyholders of those funds would depend, in our view, to some extent upon the formality of the transaction. For example, where a segregated fund contract specifically permits the insurer to make the change with respect to the underlying assets, it appears there would be no disposition for tax purposes as the policyholder would not be entitled to proceeds of disposition with respect to his or her interest in the policy (i.e. the policyholder would hold the same interest in the same policy before and after the change).
Where, on the other hand, a variation to the segregated fund contract is required in order to permit the underlying qualified disposition, the consequences would depend upon whether or not the variation causes a disposition of the interest in the particular contract at law and the acquisition of an interest in a new contract. Whether or not a disposition occurs as a consequence to the variation of a contract depends upon the specific contract provision and proposed change at issue. This type of determination is not dependent upon the draft legislation and could only be made within the framework of a request for an advance income tax ruling.
Subsection 138.1 deems a segregated fund to be an inter vivos trust for the purposes of Part I of the Act. It seems to us that an interest in a segregated fund, if treated as an interest in a trust, may be viewed as analogous to a capital interest in a trust. Therefore, if a policyholder does not realize any disposition of an interest in a segregated fund contract by virtue of a variation to that contract that occurs in connection with the qualifying disposition, our view is that paragraph 107.4(3)(k) would apply to add the policyholder's cost base in the transferor to its basis, if any, in the transferee trust. That paragraph applies where a taxpayer's beneficial interest in a property ceases to be derived from a capital interest in a transferor trust because of a qualifying disposition, where the occurrence of that qualifying disposition does not cause a disposition of the taxpayer's interest in the transferor. Similarly, if a policyholder should realize a disposition of an interest in a segregated fund contract by virtue of a variation to that contract that occurs in connection with the qualifying disposition, our view is that paragraph 107.4(3)(j) would apply to provide a rollover to the policyholder. That paragraph provides that where a taxpayer disposes of a capital interest in a trust because of a qualifying disposition, and as a consequence acquires a capital interest in the transferee trust, the proceeds of the taxpayer's disposition are deemed to be equal to the cost amount to the taxpayer of its interest in the transferor immediately before the qualifying disposition.
If a transfer of assets from one segregated fund to another requires the cancellation of one segregated fund policy and the implementation of a new policy, for example, where the assets are transferred from a segregated fund of one insurance company to a segregated fund of another insurance company, our view is that there generally would be a disposition of the interest in the first policy and an acquisition of the interest in the second policy, in absence of a specific rule providing otherwise in the particular circumstances. An example of one such rule would be subsection 248(25.1) of the draft legislation. Subsection 248(25.1) provides that, where a transfer of property between trusts is not a disposition by virtue of paragraph (f) or (g) of the proposed definition "disposition" in subsection 248(1), the transferee trust is deemed to be the same trust as the transferor. This would have the effect, for the purposes of the Act, of causing the new policy to be treated as having been made between the same parties as the original policy. If all of the provisions of the new policy are otherwise identical to those of the original policy, there would be no disposition to the policyholder in our view, on the basis that there would be no proceeds of disposition. However, if the new policy is not otherwise identical to the original policy, then whether or not a disposition has occurred would depend upon whether or not the provisions of the new policy are sufficiently different from the provisions of the old to be incompatible with there being a continuation of the original interest. In other words, we would view those provisions of the new contract that differ from those of the original contract as variations to the original contract. Whether or not a variation to a contract is sufficiently material so as to result in a disposition, as noted above, is not dependent upon the draft legislation and could only be made within the framework of an advance income tax ruling.
We would note that your two-step transaction appears to be relying upon the exception in paragraph (f) of the proposed definition "disposition" to avoid a disposition to the policyholders of the first insurer. In order for this paragraph to apply, it is necessary that the transferor fund cease to exist as a consequence of the transaction or series of transactions. If the assets at issue had been transferred directly from the general segregated fund of the first insurer to the specific segregated fund of the second insurer, the transferring fund would have continued to exist and the exception in paragraph (f) of the proposed definition "disposition" would not have been satisfied. Thus, consideration should also be given as to whether the transfer to and from the specific segregated fund of the first insurer is an avoidance transaction and if so, whether or not the provisions of the general anti-avoidance rule would be applicable.
While the foregoing comments are not binding on the CCRA, we trust they assist.
F. Lee Workman
Manager
Financial Institutions
Financial Industries Division
Income Tax Rulings Directorate
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