13 May 2002 External T.I. 2001-0102235 - SEG FUND GUARANTEE TAXATION

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:

Tax consequences of a guarantee payment made under a segregated fund policy.

Position:

Question of fact whether policyholder will have received or become entitled to receive the guarantee amount at the time it arises under the terms of the contract. If the policyholder has received or has become entitled to receive the guarantee benefit at a particular time, paragraph 138.1(1)(j) will apply to deem the policyholder to have received proceeds of disposition. If the guarantee amount is paid to the policyholder in cash or kind by the insurer, the insurer would be entitled to deduct the amount of the payment in computing income under section 9 of the Act. Where the insurer satisfies the guarantee by transferring assets from its general funds to the segregated fund trust, paragraph 138.1(1)(d) of the Act will apply to deem the insurer to have acquired an interest in the segregated fund trust.

Reasons:     The wording of paragraphs 138.1(1)(d) and 138.1(1)(j).
XXXXXXXXXX                                      2001-010223

May 13, 2002

Dear XXXXXXXXXX:

Re: Segregated Fund Guarantees

As previously discussed (XXXXXXXXXX/Campbell), we are writing to provide our general comments with regard to guarantee payments made by an insurer in respect of a segregated fund policy. We caution that the tax treatment of guarantee payments must be determined with regard to the facts of each particular case taking into account the specific terms of the relevant segregated fund policy.

Our comments are based on the premise that the guarantee forms part of the policy and as such is subject to the provisions of section 138.1 of the Act.

We are generally of the view that guarantee payments made under conditions such that the policyholder can choose to receive the guarantee payments in cash or, have the payment redirected to acquire notional units in a separate segregated fund, would be considered to a benefit that the policyholder became entitled to receive, for the purposes of paragraph 138.1(1)(j) of the Act. Accordingly, the policyholder will be deemed to have received proceeds from the disposition of an interest in the related segregated fund trust in the amount of the guarantee, and will realize a capital gain of the same amount. The insurer would generally be entitled to claim a deduction for the payment in computing income under section 9 of the Act and to the extent the insurer must dispose of assets to satisfy the payment of the guarantee amount, the insurer may realize a gain or loss for tax purposes.

There are certain circumstances where we would consider paragraph 138.1(1)(j) to not apply at the time that a payment is made by an insurer under a guarantee in respect of a fund. This would be the case where the policy provides that the insurer, will satisfy the guarantee by way of a transfer of assets to the fund, without the policyholder having the option of receiving the payment under the guarantee in cash or in kind. In these situations, the policyholder would only be entitled to receive the amount payable under the guarantee in the event of a surrender, maturity or death and therefore the transfer under the guarantee would not be considered an "amount received by the policyholder or that the policyholder became entitled to receive at any particular time in the year" for the purposes of paragraph 138.1(1)(j). Accordingly, the amount of the additional assets to be transferred by the insurer into the segregated fund would not be deemed to be proceeds from the disposition of an interest by the policyholder in the related segregated fund trust pursuant to paragraph 138.1(1)(j) of the Act until such time as the policyholder receives or becomes entitled to receive in the year such an amount.

Where an insurer satisfies a guarantee under a segregated fund policy by transferring assets to the segregated fund trust, paragraph 138.1(1)(d) would apply because there would be property in the segregated fund trust that was not funded with premiums paid under the policy. As a consequence, the insurer would be deemed to have an interest in the related segregated fund trust that is not in respect of any particular property or source of income. The insurer will have a cost of its interest in the segregated fund equal to the fair market value of the assets transferred to the fund and may realize a gain or loss in respect of the disposition of the transferred assets. At the time that the related segregated fund trust ceases to exist, it appears that the insurer will be considered to have disposed of its interest in the related segregated fund trust for nil proceeds. This would result in a loss to the insurer. At this point the legislation is unclear as to whether the loss would be on capital or income account and such a determination would have to be made based on the facts of a particular situation.

We have raised the issue of income or capital treatment in respect of the disposition of an insurer's interest in a related segregated fund trust that was acquired by virtue of the deeming rule in paragraph 138.1(1)(d), with the Department of Finance, for their consideration.

As noted, the foregoing comments are intended as a general discussion only and do not relate to any particular situation. One would have to consider the terms and conditions of the policy to determine whether the policyholder has received or become entitled to receive an amount, as is required under the wording of paragraph 138.1(1)(j). While we hope our comments are of assistance to you they neither address all of the potential income tax implications nor do they constitute an advance income tax ruling and therefore are not binding on the CCRA in respect of a specific situation.

Yours truly,

F. Lee Workman
Section Manager
Financial Industries Division
Income Tax Rulings Directorate