25 February 2002 Internal T.I. 2001-0105537 - LIABILITY IN RESPECT OF SEGREGATED FUNDS

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:

Is the Negative Reserve in respect of a segregated fund excluded from the amount determined under section 1404 of the Regulations by virtue of paragraph 1406(b) of the Regulations?

Position: No

Reasons:

An amount determined under section 1404 of the Regulations in respect of a Negative Reserve does not represent a liability in respect of a segregated fund.

                                                      February 25, 2002

TORONTO EAST TSO                          HEADQUARTERS
Section 448-1-1                                 Michèle Trotier
(613) 957-3494
Attention:  Soon Yee
                                                      2001-010553

XXXXXXXXXX ("Insurer")
Post-1995 Life Insurance Policies

This is in reply to your memorandum dated September 21, 2001 which was forwarded to us along with a memorandum from our Industry Insurance Specialist Duncan McKay dated October 10, 2001.

The Insurer has issued post-1995 segregated fund life insurance policies which you refer to as the XXXXXXXXXX (the "Policies") and the issue is what amount is to be excluded pursuant to paragraph 1406(b) of the Income Tax Regulations ("Regulations") from the amount to be determined under section 1404 of the Regulations in respect of the Insurer's post-1995 life insurance policies in Canada.

With respect to life insurance policies in Canada that are post-1995 life insurance policies an insurer is entitled to deduct a reserve, pursuant to subparagraph 138(3)(a)(i) of the Income Tax Act, calculated in accordance with section 1404 of the Regulations. The reserve pursuant to section 1404 of the Regulations which is calculated with reference to amounts reported to the Office of the Superintendent of Financial Institutions (the "OSFI") includes an amount in respect of policyholder liabilities, including the liability in respect of a guarantee in respect of a segregated fund policy, and an amount in respect of the excess of the future stream of management fee income and surrender charge income expected to be earned during the term of the segregated fund policy over the commissions and investment/administrative expenses expected to be incurred during the term of the segregated fund policy (the "Negative Reserve").

Pursuant to paragraph 1406(b) of the Regulations any amount determined under section 1404 of the Regulations shall be determined without reference to any liability in respect of a segregated fund other than a liability in respect of a guarantee in respect of a segregated fund policy.

The Insurer's liability in respect of the Policies would be in respect of the investments held by the Insurer in the segregated fund and the guarantee provided in respect of the segregated fund. The liability of the Insurer with regard to these investments is an amount equal to the fair market value of the investments which are segregated from the other assets of the Insurer and which are reported as a separate account to OSFI. This liability would not be included in the amount determined for purposes of section 1404 of the Regulations as provided for in paragraph 1406(b) of the Regulations. The amount determined in respect of the liability for the guarantee provided by the Insurer which is included in the general fund reserve of the Insurer would be included in the amount determined pursuant to section 1404 of the Regulations as provided for in paragraph 1406(b) of the Regulations.

In our view no adjustment would be made to the reserve reported to OSFI in respect of the amount of the Negative Reserve related to the Policies which is included in the general fund reserve of the Insurer as such amount is not a liability in respect of the segregated fund. As noted this amount represents the excess of the future stream of management fee income and surrender charge income expected to be earned during the term of the Policy over the commissions and investment/administrative expenses expected to be incurred during the term of the Policy.

An official of the Department of Finance expressed agreement with our interpretation. The official indicated that there was no legislative intent to view the amount of a Negative Reserve as constituting a liability in respect of a segregated fund. Accordingly the policy intent, which we believe is supported by the words of the legislation, is that no adjustment would be made pursuant to paragraph 1406(b) of the Regulations for the amount of the Negative Reserve included under section 1404 of the Regulations.

For your information a copy of this memorandum will be severed using 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 under the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

We trust that the above will be of assistance.

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