30 January 2003 Internal T.I. 2002-0163437 - CDN PROPERTY 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:

Whether an interest in a related segregated fund trust is taxable Canadian property and treaty-protected property.

Position:

1. Where the policy is a life insurance policy in Canada as defined in subsection 138(12), the interest in the related segregated fund trust is taxable Canadian property.

2. Where the policy is not a life insurance policy in Canada, the interest in the related segregated fund trust is taxable Canadian property if the policy is issued by an insurer resident in Canada.

3. Whether a particular interest is treaty-protected depends upon the particular circumstances of the taxpayer.

Reasons:

1. The definition "taxable Canadian property" in subsection 248(1) of the Act includes a life insurance policy in Canada for the purposes of section 2 of the Act.

2. An interest in a segregated fund policy is deemed to be an interest in an inter vivos trust ("related segregated fund trust") for the purposes of Part XIII and Part I of the Act. This interest is analogous to a capital interest in a trust for these purposes.

3. An interest in a related segregated fund trust is capital property. Therefore, it may qualify for treaty-protection under the Canada-US treaty. Whether or not the treaty applies depends upon the facts, such as the taxpayer's residence history.

January 30, 2003

MONTREAL TSO						HEADQUARTERS
International Division						Income Tax Rulings
									  Directorate
Attention:  Mary Seccareccia					R. Maley
(613) 957-9226

									2002-016343

Section 115 - interest in a related segregated fund trust

This is in response to your memo dated September 12, 2002 asking for our views as to whether an interest in a related segregated fund trust is taxable Canadian property for the purposes of section 115 of the Act. You have also asked for our views whether such interests could be "treaty-protected property" for the purposes of that section should we conclude that they are taxable Canadian properties.

Subsection 138.1(1) of the Act provides that an interest in a life insurance policy having reserves that vary in an amount depending on the fair market value of a specified group of properties (a "segregated fund") is deemed to be an interest in an inter vivos trust (a "related segregated fund trust") for the purposes of Part I of the Act. (Section 218.1 of the Act deems the provisions of section 138.1 to also apply in respect of the policy for the purposes of Part XIII). For the purposes of this memo, a life insurance policy having all or part of its reserves varying in an amount that depends upon the fair market value of a segregated fund will be referred to as a "segregated fund policy".

You are concerned with the application of section 115 to the gains realized by a person not resident in Canada who, in February 2002, disposed of an interest in a segregated fund policy that was a "life insurance policy in Canada" within the meaning of subsection 138(12) of the Act. As we understand it, the policyholder is of the view that the gain realized on disposition of the interest in the related segregated fund trust would not be subject be to tax in Canada on the basis that the interest in the trust was treaty-protected property.

In our view, any ownership interest in a life insurance policy in Canada is taxable Canadian property for the purposes of section 115 of the Act. Furthermore, we believe that there is a good argument that any ownership interest in a related segregated fund trust issued by a Canadian resident insurer is taxable Canadian property, irrespective of whether the policy is or is not a life insurance policy in Canada. However, whether or not a particular interest in a related segregated fund trust is a treaty-protected property would depend upon the particular circumstances of the taxpayer at issue.

In the particular situation you have described, we agree that the interest in the related segregated fund trust was taxable Canadian property of the non-resident person on the basis that the policy was a life insurance policy in Canada. However, we do not have sufficient information to provide any views as to whether or not the interest was a "treaty-protected property".

Subsection 115(1) of the Act provides that the taxable income earned in Canada for a taxation year of a person who is not resident in Canada includes the following amounts. First, it includes the amount that would have been required to be included in computing the non-resident person's income in respect of a life insurance policy in Canada by virtue of subsection 148(1) or (1.1) if the non-resident person had been resident in Canada throughout the year - see subparagraph 115(1)(a)(vi). Second, it includes taxable capital gains from dispositions of taxable Canadian property other than treaty-protected property - see paragraph 115(1)(b).

Subsection 248(1) defines "taxable Canadian property" to include property of a taxpayer that is a capital interest in a trust resident in Canada (other than a unit in a unit trust that is a mutual fund trust). It goes on to provide, further, that for the limited purposes of section 2, subsection 107(2.001) and sections 128.1 and 150, and for the purpose of applying paragraphs 85(1)(i) and 97(2)(c) to a disposition by a non-resident person, it includes a life insurance policy in Canada. (NB emphasis added)

In our view, this "extended meaning" of taxable Canadian property confirms that a life insurance policy in Canada is a taxable Canadian property for the purposes of section 115. Paragraph 2(3)(c) of the Act provides that a person who is not taxable under subsection (1) for a taxation year who disposed of taxable Canadian property at any time in the year or a previous year shall pay income tax as required by the Act on the taxable income earned in Canada for the year determined in accordance with Division D. Division D of the Act comprises sections 115 and 116.

Subsection 248(1) defines a "life insurance policy in Canada" to have the meaning assigned by subsection 138(12) of the Act. Subsection 138(12) defines a "life insurance policy in Canada" to be a life insurance policy issued or effected by an insurer on the life of a person resident in Canada at the time the policy was issued or effected.

As it appears to not be in dispute that the subject policy was a life insurance policy in Canada, our view is that it was taxable Canadian property of the taxpayer for purposes of section 115 of the Act.

You have indicated that the policyholder's view is that the gain realized on disposition of the interest in the related segregated fund trust is exempt from Part I tax because such interests are treaty-protected properties. We understand that you currently do not know the bases for this conclusion other than the view that such interests are capital properties.

"Treaty-protected property" is defined in subsection 248(1) of the Act to mean property any income or gain from the disposition of which by the taxpayer at that time would, because of a tax treaty with another country, be exempt from tax under Part I. We note that Article XIII of the Canada-US Tax Convention does provide some relief from double taxation in respect of gains realized on disposition of capital properties.

Article XIII of the Canada-US tax treaty applies generally to "gains" realized in respect of property or, in the case of section 9 thereof, to "capital assets". Rulings opinions E9518087 and E9323846 confirm that, in applying that article of the treaty, "gains" means "capital gains" for Canadian tax purposes and "capital assets" means "capital property" within the meaning set out in section 54 of the Act. As interests in related segregated fund trusts can generate capital gains within the meaning of section 39 of the Act, our view is that such interests are capital properties and may be treaty-protected property by virtue of this Article of the Canada-US tax treaty.

However, it is our view that the application of this Article to the interest at issue could not be determined without complete details of the individual's residence history and details of the capacity in which he held the segregated fund policy.

We would also note that certain interests in segregated fund policies may be taxable Canadian properties in circumstances where the policies are not life insurance policies in Canada. As noted above, the definition "taxable Canadian property" in subsection 248(1) of the Act includes capital interests in trusts resident in Canada other than units in unit trusts that are mutual fund trusts.

In rulings' opinion E2000-0032685 we noted that a policyholder's interest in a related segregated fund trust is analogous to a capital interest in a trust for the purposes of Part I and Part XIII of the Act. In rulings' opinion E2000-0038745, we further noted that a segregated fund policy generally includes two distinct types of interests:

Under the current scheme of the Act, two distinct types of interests are contemplated for life insurance contracts. First, there is the interest in a contract that is deemed to be an interest in a related segregated fund trust ("the first interest"). Second, there is the remaining interest in the life insurance policy that is not deemed to be an interest in a related segregated fund trust ("the second interest"). The adjusted cost base of the first interest is defined by section 53 of the Act, while subsection 148(3) excludes amounts relevant to the first interest from the adjusted cost base of the second interest. Similarly, our view is that dispositions in respect of the first interest are defined by section 54 of the Act (sic, now subsection 248(1)), while dispositions in respect of the second interest are defined in subsection 148(9).

We would note that only an interest in a related segregated fund trust is analogous to a capital interest in a trust (i.e., the first interest discussed above) and not necessarily the taxpayer's interest in the entire policy. Thus, it must be kept in mind that only the interest in the related segregated fund trust could be viewed (depending on the facts) as treaty-protected property. The second interest discussed above in a life insurance policy is subject to section 115 of the Act pursuant to subparagraph (a)(vi) of that section.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. 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 electronic library version, or they may request a copy severed using 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.

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