21 June 2007 Roundtable, 2007-0229731C6 - Segregated Funds - Various Issues

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.

Principal Issues: 1. Do the Qualifying Disposition Rules in section 107.4 of the Act apply to mergers and partitions of segregated funds?

2. How are non-capital losses realized by a segregated fund treated under sections 138.1 and 104 of the Act?

3. How does paragraph 138.1(1)(j) of the Act apply to payments of segregated fund guarantee benefits in certain circumstances?

Position: See document.

Reasons: See document

CLHIA Conference - May 2007

Question 2

Segregated Fund Issues

Since 1995, the life insurance industry has been requesting the amendment of the rules in Section 138.1 of the Act governing segregated funds to address a number of deficiencies which it believes create competitive disparity relative to issuers of comparable financial products (most notably mutual fund trusts), including:

(i) allowing for certain re-organizations (mergers and partitions) of such funds on a tax deferred basis,

(ii) providing certainty re the efficient flow-through (and/or carry forward) of non-capital losses, and

(iii) creating certainty with respect to both the nature/character (as income vs. return of capital vs capital gain) of payments to honour minimum benefit guarantees (arising upon death and/or maturity) and the timing of inclusion of such payments in the hands of the beneficial owners of segregated fund interests. This last issue is also relevant in order to establish competitive parity with principal protected notes.

Questions:

Will the CRA comment on the following:

(i) the application of section 107.4 of the Act to the transfer of assets between segregated funds on a tax deferred basis, and

(ii) the application of sections 138.1 and 104 of the Act in the context of a non-capital loss realized by a segregated fund trust, and

(iii) the effect of the circumstances listed below, on the application of paragraph 138.1(1)(j) to the payment of a segregated fund guarantee benefit:

A. the guarantee amount under the terms of the segregated fund policy is greater than the amount of premiums paid by the policyholder, net of any withdrawals made from the segregated fund policy,

B. the amount of the guarantee under the terms of the segregated fund policy is to be made to the policyholder on a periodic basis rather than as a lump-sum, and

C. the policyholder may choose, at the time that the guarantee benefit becomes payable under the terms of the segregated fund policy, to receive the guarantee amount directly or to have the insurer apply the amount of the benefit as a premium to purchase additional interests in the segregated fund.

CRA Response:

Qualifying Dispositions

Section 107.4 of the Act provides for the transfer of property between trusts to be effected on a tax deferred basis where the transfer is a "qualifying disposition" as defined in subsection 107.4(1) of the Act. Given that both paragraph 107.4(1)(j) and paragraph 107.4(3)(g) of the Act refer to circumstances where the transferor and transferee are both related segregated fund trusts (having the meaning assigned by section 138.1), it is our view that Parliament contemplated that section 107.4 of the Act could apply to the transfer of assets between related segregated fund trusts. Whether any particular transaction involving the transfer of assets between related segregated fund trusts will be a "qualifying disposition", such that the transfer can be effected on a tax deferred basis, will depend upon the facts of the particular case.

Non-Capital Losses

Where a non-capital loss is realized by a related segregated fund trust, it is our view that section 138.1 of the Act does not provide for a flow-through of the non-capital loss to the beneficiaries of the related segregated fund trust. Subsection 104(13.1) of the Act, provides for many trusts to effectively flow-through the benefits of a non-capital loss realized by a trust to the beneficiaries of the trust. However, pursuant to paragraph (b) of the definition of "trust" in subsection 108(1) of the Act, subsection 104(13.1) of the Act does not apply to a related segregated fund trust.

The ability of a trust to make a subsection 104(13.1) designation in respect of income payable to a beneficiary of the trust, also impacts the adjusted cost base of the beneficiary's interest in the trust. In the case of a trust that can and does make a subsection 104(13.1) designation, the adjusted cost base of the beneficiary's interest in the trust must be reduced pursuant to subparagraph 53(2)(h)(i.1) of the Act. However, the adjusted cost base of a policyholder's interest in a related segregated fund trust will not be reduced by any non-capital loss realized by the related segregated fund trust.

Guarantee Payments

We can confirm that we have not altered the views expressed in document 2001-0102235, with respect to the particular circumstances described therein. It would seem however, from question (iii) above, that there is some concern as to whether the general comments in document 2001-0102235 would apply in those particular circumstances. In this regard, we can clarify that the comments made were in the context of segregated fund policies that provided for guarantee payments, that did not exceed 100% of the net contributions made by a policyholder under the policy, and that were payable under the terms of the policy at the maturity date, upon death of the life insured and at one anniversary date which was half-way through the term of the policy. We have not considered, and were not providing comments with respect to the application of paragraph 138.1(1)(j) of the Act in circumstances where the guarantee amount exceeds the net contributions under the policy or where the guarantees are payable on a more frequent or periodic basis.

We can also clarify at this time that the reference in our document to a transfer of assets to the segregated fund not being a situation to which paragraph 138.1(1)(j) applies, was intended to address a general transfer of assets by the insurer to the segregated fund without any allocation of additional notional units to the policyholder. Where a guarantee owing to a policyholder under a segregated fund policy is satisfied by way of a transfer of assets to the segregated fund and the allocation of additional notional units in the same fund or a separate fund, having a value equal to the value of the assets transferred, it is our general view that the allocation of notional units will constitute the "receipt" of the benefit by the policyholder. In such a case, paragraph 138.1(1)(j) could apply to all or a portion of the amount of the transferred assets.

We are not in a position however, to provide comments at this time, on other concerns that you may have with regard to the questions posed. We are prepared to consider any specific concerns that you may have in the context of an advance income tax ruling request, or a general technical interpretation request, as appropriate in the circumstances.