2008 Ruling 2008-0266481R3 - Mortgage interest

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: Is interest paid by the bank the amount required to be included in income of the deposit holders?

Position: Generally yes

Reasons: All deposit holders will be paid at the same rate for the same type of accounts.

XXXXXXXXXX 							2008-026648

XXXXXXXXXX , 2008

Dear XXXXXXXXXX :

Re: XXXXXXXXXX (the "Bank") BN XXXXXXXXXX

This is in reply to your letters of XXXXXXXXXX , and is further to meetings of XXXXXXXXXX and a conference call of XXXXXXXXXX , wherein you requested an advance income tax ruling on behalf of the above-named taxpayer. We also acknowledge earlier letters from XXXXXXXXXX .

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues contained in this ruling request herein are:

(i) dealt with in an earlier return of the Bank or a related person;
(ii) being considered by a tax services office or a taxation centre in connection with a tax return already filed by the Bank or a related person;
(iii) under objection by the Bank or a related person;
(iv) the subject of a previous ruling issued by the Income Tax Rulings Directorate to the Bank or a related person; nor
(v) before the courts, or if a judgment has been issued, the time limit for appeal to a higher court has expired.

The rulings given herein are based solely on the facts, the proposed transactions and the purpose of the proposed transactions described below. The documents submitted with your request do not form part of the facts and proposed transactions on which this ruling is based and any reference to these documents is provided solely for the convenience of the reader.

Unless otherwise expressly stated, all references to a statute are to the Income Tax Act, R.S.C. 1985, c.l (5th Supp.), as amended to the date hereof (the "Act"). All monetary amounts are expressed in Canadian dollars.

Definitions:

(a) "Arm's length" has the meaning assigned to it by section 251 of the Act;

(b) "Customer" and "Customers" refer to individuals resident in Canada who deal at Arm's length with the Bank in order to facilitate personal money deposit accounts, mortgages and other financial service needs; for greater certainty, the term "Customer" shall also include two or more individuals who hold a Performance Offset Mortgage or Deposit Account jointly;

(c) "Deposit Account" means any savings or chequing account regularly offered by the Bank to the public, either as a sole account held by one individual alone or a joint account held by two or more individuals together, which savings or chequing account pays interest monthly at a standard posted interest rate (as amended from time to time) on the deposits held within the account and which deposits are payable to the Customer(s) at any time at the Customer(s)' request. At this time, Deposit Accounts shall include the following:

(i) All chequing accounts; and
(ii) All savings accounts.

For greater certainty, at this time, Deposit Accounts shall not include:

(i) Fixed term accounts or investments regularly offered by the Bank which are not, by the legal terms of the investment, payable with full interest and/or payable at all to the customer until a fixed future date;
(ii) Guaranteed Investment Certificates ("GICs") whether fixed term or redeemable prior to maturity;
(iii) Deferred income an other special income arrangements described in Division G of the Act including Employee Profit Sharing Plans, Tax Free Savings Accounts, Registered Retirement Savings Plans, Deferred Profit Sharing Plans and Registered Retirement Income Funds; and
(iv) Mutual Funds;

(d) "Performance Offset Mortgage" or "POM" has the meaning assigned in the description of the Proposed Transactions below;

(e) "Proposed Transactions" means the proposed transactions contemplated in 11 to 22 below;

(f) "public corporation" has the meaning assigned by subsection 89(1) of the Act;

(g) "Regulations" refers to the Income Tax Regulations, c. 95, as amended;

(h) "Standard Mortgage" refers to the personal mortgage loan products sold commercially on a widespread basis by the Bank, either to one individual as sole borrower or to two or more borrowers together as joint borrowers with joint and several obligations to repay the mortgage loan. Current examples of these types of mortgages include: the High Ratio Mortgage, the Equity Power Mortgage, the Conventional Mortgage and the Construction Mortgage;

(i) "taxable Canadian corporation" has the meaning assigned by subsection 89(1) and 248(1) of the Act;

(j) "taxation year" has the meaning assigned by subsection 249(1) of the Act;

(k) "taxpayer" has the meaning assigned by subsection 248(1) of the Act;

Facts:

1. The Bank is a body corporate duly formed under the Bank Act (Canada), and is a public corporation and a taxable Canadian corporation. The Bank's head office is located in XXXXXXXXXX . The Bank is serviced by the XXXXXXXXXX TSO and it files its returns with the XXXXXXXXXX Taxation Centre.

2. The Bank provides a full range of Canadian financial products and services to businesses, institutions and individuals. This includes deposit taking activities and money lending activities.

3. Services to individuals are provided by the Bank's Personal Financial Services Group ("PFS"). PFS provides individual Customers with a wide range of banking and related financial services including Deposit Accounts, mortgages, personal loans, credit cards and local and international payment service.

4. Customers frequently avail themselves of multiple Bank products and services, including Deposit Accounts, home mortgages, Registered Retirement Savings Plans and various investment products.

5. In particular, the Bank has individual Customers who hold home mortgages with the Bank, and who also have money in Deposit Accounts. As of XXXXXXXXXX, home mortgages bear rates of interest in the range of XXXXXXXXXX % to XXXXXXXXXX %, and Deposit Accounts earn rates of interest in the range of XXXXXXXXXX % to XXXXXXXXXX %. As of XXXXXXXXXX , there were approximately XXXXXXXXXX Deposit Accounts held by customers of the Bank.

Market Linkage between Deposit and Credit Products:

6. Bank posted rates for financial products are usually used as a starting point for negotiations with Customers.

7. XXXXXXXXXX

8. To reduce negotiations and to increase pricing transparency, the Bank, and other financial institutions, have moved to "bundled pricing" strategies where special offers are made to Customers who elect to purchase a package of products rather than a single product. For example, the Bank may offer a Customer a mortgage rate which is significantly lower than the "posted" rate in circumstances where the customer has a $XXXXXXXXXX GIC with the Bank. Conversely, a Customer who has a mortgage with the Bank may receive a reduced fee in respect of a premium credit card.

9. In addition, the Bank, as well as other financial institutions, currently offer preferential pricing or fee discounting for products and services based on deposit balances maintained. Service charges on chequing accounts may be reduced or eliminated when the consumer maintains or exceeds a specified account balance. For example, if a Customer maintains a monthly balance of $XXXXXXXXXX or more in a chequing account, the Bank will waive the monthly fee for all of the Customer's debit transactions.

10. Nevertheless, there is no dynamic pricing in the marketplace. Once the interest rate is set with respect to a financial product, the rate generally remains in force for the term of the contract. For example, the Bank will rarely change the interest rate on a Customer deposit or loan regardless of whether the Customer's dealings with the Bank increase or decrease over the term of the contract. While a Customer may be rewarded with a lower interest rate on a mortgage for depositing $XXXXXXXXXX with the Bank in the form of a GIC, the mortgage rate rarely moves if the Customer subsequently changes the GIC amount.

Proposed Transactions:

11. The Bank proposes to introduce, to individual customers, the "Performance Offset Mortgage" ("POM") option as a modification to one or more of its Standard Mortgage offerings. The POM will be a variation of the Standard Mortgage and, with the exception of the determination of the rate of interest charged on the mortgage in respect of any given month, will operate on the same terms and conditions as a Standard Mortgage. The POM will be available to all Customers who qualify for a Standard Mortgage and who have at least one Deposit Account with the Bank.

12. XXXXXXXXXX

13. Subject to the receipt of a favourable advanced income tax ruling, the Bank will advertise the POM in the retail market and will subsequently sell the POM to Customers who otherwise qualify for the Standard Mortgages and who wish to take advantage of the commercial terms of the POM.

How the POM Reduces Interest Payable:

14. There are two components involved in determining the interest payable on a POM:

(i) A "Linked" Deposit Account; and
(ii) The POM Rate.

A "Linked" Deposit Account:

15. A customer must have at least one Deposit Account with the Bank to be eligible for the POM.

16. A customer, who is otherwise eligible for a POM, will be entitled to designate or "link" his/her Deposit Account with the Bank to his/her POM. The Customer may change the Deposit Account which is "linked" to the POM at any time. At this time, however, only one Deposit Account may be "linked" to a POM. As early as XXXXXXXXXX , the option of linking more than one Deposit Account at a time to a POM may be available. The Bank intends to make "linking" available between any Deposit Account, whether held solely or jointly, and any POM, whether held solely or jointly, provided that in all cases, at least one of the customers holding the POM must also be a holder of the Deposit Account (either alone or jointly with others).

17. Designation of a Customer's Deposit Account to be "linked" to a POM will not affect the terms and conditions of the Deposit Account in any way. In particular, a Deposit Account which is "linked" to a POM will bear the same rate of interest and will be subject to the same terms and conditions as any Deposit Account of the same type that is not "linked" to a POM.

18. The Bank will issue applicable T-5s, at each year end, to all Customers with Deposit Accounts regardless of whether the Deposit Accounts are or are not "linked" to a POM. A T-5 issued to a Customer in respect of a Deposit Account will reflect the full amount of interest paid by the Bank, to the Customer, in respect of that Deposit Account during the calendar year.

The POM Rate:

19. The POM will bear interest computed daily on the full principal balance outstanding under the mortgage account. However, the rate of interest charged on the POM will be reduced in proportion to the balances held by the Customer in the "linked" Deposit Account.

20. Each month, under the terms of the POM, the rate of interest which will apply to the outstanding balance of the POM and which will be used to determine the amount of interest legally payable on the POM will be determined by way of the following formula:

POM Interest Rate = (Mortgage Balance x Mortgage Contract Rate) - (Average Deposit Balance x Mortgage Contract Rate)

Mortgage Balance Another representation of the same formula would be:

POM Interest Rate/Mortgage Balance = (Mortgage Balance - Average Deposit Balance) x Mortgage Contract Rate

and in either case:

(i) "POM Interest Rate" shall be the rate resulting from the formula above that will be used to calculate the daily interest on the POM from the first business day of a calendar month until the first business day of the following calendar month;

(ii) "Mortgage Contract Rate" shall be the rate of interest, whether fixed or floating, agreed upon with the particular Customer and set out in the loan agreement governing the POM as the interest rate to be applied when the Customer carries no balance in the "linked" Deposit Account. If the Mortgage Contract Rate is a floating interest rate, the POM Interest Rate may change in the course of a given month;

(iii) "Mortgage Balance" shall be the total actual outstanding balance of the POM on the first business day of the calendar month;

(iv) "Average Deposit Balance" shall be the average of the daily closing balance in the Deposit Account in the previous calendar month except that:

A. Where the cumulative Average Deposit Balance is zero or negative in a given calendar month, no change to the Mortgage Contract Rate will result for the following calendar month; and

B. The Average Deposit Balance in excess of a specified proportion of the Mortgage Balance will not be considered in the determination of the POM Rate during the following month. In other words, a cap will be applied to designate a maximum Average Deposit Balance amount that can be used to calculate the POM Rate. This cap will be proportional to the mortgage balance and will not exceed 50% of the mortgage balance.

21. Any change to the Average Deposit Balance in a given month will change the POM Rate applied to the POM during the following month. On the first business day of the following month, the POM Rate will be re-calculated and re-set again to be applied for that month.

22. The Bank will earn revenue by either offering a reduced discount off the Bank's posted mortgage rates when setting the agreed Mortgage Contract Rate applicable to the POM or by charging a fee for the POM.

Purpose of the Proposed Transactions:

23. Consumers are telling the Bank that the negotiation process with respect to mortgage pricing is frustrating. Mortgage pricing is not transparent. Consumers view "posted" mortgage rates as merely a starting point for negotiations.

24. A large segment of consumers recognize that the best way to reduce the amount of interest they are paying on their loans is to liquidate their savings and pay down higher interest bearing debt. However, the Bank's research has revealed that these consumers are reluctant to do so for all or some of the following reasons:

(i) An inherent desire to save ("active savers");
(ii) A desire to accumulate readily accessible funds in the event of an emergency the "rainy day" need) without having to access credit; and
(iii) A need to save for family education.

25. The Proposed Transactions will allow the Bank to expand the range of financial products it offers Customers and is expected to attract an even larger Customer base, thereby increasing its money lending business and strengthening its position as a major lender in the Canadian marketplace.

26. The Bank also expects to increase Customer retention as a result of the development of a deeper banking relationship with existing Customers and to increase Customer receptivity to consolidation of financial assets with the Bank.

27. If implemented, the Proposed Transactions will enable Customers to obtain the benefit of a reduced interest rate on their mortgage loans while maintaining a positive balance in the Deposit Accounts. It will also allow Customers to maintain liquidity in the form of Deposit Accounts, such that the funds on deposit may be withdrawn without notice if needed at any time. Customers will pay less interest on their mortgages and be able to repay their mortgages faster.

Rulings Given:

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, the Proposed Transactions and purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, we rule as follows:

A. Provided the Customers of the Bank who have a POM as described in 11 to 22 above receive the same interest rate on a designated Deposit Account as all the other Customers of the Bank who hold a similar Deposit Account, the amount of interest required to be included in income by a Customer of the Bank who has a POM linked to the balance in his/her Deposit Account will not exceed the amount of interest actually paid in the year by the Bank on the Deposit Account as calculated by reference to the Bank's publicly posted rates, solely as a result of the reduction in the mortgage interest rate.

B. Provided the Customers of the Bank who have a POM as described in 11 to 22 above are paid at the same interest rate for a designated Deposit Account as all other Customers of the Bank who hold a similar Deposit Account, the Bank will only be required to issue T5s to its Customers in respect of any amount of interest paid in the year on the balance held by Customers in designated Deposit Accounts.

C. The general anti-avoidance rule in section 245 of the Act ("GAAR") will not be applied, in and by itself, as a result of the Proposed Transactions to re-determine the tax consequences confirmed in the above rulings.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on the CRA provided that the Proposed Transactions discussed in 13 above is implemented by XXXXXXXXXX .

The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Yours truly,

XXXXXXXXXX
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch