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: Request from International Relations Office of Legislative Policy Directorate for information on the mark-to-market property rules XXXXXXXXXX.
Position: Provided some very general comments.
Reasons: See below.
November 14, 2013
Alexandro Pace, LL.B, J.D. HEADQUARTERS
International Relations Office Income Tax Rulings
Legislative Policy Directorate Directorate
Bob Naufal
2013-050511
Tax treatment of financial instruments
We are writing in response to your email dated September 17, 2013 wherein you requested information XXXXXXXXXX regarding the income tax treatment of financial instruments in Canada under the Income Tax Act (the "Act").
Please note that based on the general nature of your questions, we are only able to provide you with a broad overview of the relevant Canadian income tax rules regarding the taxation of financial instruments.
In broad terms, under the Canadian income tax rules, a taxpayer's gain or loss from the disposition of shares or a debt obligation such as a bond, debenture, bill, note or hypothec will be taxed as either an income gain or loss or as a capital gain or loss. The full amount of income gains is subject to tax while one-half the amount of capital gains is subject to tax. Information in this regard is available in Interpretation Bulletin, IT-479R Transactions in securities as well as Guide T4037 Capital Gains, both of which are available on our web site at www.cra-arc.gc.ca.
Mark-to-market properties
Sections 142.2 to 142.6 or the Act (commonly referred to as the mark-to-market property rules) were enacted to govern the taxation of certain securities held by certain taxpayers. The mark-to-market property rules apply on an institutional basis rather than a transactional basis. Generally, these rules require a taxpayer that is a financial institution to report all gains or losses from the dispositions of mark-to-market property held by it on income account. The general purpose of the mark-to-market property rules was to clarify the income tax treatment of securities held by financial institutions and to ensure that the income of financial institutions from securities was measured appropriately.
For these purposes, a "financial institution" is defined in subsection 142.2(1) of the Act to include a corporation referred to in paragraphs (a) to (e.1) of the definition "restricted financial institution" in subsection 248(1) of the Act. A financial institution would generally include a Canadian bank or trust company, a credit union, an insurance corporation, a corporation whose principal business is money lending to arm's length parties or acquiring debts from arm's length parties, an investment dealer or any corporation controlled by a financial institution.
The term "mark-to-market property" is defined in subsection 142.2(1) of the Act and generally includes the following:
- most shares;
- where the taxpayer is not an investment dealer, a specified debt obligation that is a fair value property (see commentary below);
- a specified debt obligation of an investment dealer; and
- tracking property that is fair value property.
Mark-to-market property does not include property that is "excluded property", as defined in subsection 142.2(1) of the Act. Generally, the following property is excluded property:
- a share of a corporation in which the financial institution has a significant interest at any time in the year;
- a property that is, at all times in the year at which the financial institution held the property, a prescribed payment card corporation share of the financial institution;
- a property that is, at all times in the year at which an investment dealer held the property, a prescribed securities exchange investment of the investment dealer;
- a share of a corporation held at any time in the year by a financial institution where, within the 24-month period that begins immediately after the end of the year, control of the corporation is acquired by the financial institution (alone or together with persons related to the financial institution) and the financial institution elects to treat the share as not being mark-to-market property; or
- a prescribed property (see section 9002 of the Income Tax Regulations).
Under subsection 142.2(2) of the Act, a taxpayer has a "significant interest" in a corporation at any time if the taxpayer is related to the corporation at that time or if the taxpayer holds shares of the corporation carrying at least 10% of the votes, and representing at least 10% of the fair market value ("FMV"), of all issued shares of the corporation.
Section 142.5 of the Act generally requires a taxpayer that is a financial institution to annually include in computing income the increase or decrease in value of securities that are considered mark-to-market property. Under subsection 142.5(2) of the Act, a taxpayer that is a financial institution is deemed to have disposed of the property immediately before the end of each taxation year for proceeds equal to FMV, and to have reacquired the property at the end of the year at a cost equal to those proceeds.
Specified debt obligations
The term "specified debt obligation" is defined in subsection 142.1(1) of the Act as generally any interest held by a taxpayer in a loan, bond, debenture, mortgage, hypothecary claim, note, agreement of sale or any other similar indebtedness as well as a debt obligation, where the taxpayer purchased the interest. However, a specified debt obligation does not include an interest in an income bond, an income debenture, a small business development bond, a small business bond or a prescribed property as well as any instrument issued by or made with a person to whom the taxpayer is related or with whom the taxpayer does not otherwise deal at arm's length, or in which the taxpayer has a significant interest.
As noted above, where a specified debt obligation that is a fair value property is a mark-to-market property, each year's increase or decrease in value is included in computing the income of the financial institution for the year.
Sections 142.3 and 142.4 of the Act provide for the income tax treatment of specified debt obligations of a financial institution that would not otherwise be a mark-to-market property. In broad terms, these provisions require a financial institution that holds an interest in a specified debt obligation to accrue income annually on such obligation on a yield to maturity basis (as prescribed by regulation). As with the mark-to-market provisions, the general intent of the specified debt obligation rules was to bring the income tax rules in line with the accounting rules for financial institutions (i.e., premiums or discounts are essentially amortized annually and gains or losses on the disposition of such obligations are generally included in income or deducted from income in full).
Tracking property
Generally, a "tracking property" is defined in subsection 142.2(1) of the Act as a property the FMV of which is determined primarily by reference to specified criteria in respect of another property that, if owned by the taxpayer, would constitute a mark-to-market property. The specified criteria include the FMV of the tracked property, the profits or gains from the disposition of the tracked property, the revenue, income or cash flow from the tracked property, or any other similar criteria in respect of the tracked property. Basically, the tracking property rules provide for a "look through" to determine whether the tracked property, if held directly by the taxpayer, would be mark-to-market property. Note that the tracking property definition was added and other amendments to the mark-to-market property rules were made to better align the tax rules with accounting changes that came into effect on October 1, 2006.
Finally, section 142.6 of the Act provides specific rules that apply in various situations such as status changes and transitional measures that generally support the mark-to-market property rules.
We enclose a copy of the legislation, regulations and technical notes to such legislation for your information along with a copy of technical interpretation 2009-032878 that further discusses tracking property.
We trust the above comments are of assistance.
Yours truly,
Jenie Leigh
for Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Enclosures
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