8 November 2024 External T.I. 2024-1006321E5 - Foreign segregated funds and 138.1(1)

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) Whether a foreign life insurance policy can meet the conditions of 138.1(1) following the 2022 amendments? (2) Where the reported amount as defined in 138(12.3) is nil, can a life insurance policy meet the conditions of 138.1(1) without reporting to a relevant authority? (3) What are the tax implications of a life insurance policy ceasing to meet the requirements under subsection 138.1(1)? (4) Will the CRA consider grandfathering life insurance policies issued before the amendments?

Position: (1) Likely not. (2) No. (3) It depends. (4) No.

Reasons: (1) The specified group of properties must be reported to a relevant authority. (2) A reported amount must be reported to a relevant authority. (3) Question of fact. (4) Tax policy matter that should be addressed to the Department of Finance.

XXXXXXXXXX                                                  2024-100632
                                                            Sylvie Danis

November 8, 2024

Dear XXXXXXXXXX,

Re: Foreign Segregated Funds

We are writing in response to your correspondence dated February 2, 2024 wherein you requested clarification of the segregated fund definition in subsection 138.1(1) of the Income Tax Act (Act) in the context of life insurance policies issued by foreign insurers. More specifically, you ask whether a life insurance policy, issued by a foreign insurer that does not operate in Canada and has no reporting obligation to a relevant authority with respect to such a policy, would qualify as a segregated fund under subsection 138.1(1) of the Act, following the enactment of the legislative amendments to that provision applicable to taxation years that begin after 2022. We apologize for the delay of our response.

Our comments

This technical interpretation provides general comments about the provisions of the Act and related legislation. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC70-6R12, Advance Income Tax Rulings and Technical Interpretations.

Where certain conditions are met, section 138.1 of the Act applies to a life insurance policy that is a segregated fund policy issued by an insurer. For purposes of Part I of the Act, paragraph 138.1(1)(a) of the Act deems the creation of a trust and paragraph 138.1(1)(b) of the Act deems the property allocated to the segregated fund, and any income accrued thereon, to be the property and income of the segregated fund trust and not that of the insurer. Consequently, the provisions governing the taxation of trusts and their beneficiaries generally apply to a segregated fund trust.

Under subsection 138.1(1) of the Act, a segregated fund refers to a life insurance policy for which an insurer’s reserves vary depending on the fair market value of a specified group of properties. For taxation years that begin after 2022, the specified group of properties must also be specifically reported to a relevant authority as a segregated fund. Under subsection 138(12) of the Act, a “relevant authority” of an insurer means the Superintendent of Financial Institutions (SFI) if the insurer is required by law to report to the SFI or, in any other case, the Superintendent of Insurance or other similar officer or authority of the province under whose laws the insurer is incorporated.

In general terms, subsection 138(12.3) of the Act provides that for purposes of subsections 138(12) and 138.1(1) of the Act as well as Parts XIV, XXIV and LXXXVI of the Income Tax Regulations, a reference to an amount reported (or that would be reported) as at the end of a taxation year means the amount that is reported (or that would be reported),

(a) if the insurer is a foreign affiliate of a Canadian resident taxpayer, in the insurer's financial statements for the year if those statements conformed with International Financial Reporting Standards;

(b) if the insurer is not described in paragraph (a) and reporting to the insurer's relevant authority is required at the end of the year, in the insurer's non-consolidated balance sheet for the year accepted by the insurer's relevant authority;

(c) if paragraphs (a) and (b) do not apply, and the insurer is subject to the supervision of a relevant authority (even if the insurer is not required to report at the end of the taxation year), in a non-consolidated balance sheet for the year that is prepared in a manner consistent with the requirements that would have applied had reporting to the insurer's relevant authority been required at the end of the year; and

(d) if paragraphs (a) through (c) do not apply, nil.

In our view, an amount referred to in (a) to (d) above, in respect of a specified group of properties, must be reported to a relevant authority in order to meet the requirements in subsection 138.1(1) of the Act.

Whether a life insurance policy constitutes a segregated fund within the meaning under subsection 138.1(1) of the Act is a question of fact. In our view, a key characterization question for the purposes of determining whether a particular life insurance policy is a segregated fund policy for the purpose of section 138.1 of the Act is whether the insurer's reserves vary depending on the performance of a specified group of properties (as reported to a relevant authority). This determination must be based on a review of the actual policy under consideration and the insurer's accounting and valuation methodologies for determining its liabilities in respect of the policy.

In addition, in the absence of specific facts relating to a particular life insurance policy, we are unable to comment on the tax consequences to the policy and/or to the policyholder that would arise from the policy no longer meeting the requirements to be considered a segregated fund under subsection 138.1(1) of the Act. In a self-assessing system, the onus to compute and report taxable income pursuant to provisions of the Act and to determine the amount of tax owing rests with the taxpayer.

It should be noted that the addition of subsection 138(12.3) of the Act, the new definition of relevant authority in subsection 138(12) of the Act and the amendment to subsection 138.1(1) of the Act are part of a comprehensive set of amendments to the Act, applicable to taxation years that begin after 2022, arising as a consequence of the adoption, by the Accounting Standards Board in Canada, of the new International Financial Reporting Standards for insurance contracts (commonly referred to as “IFRS 17”).

Finally, the Act does not provide for the grandfathering of foreign segregated funds that no longer meet the definition in the preamble of amended subsection 138.1(1) of the Act for taxation years that begin after 2022. The question you raise regarding the grandfathering of foreign life insurance policies that may have qualified as segregated fund policies prior to the coming into force of the amendment to subsection 138.1(1) of the Act is a tax policy matter that is the responsibility of the Department of Finance Canada.

We trust our comments will be of assistance.

Yours truly,

Bob Naufal
Manager
for Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch