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 Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues: Request for information on Mark-to-Market rules from XXXXXXXXXX
Position: Provided some very general comments and copies of articles and legislation.
Reasons: See above - as requested.
XXXXXXXXXX 980316
Attention: XXXXXXXXXX
April 30, 1998
Dear Sirs:
Re: Mark-to-Market Property Taxation in Canada
This is in reply to your letter dated February 9, 1998, concerning your request for information pertaining to the income tax treatment of mark-to-market property in Canada under the Income Tax Act (the Act).
In response to your first question concerning the scope of the mark-to-market property rules in Canada the rules are applied on an institutional basis, rather than on a transactional basis. Specifically, the Act generally requires a taxpayer that is a "financial institution" to report all gains or losses from the dispositions of "mark-to-market property" held by it in a year on income account. The general purpose of the mark-to-market property rules is to bring the income tax reporting of gains and losses from such property in line with their accounting treatment (i.e., on income account rather than on account of capital).
The terms "financial institution" and "mark-to-market property" are defined in the Act for the purpose of these rules. 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 arms length parties, an investment dealer or any corporation controlled by a financial institution. Mark-to-market properties will generally include all shares held by a financial institution (other than certain share investments) and certain specified debt obligations (also defined in the Act) where the specified debt obligations are carried at their fair market value on the taxpayer's financial statements for the year (with certain exceptions). To accomplish this objective, if there has not been an actual disposition of a mark-to-market property in the year the Act will generally deem a disposition and reacquisition of each mark-to-market property held by them at the end of each year for proceeds of disposition equal to the property's fair market value at that time.
As part of the introduction of the mark-to-market rules in Canada, new rules were also introduced that 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). Specified debt obligations are generally defined in the Act to include an interest in a loan, bond, debenture, mortgage, note, agreement of sale or any other similar indebtedness, whether purchased or otherwise, other than certain defined or prescribed exclusions. It should be noted that a specified debt obligation can also be considered a mark-to-market property and in that situation the mark-to-market rules, as described above, will apply rather than the specified debt obligation rules. The general intent of the specified debt obligation rules is 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). The rules for specified debt obligations will generally first apply to a financial institution's taxation year that ends after February 22, 1994.
In response to your second and third questions there are some transitional rules that may apply to smooth the impact of the first application of the mark-to-market rules at the end of the financial institution's taxation year that includes October 31, 1994 and for dispositions of specified debt obligations after February 22, 1994.
Generally speaking, any gains and losses from a disposition of mark-to-market property in the first taxation year these rules apply will not automatically be considered to be on income account (as will be the case for later taxation years). Accordingly, the treatment of the gain or loss in this taxation year as being on income account or capital account must be determined based on the facts of the particular situation (only 3/4 of any net capital gains/losses are taxable/deductible, as the case may be, and net capital losses can only be deducted against other net capital gains subject to a three year carry back and an indefinite carry forward period). However, a financial institution will generally be permitted (under prescribed regulations) to spread the impact of any deemed gains incurred as a result of the first application of these rules over a five year period.
Where a financial institution disposes of an interest in a specified debt obligation after February 22, 1994 (that is not a mark to market property), there are essentially three separate components that are included in the taxpayer's income. The first component is referred to as the "transition amount". The transition amount is generally the portion of the gain or loss that relates to any premium or discount that was recognized for financial statement purposes but not for income tax purposes before the new rules came into force. Essentially, any premium or discount not previously recognized for tax purposes before these rules came into effect must be recognized in full in the year of disposition.
The second component is referred to as the "current amount". The current amount is generally the portion of the gain or loss that is attributable to the change in the credit risk of the debtor over time (i.e., the increase in the probability that the debtor will make all payments - a positive amount or an increase in the probability that the debtor will default - a negative amount). Essentially, the portion of the gain or loss on the disposition that results from a change in the creditworthiness of the debtor must be recognized in full in the year of disposition.
The third component that must be considered is referred to as the "residual portion". The residual portion is generally the amount by which the gain or loss exceeds the current amount and the transition amount as described above. This residual portion is essentially the portion of the gain or loss that relates to changes in market interest rates on such obligations and must generally be amortized over the remaining term to maturity of the obligation using one of the methods prescribed by the regulations.
We enclose a copy of the legislation, regulations and technical notes to such legislation and regulations for your information along with a copy of a Canadian Tax Foundation article by Hugh Chasmar which discusses the history and application of these rules for your personal use. In addition we have included a copy of some internally prepared technical material on these rules that was prepared by us when these rules were first introduced. However, we caution that there have been some consequential changes to this legislation since the time Mr. Chasmar's article was published and the internally prepared technical material was prepared but we trust you will find this information to be of some use.
Should you have any tax policy questions concerning the formulation of the mark-to-market rules in Canada please contact Mr. Brian Ernewein. We trust this is the information you require.
Yours truly,
C.B. Darling
Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 1998
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 1998
Email this Content