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.

XXXXXXXXXX 	Tim Kuss
		990983
Attention: XXXXXXXXXX 

July 20, 1999

Dear Sirs:

Re: Article XXI(2) of the Canada - U.S. Income Tax Convention
Request for Technical interpretation

This is in reply to your letter dated April 14, 1999 requesting a technical interpretation on behalf of XXXXXXXXXX regarding the application of paragraph 2 of Article XXI of the Canada - U.S. Income Tax Convention (the “Convention”) with regard to certain “enhanced policy benefits” that may be received, in connection with a demutualization, in respect of certain life insurance policies held by U.S. residents.

Background Information

Demutualization is the process by which mutual companies convert to stock companies. Holders of certain types of policies of a mutual life insurer have rights analogous to those of shareholders, including the right to vote at annual meetings of the insurer and the right to the residual assets of the insurer on liquidation. Legislation to allow insurers to demutualize and to regulate the process has recently been enacted by the government. Each of the above-named insurers has announced its intention to demutualize.

For the past year, the insurers have been working with the Department of Finance to develop an appropriate set of tax rules that will apply on demutualization. In this regard, the Department of Finance released draft legislation on December 15, 1998 (Press Release No. 98-125) (the “Draft Legislation"). We understand that the consultation process is continuing as further issues are identified.

When an insurer demutualizes, the value of the insurer will be distributed to policyholders eligible to participate in the demutualization. Many of the eligible policyholders will receive shares of the insurer (or of a holding corporation); the remainder will receive either cash payments or policy enhancements.

The demutualization benefit for individuals who hold U.S. policies that are “individual retirement annuities” or other U.S. tax-favored retirement policies is expected to take the form of an enhancement of the benefits under the policies. You have told us that if the holders of such policies received shares or cash payments on the demutualization, adverse U.S. tax consequences would result. Such shares could be considered an ineligible distribution that could cause the retirement arrangement to lose its favorable status. Also, a tax on premature distributions could apply.

You have told us that the specific form of enhancement will depend on the type of policy. For annuity contracts in the accumulation phase, there will be an increase in the amount accumulated under the policy. For annuities under which payments are being made or that provide for fixed payments commencing at a future date, the level of payments will be increased. For life insurance policies, the enhancement will generally take the form of an addition to the policy dividends that have accumulated under the policy or to the amount of paid-up insurance that has accrued because of policy dividends. In all cases, the result is that the insurer will have an obligation to make larger payments under the policy.

Under paragraph 139.1(4)(a) of the Draft Legislation, for the purposes of that section, where benefits under an insurance policy are enhanced in connection with a demutualization, the value of the enhancement is deemed to be a benefit received by the policyholder and not by any other person. Such a benefit would be considered a “conversion benefit”, a “specified insurance benefit” and a “taxable conversion benefit” within the meaning of those terms under the Draft Legislation.

Generally, pursuant to paragraph 139.1(4)(f) of the Draft Legislation, where at any time a stakeholder receives a “taxable conversion benefit” the corporation that conferred the benefit is deemed to have paid a dividend at that time on shares of its capital stock equal to the value of the benefit, and the benefit received by the stakeholder is deemed to be a dividend received by the stakeholder at that time.

Pursuant to subsection 139.1(8) of the Draft Legislation where, in connection with a demutualization of an insurance corporation, a stakeholder receives a “specified insurance benefit” the stakeholder is deemed to have paid and the corporation is deemed to have received, at the time of the demutualization, a premium in respect of the policy to which the benefit relates equal to the value of the benefit.

Opinion Requested

You have requested our opinion regarding the application of paragraph 2 of Article XXI of the Convention in respect of the deemed dividends arising because of the policy enhancements received, in connection with a demutualization, in respect of certain U.S. tax-favored, individually-owned annuity contracts and life insurance policies that have as their purpose the provision of pension or retirement benefits.

The specific types of policies you have asked us to consider are as follows:

1. “individual retirement annuities” pursuant to paragraph 408(b) of the Internal Revenue Code (the “Code”);

2. “tax-sheltered annuities” pursuant to paragraph 403(b) of the Code;

3. “qualified annuity plan” annuities issued directly to the participant in a plan under paragraph 403(a) of the Code;

and

4. annuity contracts or life insurance policies issued directly to the plan participant under a plan qualified under paragraph 401(a) of the Code.

In this regard, you have represented (and we have assumed as fact for purposes of the opinion given below) that the above-named plans or arrangements are generally exempt from income taxation in a taxable year in the U.S. and the purpose of such plans or arrangements is exclusively to administer or provide pension, retirement or employee benefits within the meaning of paragraph 2 of Article XXI of the Convention.

Opinion

It is our opinion that dividends that are deemed to be received pursuant to paragraph 139.1(4)(f) of the Draft Legislation, relating to “enhanced policy benefits” received in respect of one of the above-named plans or arrangements, in the circumstances described in this letter, are exempt from income taxation in Canada pursuant to paragraph 2 of Article XXI of the Convention.

For greater certainty, this opinion only applies in respect of dividends arising because of enhanced policy benefits and not dividends arising due to cash or other consideration paid directly to the policyholder. It is our view that such dividends would not be derived by the “... trust, company, organization or other arrangement...” referred to in paragraph 2 of Article XXI of the Convention. The opinion is also restricted to those plans or arrangements described in this letter. Other types of arrangements would have to be considered on a case by case basis.

In accordance with the comments in paragraph 22 of Information Circular 70-6R3, written opinions are not income tax rulings and are not binding on the Department.

We hope our comments are of assistance.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch