Section 207.5

In finding that the advantage tax in s. 207.62 applied where a specified beneficiary of an RCA assigned their rights to receive distributions from the RCA in order to secure a personal loan, CRA stated:

By providing security to the lender by way of an assignment of their right to receive distributions under the RCA, the beneficiary was able to obtain a loan on more favourable terms than would otherwise be the case. Taking into account that the RCA custodian was party to the assignment and the RCA permitted the beneficiary to assign their rights under the arrangement, the purpose of which is to provide an income to the beneficiary in retirement, the favourable loan terms represent a benefit to the beneficiary. Since the benefit is conditional on the existence of the RCA, the advantage tax rules apply.

…[T]he advantage is the benefit derived from the security (that is, the favourable loan terms), not the loan itself. Consequently, the advantage tax is equal to the present value of the beneficiary’s savings from the secured borrowing terms as compared to those of an unsecured borrowing. If it had been determined that the loan terms did not reflect arm’s length terms, the full amount of the loan would have been subject to the advantage tax.

An RCA trust acquires and holds a universal life insurance policy on the life of the individual who is the sole specified beneficiary of the RCA. The policy is an exempt policy under the life insurance policy taxation rules in the Act. The death benefit includes the cash value of the policy immediately before death. The amount of the death benefit under the life insurance policy is constant over the duration of the policy as the cash value increases each year, whereas the protection component correspondingly decreases each year. CRA stated:

[T]he amount of the protection component of the death benefit under the policy far exceeds the individual’s own entitlement to retirement benefits under the RCA. The amount also far exceeds a reasonable level of survivor benefits and there is no actuarial basis to support the amount as being reasonable. Upon the death of the individual, regardless of the individual’s number of years of service, salary history or age, the funds derived from the proceeds of the protection component of the death benefit (as well as the cash value…) would become available to the individual’s spouse (or the individual’s estate if the spouse predeceases the individual). That amount would be larger if the individual were to die during the early years of the life insurance policy.

Accordingly…the yearly life insurance coverage is a benefit enjoyed by the individual that is conditional on the existence of the RCA and therefore… is subject to advantage tax.

2013-0481421C6 concerned an RCA holding a life insurance policy that provided more than a nominal death benefit where, after indicating that the holding of the policy appeared to have little to do with providing for benefits under the RCA in relation to retirement, a loss of an office or employment, CRA concluded that the holding of such a life insurance policy by the RCA could give rise to an advantage.

CRA now considered an example of a private-corporation employer, which in addition to establishing a defined benefit registered pension plan (RPP) for all of its employees, also established a trusteed defined benefit supplementary pension plan (an RCA) for several key owner-managers, and which purchased exempt life insurance policies on the life of certain (but not all) plan members, and with the employer contributions (after the RCA refundable tax) being used both to fund the mortality charges and to accumulate cash within the policy. Benefits for those members whose lives were insured will be primarily funded by the RCA through withdrawals from the cash values on their life and using those funds to make payments to those members. On the death of an insured member, the death benefit under the life insurance policy will be retained in the RCA to fund benefits to the surviving spouse (if any) and/or fund benefits to other members of the plan (or surviving spouses) who continue to participate in the plan. Upon a future winding-up of the RCA, any remaining funds including any funds derived from the proceeds of life insurance death benefits will be returned to the employer on a taxable basis.

CRA stated:

[I]f the survivor benefits under the RCA are in line with the survivor benefits under the RPP, and the amount payable under the life insurance policy on death of the insured does not exceed the amount reasonably required to satisfy the RCA survivor benefits payable in respect of the insured, then generally there would not be an RCA advantage. [However] there…[f]or example… would be an RCA advantage if the policy was acquired to, in effect, provide key-person coverage to indemnify the employer for potential loss of profits or additional costs that may be incurred in the event of the death of the insured. If the insured is a specified beneficiary of the RCA and does not deal at arm’s length with the employer, RCA advantage tax would arise in this situation.

[I]n the determination of the amount of the RCA advantage in each year…the cost of equivalent term-life insurance coverage based on insurance underwriting considerations such as the individual’s age, gender, and health would be a relevant factor.

A corporation is the owner and beneficiary of an insurance policy on the life of a senior executive officer, who is also a shareholder, which was acquired to provide key person coverage to indemnify the corporation for a potential loss of profits on the insured’s death. The corporation no longer needs the policy on the executive’s retirement, and it transfers the policy to him for no consideration at a time when the particulars are:

• Death benefit $1,000,000
• Cash surrender value $ 125,000
• Adjusted cost basis $ 50,000
• Fair market value $ 125,000

Without being queried on this issue, CRA stated:

Although there are certain exceptions in the "advantage" definition, a benefit arising from the RCA holding a life insurance policy is not among them.

It is not clear under what circumstances an RCA would be holding a life insurance policy that provides for more than a nominal death benefit. The holding of such a life insurance policy would appear to have little to do with providing for benefits under the RCA in relation to retirement, a loss of an office or employment, or a substantial change in services rendered. The holding of such a life insurance policy by the RCA could give rise to an advantage and, therefore, advantage tax under section 207.62… .

Background

Holdco (a taxable Canadian corporation) holds all the shares of Opco, as its only asset other than cash. Holdco’s common shares are owned by X and its preferred shares by Parent (a non-resident corporation). While Opco was still carrying on a business, it entered into “SERP Agreements” with executive employees of Opco (the “Pensioners”) pursuant to which it undertook the “SERP Obligations,” i.e., to pay supplemental executive pension benefits to each Pensioner (including a surviving spouse) respecting services rendered by the Pensioner in Canada. The Opco business has been discontinued, and its assets consist predominantly of cash.

Parent assumption of SERP Obligations

Pursuant to the terms of a Consent, Assignment and Release Agreement that will be entered into with each Pensioner, each Pensioner will permit Opco to assign to Parent, and Parent to assume from Opco, the SERP Obligations, and Opco will assign to Parent, and Parent will assume, all of the SERP Obligations for no consideration. Neither Parent, nor any other entity in the Corporate Group, will be required to, or will, “ear-mark” or segregate any of its assets, or purchase a specific asset to secure or fund the SERP Obligations.

Wind-ups

Opco will transfer certain of its assets, if any, that have accrued gains to Holdco for cash consideration equal to the FMV of such assets so transferred.

Opco will be wound up so as to have s. 88(1) apply.

Holdco will be wound-up, so that:

a) Holdco will settle all of its liabilities.

b) Holdco will transfer sufficient cash deposits and other assets to Parent, to satisfy the liquidation entitlement of the preferred shares.

c) To the extent that there are any remaining assets of Holdco, they will be transferred to X to satisfy the liquidation entitlement of the Holdco common shares.

No portion of the cash deposits or near-cash investments that become assets of Parent as a result of the wind-up of Holdco, or as a result of the wind-up of Opco, will be required to be, or will be, “ear-marked” or segregated to secure the SERP Obligations that were assumed by Parent from Opco or by Holdco from Opco prior to the commencement of the winding-up of each of Opco and Holdco.

Opco and Holdco will be dissolved.

Rulings

No portion of the cash or near cash investments distributed by Opco to Holdco, or by Holdco to Parent, will be considered to be subject property of an RCA for the purposes s. 207.6(1), or a “contribution” made to an RCA, in respect of the SERP Obligations that will be assumed by Parent. In its summary, CRA stated:

The existing arrangement is an unfunded SERP of Opco that is not an RCA and none of the proposed transactions involving the transfer of the SERP liability to Parentco would create an RCA.

Background (current LC structure)

The company maintains a non-registered supplemental employee retirement plan (the “SERP”), which is a retirement compensation arrangement (“RCA”) in order to provide pension benefits to eligible employees whose benefits under the Company’s registered pension plan are restricted by the Act’s maximum pension limitations. Benefits payable under the SERP upon retirement, death or termination of employment of the member are paid by the Company out of its general revenues. Benefits under the SERP are secured with renewable letters of credit (“LOCs”) issued by, e.g., a chartered bank naming the Trustee of a trust governed by an RCA as the beneficiary of the LOCs. The Company periodically makes arrangements for the renewal or replacement of the LOCs in a face amount equal to the “Net Liabilities,” i.e., the actuarially-determined liabilities of the SERP less the market value of any SERP assets. The Company makes a payment to the Trustee in an amount equal to the issuing bank’s Standby Fee and makes a payment in the same amount to the Receiver General on account of the refundable tax payable under Part XI.3. The Trustee, in turn, pays the Standby Fee to the bank which then delivers the renewal or replacement LOCs to the Trustee.

Proposed transactions

The Company, in conjunction with the establishment of ae New Trust, the Company will make arrangements with one or more insurance companies (“Sureties”) to deliver surety bonds to the Trustee which have an aggregate penal sum equal to the Net Liabilities and have a term not less than one year. The SERP will be amended to provide for the Net Liabilities of the plan to being secured using surety bonds rather than LOCs.

Every time a surety bond is required to be issued, renewed or replaced, the Company will be required to pay the Surety Fee to the Trustee under the New Trust, and the Company will make a corresponding payment to the Receiver General equal to the Surety Fee on account of the refundable tax payable under Part XI.3. The Trustee will, in turn, pay the Surety Fee to the Surety for such issuance, renewal or replacement of a surety bond.

The Current Trust Agreement will be terminated and the Company will continue paying benefits under the SERP as they fall due out of its general revenues.

Purposes

The fees for the surety bonds are expected to be lower than those for the LOCs. In addition, “surety bonds will not reduce the Company’s borrowing capacity (in contrast to LOCs).”

Rulings

The amounts paid to the Trustee by the Company and the amounts remitted to the Receiver General by the Company pursuant to s. 153(1)(p) and Regs. 103(7) and 108(1) will constitute contributions made to the RCA , and will be will be deductible by the Company to the extent permitted by s. 20(1)(r) for the taxation year in which they are made.

Regarding the deductibility of foreign tax paid on non-business income in computing income for purposes of the Part XI.3 tax on retirement compensation arrangements, CRA stated:

Subsection 207.7(1) requires an RCA trust to pay, for each taxation year of the trust, a refundable tax under Part XI.3 of the Act equal to the amount calculated under that subsection. For this purpose, the trust must include, inter alia, income from a property (determined without reference to paragraph 82(1)(b).) The computation of this income from property must be made in accordance with the provisions of Part I. For this purpose, the foreign tax deductions in subsections 20(11) and 20(12) may be applicable depending on the circumstances.

Is an RCA trust subject to the provisions of s. 12 in determining its refundable tax under Part XI.3? CCRA responded:

The determination of the refundable tax within the meaning of that expression in subsection 207.5(1) of the Act requires, among other things, a determination of the trust's income from property calculated without reference to the dividend gross-up in paragraph 82(1)(b). Consequently, we are of the view that the provisions of section 12 are applicable in determining the income from property for the purpose of calculating the refundable tax since there is no reference to disregarding it. … Thus, an RCA trust will be required to include in computing its refundable tax at the end of a taxation year the amount of interest required to be included in computing income from property pursuant to subsections 12(3) and 12(4) and paragraph 12(1)(c) for the year or for a preceding taxation year.

Where an RCA trust holds strip bonds and debentures with interest payable at maturity, should such interest income be recognized only at maturity in computing the "refundable tax" of the RCA. Before finding that the interest was instead to be recognized annually under s. 12(9) and s. 12(3) or (4), CCRA noted that the stripped coupons were prescribed debt obligations pursuant to Reg. 7000(1)(b) and that s. 149(1)(q.1) “does not render the provisions relating to computing income pursuant to subdivision b of the Act inapplicable to an RCA trust.”

In connection with a supplemental executive retirement plan (the “Plan”), the Employer established a trust and made annual contributions to it so that the independent trustee could pay the annual fees for a letter of credit provided by a bank to pay the promised benefits in the event of the Employer’s bankruptcy. The contributions so made were twice the LC fees in order that the Employer could withhold and remit to CRA 50% of the amount of the contributions made to the trustee as Part XI.3 tax. In accordance with the Plan, the Employer pays post-retirement benefits totaling $300,000 directly to the retired employees during the current taxation year. Do such benefits paid directly by the Employer qualify as distributions under the retirement compensation arrangement (“RCA”) as described in para. (c) of the s. 207.5(1) “refundable tax” definition? CRA responded:

[A]n amount is not paid as a distribution under the RCA unless the amount is paid from property held in connection with the RCA. In the above situation, the amounts of the direct payments made by the Employer to retired employees of post-retirement benefits in accordance with the Plan are not amounts paid as distributions under the RCA and would not be taken into account under paragraph (c) of the definition.