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Ottawa, October 23, 1997
1997-091
Minister Provides Details of Foreign Property Limit for Segregated Funds
Related document:
Finance Minister Paul Martin today announced details of the proposed changes to the Income Tax Act that will extend the 20 per cent foreign property investment limit to segregated fund policies held under registered retirement savings plans, registered retirement income funds and other deferred-income vehicles.
A segregated fund policy is an arrangement created by an insurance company, under which investors' returns are based on the return earned by the insurer on a specified group of properties. It is a life insurance product that, from the perspective of an investor, is similar to a mutual fund.
Under the existing law, units in a mutual fund are generally treated as foreign property at any time in a year if more than 20 per cent of the mutual fund's assets in the preceding year consisted of foreign property. On December 19, 1996, Minister Martin announced that beginning in 1998 similar rules would apply to segregated funds subject to transitional measures that would be discussed with the insurance industry.
Further to these consultations, it is proposed that the foreign property limit be phased-in over 4 years for segregated funds created before 1997 and that certain segregated funds no longer issued be exempt from the proposed rules. Where the 20 per cent foreign property limit is exceeded, the special penalty tax in the Income Tax Act will apply beginning January 1999 to interests in a segregated fund that are foreign property. The characterization of an interest in a segregated fund as foreign property is generally based on the amount of foreign property held by the fund in the previous year. Consequently, beginning in 1998, insurance companies will need to monitor the level of foreign property in segregated funds that they offer.
The attached appendix describes the proposed new rules in greater detail. Draft legislation to implement these proposals will be released next year.
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For further information:
Andrew Nicholls
Tax Legislation Division
(613) 995-3586
Appendix
Application of Foreign Property Limit to Segregated Funds
1. Introduction
The new foreign property rules for segregated funds will apply in three situations.
First, they will apply where an interest in a segregated fund is held by a tax-exempt taxpayer described in paragraphs 205(a) to (f) of the Income Tax Act, such as a registered pension plan (RPP), a trust governed by a registered retirement savings plan (RRSP) or a trust governed by a registered retirement income fund (RRIF). Such taxpayers are subject to tax under Part XI of the Act if they invest too heavily in "foreign property". Under the proposed changes, an interest in a segregated fund will, in some circumstances, become a "foreign property" and the holding of such an interest can result in Part XI tax becoming payable.
A similar penalty tax may apply where an interest in a segregated fund policy is held directly as an RRSP or RRIF (i.e., outside of an RRSP or RRIF trust), or where such an interest is issued under an RPP that is not an RPP trust or corporation. The tax will generally be collected by the insurer that issued the segregated fund policy on behalf of the policyholder that is liable to pay it.
Third, the new rules can result in Part XI tax for an insurer where the Minister accepts a segregated fund administered by the insurer as a "registered investment" under proposed amendments to Part X.2 of the Act.
The application of the proposed rules to these three situations is described below.
2. Tax payable under Part XI of the Income Tax Act by trusts governed by RRSPs, RRIFs and RPPs
General
A trust governed by an RRSP, RRIF or RPP is generally liable to pay a penalty tax under subsection 206(2) of the Act in respect of a month where the cost amount to the trust of the "foreign property" (as defined in subsection 206(1)) held by the trust exceeds 20 per cent of the cost amount to the trust of all property held by it.
Under paragraph (i) of the definition "foreign property", an interest in a trust is a foreign property, except where the trust is a "registered investment" or where the interest in the trust is prescribed not to be a foreign property under the Income Tax Regulations. Under the proposed amendments, after 1998, an interest in a segregated fund will be a treated as an interest in a trust for the purpose of Part XI. As a consequence, a trust governed by an RRSP, RRIF or RPP that holds a segregated fund policy in any month that ends after 1998 may be liable to pay the penalty tax under Part XI.
When is an Interest in a Segregated Fund Prescribed Not to be a Foreign Property?
The proposed amendments include a number of transitional provisions described below. However, section 5000 of the Regulations will prescribe an interest in a segregated fund held at a particular time not to be a foreign property in two cases:
- where the particular time is after 1999 and, throughout the last year that ended before the particular time (or at the end of the year that includes the particular time, if the fund was created in the year that includes the particular time), the total cost amount of all the foreign property held by the segregated fund does not exceed 20 per cent of the cost amount of all the property held by it; or
- where each policyholder holding an interest in the segregated fund at the particular time held an interest in the fund at the end of 1996 or acquired the interest from another policyholder who held an interest in the fund before 1997.
Transitional rules are proposed for 1999, 2000 and 2001 to give insurers an opportunity to shift the properties held by the segregated funds that they administer from foreign properties to non-foreign properties. To this end, an interest in a segregated fund will be prescribed not to be a foreign property in 1999 where:
- the segregated fund was created before 1997 and, at any time in the first 90 days of 1998, the fair market value (FMV) of all the foreign property held by the fund does not exceed 80 per cent of the FMV of all the property held by the fund;
- the segregated fund was created in 1997 or 1998 and, at any time in the first 90 days of its 1998 taxation year, the FMV of all the foreign property held by the fund does not exceed 20 per cent of the FMV of all of the property held by the fund; or
- the segregated fund was created in 1999 and, at the end of 1999, the cost amount of all of the foreign property held by the fund does not exceed 20 per cent of the cost amount of all of the property held by the fund.
In 2000, an interest in a segregated fund will be prescribed not to be a foreign property if the segregated fund was created before 1997 and, throughout 1999, the cost amount of all the foreign property held by the segregated fund does not exceed 60 per cent of the cost amount of all the property held by the fund.
In 2001, an interest in a segregated fund will be prescribed not to be a foreign property if the segregated fund was created before 1997 and, throughout 2000, the cost amount of all the foreign property held by the segregated fund does not exceed 40 per cent of the cost amount of all the property held by the segregated fund.
"Cost Amount" for the Purposes of Part XI of the Act
Under the proposed amendments, where an interest in a segregated fund is, after 1998, treated as "foreign property", the "cost amount" of the interest will be determined on a lagged basis.
Specifically, the "cost amount" of an interest in a segregated fund to an RRSP trust, RRIF trust or RPP will be its adjusted cost base (ACB), except that the ACB adjustments that would otherwise be required in a particular calendar year will not be made until after March of the following calendar year. An interest in a segregated fund will have a known constant ACB throughout each year as ACB adjustments in respect of the year will not be made until the following year, making it possible for taxpayers subject to the foreign property penalty tax to comply with the foreign property limit on an on-going basis.
3. New Foreign Property Limits with respect to Segregated Fund Policies Issued or Effected as RRSPs or RRIFs and Policies Issued under RPPs
Segregated Fund Policies Issued or Effected as RRSPs or RRIFs
The new rules will also apply where, after 1998, an individual holds an interest in a segregated fund directly as an RRSP or RRIF (i.e., outside a RRSP or RRIF trust). In general, the policyholder's liability for penalty tax will be determined on a policy-by-policy basis. Where the penalty tax is owing, the insurer that issued the segregated fund will be required to collect the penalty tax on behalf of the policyholder.
A policyholder will be liable to pay the penalty tax in respect of a segregated fund policy for any month where the total cost amount (determined on a lagged basis as described above) at the end of the month of all the interests in segregated funds under the policy that are foreign properties exceeds 20 per cent of the total of
- the cash surrender value of the policy at the end of the month (not including any amount in respect of an interest in a segregated fund), and
- the total cost amount (determined on a lagged basis) at the end of the month of all the interests in segregated funds under the policy.
For this purpose, whether an interest in a segregated fund is a foreign property is determined using the definition of "foreign property" described above.
Where an insurer has issued interests in more than one segregated fund policy, the insurer will be able to treat those policies as one policy for purposes of calculating how much penalty tax is payable. The election will allow policies that derive their value largely from foreign property to be offset by policies that derive their value largely from non-foreign property.
Segregated Fund Policies Issued under RPPs
The administrator of an RPP (other than an RPP trust or corporation) may also be liable to pay foreign property tax where the RPP is funded or partially funded by an interest in a segregated fund policy.
The administrator's liability will be determined on an insurer-by-insurer basis. As a consequence, all the segregated fund policies used to fund the RPP that were issued by a particular insurer will be grouped together for this purpose. The administrator will be liable to pay tax in a given month in respect of the policies issued by a particular insurer where the total cost amount (determined on a lagged basis as described above) at the end of the month of all the interests in segregated funds that arise under the policies and that are foreign properties exceeds 20 per cent of the total of
- the cash surrender values, at the end of the month, of all the policies (not including any amount in respect of an interest in a segregated fund), and
- the total cost amount (determined on a lagged basis) at the end of the month of all the interests in segregated funds that arise under the policies.
For this purpose, whether an interest in a segregated fund is a foreign property will be determined using the definition of "foreign property" described above.
Where an RPP is funded with segregated fund policies issued by more than one insurer, the administrator of the RPP will be able to elect to treat all such insurers as one insurer for purposes of determining its penalty tax liability. Where the policies issued by one insurer have a high foreign property content, the election will make it possible for an administrator to offset that high foreign property content with the non-foreign property content of policies issued by other insurers.
The responsibility for collecting and remitting an administrator's penalty tax falls on the insurer, unless the administrator makes the election to treat all insurers as one. Where this election is made, the responsibility for collecting and remitting the penalty tax falls on the administrator.
4. Registered Investments
Under the proposed rules, Revenue Canada will be able to accept a segregated fund as a registered investment under subsection 204.4(1) of the Income Tax Act. If a segregated fund is accepted, an interest in the fund will not be a foreign property for the purposes of the Act. However, the insurer administering the segregated fund will be subject to tax under Part XI of the Act if the foreign property held by the segregated fund ever exceeds the 20 per cent foreign property limit.
The proposed amendments include a transitional provision. If a segregated fund that was created before 1997 is accepted by Revenue Canada as a registered investment under subsection 204.4(1) of the Act, the foreign property limit under Part XI in respect of the fund will be 60 per cent in 1999 and 40 per cent in 2000.
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