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Ottawa, December 19, 1996
1996-100
Minister Announces Proposals Affecting Segregated Fund Policies and Other Annuity Contracts
Related document:
Finance Minister Paul Martin today announced a number of proposed measures affecting the tax treatment of annuity contracts, including segregated fund policies, offered by insurers.
A segregated fund policy is an arrangement made by a person with an insurer, under which the person's returns are based on the returns 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.
The most important measures announced today relate to the 20% foreign property limit set out in Part XI of the Income Tax Act for taxpayers such as trusts governed by registered retirement savings plans. Under the existing law, units in a mutual fund are generally treated as foreign property where more than 20% of the mutual fund's assets are foreign property. In order to bridge a gap in the existing law and to provide for a more level playing field, the same characterization will now apply to segregated fund policies.
The proposed changes are described in more detail in the attached appendix. It is intended that the new rules applying the foreign property limits will be effective after 1997. This will provide a full opportunity to discuss with representatives of the insurance industry the nature of any transitional measures that might be considered to be appropriate. Once consultations are completed, the Minister intends to table the necessary legislation to implement these proposals in the House of Commons.
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For further information:
Andrew Nicholls
Tax Legislation Division
(613) 995-3586
Appendix
Proposed Changes For Segregated Funds And Other Annuities
Background
There are a number of different types of RRSPs and RRIFs currently available to Canadians. One type is the RRSP or RRIF trust, which is a trust established to hold "qualified investments" for the benefit of the RRSP or RRIF annuitant. Another type is the RRSP or RRIF deposit, which is a contract under which a financial institution agrees to repay a principal amount deposited plus stipulated interest.
A deferred annuity contract issued by an insurer can also be an RRSP or RRIF. Under a deferred annuity contract, the annuitant is entitled to, or is ultimately entitled to elect to receive, a stream of annuity payments at a later date. Quite often a deferred annuity contract provides for amounts, determined with reference to fixed rates of interest, to accumulate prior to maturity in much the way that funds can accumulate through GICs. Variable or segregated fund annuity contracts can also be issued, under which the amount of a future stream of annuity payments will depend largely on the value of a specified group of properties acquired by the insurer with the premiums contributed. An individual's interest in a segregated fund annuity contract is analogous to an investment in a mutual fund.
The foreign property rules in Part XI of the Income Tax Act limit the extent to which a number of specified taxpayers (including RRSP and RRIF trusts) can invest outside Canada. There is a 20% foreign property limit in this context. However, for these purposes, under the existing rules a segregated fund policy is technically not considered to be foreign property regardless of the nature of the segregated fund's assets. In addition, the existing foreign property rules do not apply to segregated fund policies issued as RRSPs and RRIFs.
In addition, there are two technical anomalies under the existing income tax rules that apply to RRIFs and annuities which are addressed by the proposed amendments described below.
First, RRIF trusts cannot acquire an annuity as a "qualified investment" and the law is not entirely clear on the circumstances in which RRSP trusts can acquire annuities.
Second, annuities that are issued as RRIFs may technically not be exempt from the accrual rules under section 12.2 of the Act. These rules require income accruing under annuity contracts to be reported annually. The application of these rules to RRIFs is particularly anomalous because annuities issued as RRSPs are exempt from these rules.
Proposed Amendments
(a) Qualified Investments
- An annuity contract (including a segregated fund policy) that is issued by a person licensed or otherwise authorized under the laws of Canada or a province to carry on in Canada an annuities business will be allowed to be a qualified investment for an RRSP or RRIF trust. For such an annuity contract to be a qualified investment under an RRSP or RRIF trust under the new rules,
- the contract must be acquired by the trust after 1997,
- the trust must be the only person (other than the insurer who issued the contract) entitled to future rights or benefits under the contract, and
- the timing and amount of the trust's entitlements cannot be affected by the personal circumstances of any individual, other than the length of the life of the individual who was the RRSP or RRIF annuitant immediately after the contract was acquired.
- This amendment will be implemented by way of an amendment to Part XLIX of the Income Tax Regulations. No change to paragraph (c) of the definition "qualified investment" in subsection 146(1) of the Act is contemplated. However, it is contemplated that subsection 146(11) of the Act will be amended to provide that it does not apply to annuity contracts issued after 1997.
(b) Accrual Rules
- An annuity contract issued as a RRIF will not be subject to the accrual rules under section 12.2 of the Act.
- This amendment will be implemented by way of an amendment to subsection 304(1) of the Regulations. It is contemplated that it will apply to taxation years that begin after 1986, given that the original amendments to the Act that gave rise to the need for this amendment applied after 1986.
(c) Foreign Property
- An interest in an annuity contract will be "foreign property" for the purposes of the Act if the annuity contract is a segregated fund policy and more than 20% of the segregated fund's assets are "foreign property". As a consequence, if an RRSP or RRIF trust or any other taxpayer described in paragraphs 204(1)(a) to (f) of the Act acquires such a foreign property, it will be included in the 20% foreign property limit set out in Part XI of the Act.
- If an insurer issues interests in one or more registered annuity policies directly to an RRSP or RRIF annuitant or to a registered pension plan (RPP), the insurer will be likewise liable to pay a monthly foreign property penalty tax in respect of each RRSP annuitant, RRIF annuitant and RPP equal to the amount, if positive, determined by the formula:
1% X (A - (20% X B))
where
A is the total of all premiums and other amounts paid on account of the acquisition by the RRSP annuitant, RRIF annuitant or RPP, as the case may be, of such of those interests outstanding at the end of the month as constitute foreign property, and
B is the total of all premiums and other amounts paid on account of the acquisition by the RRSP annuitant, RRIF annuitant or RPP, as the case may be, of such of those interests as are outstanding at the end of the month.
- Issuers of segregated fund policies will be allowed to elect to have their segregated funds registered under Part X.2 of the Act. The result of this election would be to exclude interests in registered segregated funds from the "foreign property" definition. However, as a consequence of the election in respect of a segregated fund, the issuer of the segregated fund would be required to pay any penalty tax under Part XI of the Act in respect of foreign property holdings of the segregated fund.
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