18 November 2004 GST/HST Ruling 50425 - Segregated Fund Early Withdrawal Fees

Please note that the following document, although correct at the time of issue, may not represent the current position of the Agency. / Veuillez prendre note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'Agence.

This is in reply to XXXXX addressed to our office with respect to the application of the Goods and Services Tax (GST) to the Segregated Funds early withdrawal fees of XXXXX.

All legislative references are to the Excise Tax Act (ETA) unless otherwise noted.

Background

We have reviewed the documents submitted by you and our understanding of the situation is as follows:

1. XXXXX.

2. Insurers receive early withdrawal fees or back end load fees from their segregated fund activity. The amounts received from the segregated fund by the insurer for any withdrawal by the insured/investor is determined by a sliding scale formula in the insurance contract.

3. The early withdrawal fees or back end loads used by the insurers are a type of cost recovery mechanism so that higher costs associated with the early years of the insurance/investment contract will be recovered. These costs are primarily distribution costs. XXXXX. Under the current legislation this amount appears to be taxable from XXXXX. XXXXX.

4. Note from the section on early withdrawal fees that the owner is clearly identified as being directly subject to early withdrawal fees. XXXXX.

5. Besides being a disincentive for early withdrawal, the early withdrawal fees are a recovery of distribution costs.

6. You indicated that based on the Investment Fund Information folder for XXXXX, the early withdrawals are deducted from the policyholders segregated fund balance and transferred to the insurer's general fund.

7. XXXXX you required XXXXX the following information and documentation so that the nature of the early withdrawal fees for segregated funds could be verified:

(a) A sample copy of an actual policy or contract for a segregated fund detailing the early withdrawal fees and other fees stipulated in the policy or contract XXXXX.

(b) Provide information, which shows how the funds flow. Assume this example. A Seg fund investor owns a $1,000 Seg fund, which is subject to an early withdrawal fee of 5%. The policyholder withdraws the entire amount of his or her holding. Does the Seg fund pay the $950 to the policyholder and then $50 separately to the general fund XXXXX or does the Seg fund pay $1,000 to the general fund, which then withholds $50 and then in turn pays the policyholder $950. XXXXX.

(c) Please provide internal documentation that describes the duties, responsibilities and services provided by the general fund to the seg fund for XXXXX.

(d) In addition to early withdrawal fees, please provide internal documentation regarding the entitlement of the general fund to any other types of fees generated by Seg fund products for XXXXX.

8. XXXXX provided you with the following information and documentation:

(a) Investment Fund Information folder for XXXXX. Information on all fees and expenses related to segregated fund operations is included in these documents.

(b) Financial statements for XXXXX.

(c) In the documentation, the owner is clearly identified as being directly subject to early withdrawal fees.

(d) Gross withdrawals (including any back end load fees) are reported under XXXXX.

9. Since the documentation provided XXXXX does not clearly mention that the early withdrawals are deducted from the policyholders segregated fund balance and transferred to the insurer's general fund, we asked XXXXX additional documentation to support this information.

10. To this date, the documentation requested has not been provided, however, we can issue an interpretation based on the assumption that the early withdrawals are deducted from the policyholders segregated fund balance and transferred to the insurer's general fund.

Issue

Are the early withdrawal fees considered to have been acquired from the segregated fund by the insurer pursuant to paragraph 131(1)(c) or are the early withdrawal fees consideration for "the amount of a redemption" pursuant to paragraph 131(2)(a)?

Our comments

Paragraph 131(1)(c) deems amounts deducted from segregated funds to be "a taxable supply of a service and the amount shall be deemed to be consideration for the supply that becomes due at the time". Pursuant to subsection 131(2) this deeming provision found in paragraph 131(1)(c) does not apply if the amount is an income distribution, a benefit payment or an amount redeemed regarding the interest of another person in the fund. The relevant sections of the ETA read as follows:

131. (1) Segregated fund a separate person — For the purposes of this Part, a segregated fund of an insurer shall be deemed to be a trust that is a separate person from the insurer and that does not deal at arm's length with the insurer and

(a) the insurer shall be deemed to be a trustee of that trust;

(b) the activities of the segregated fund shall be deemed to be activities of the trust and not activities of the insurer; and

(c) where, at any time, an amount (other than an amount in respect of tax under this Part) is deducted from the fund,

(i) if the amount is in respect of property or a service that the fund is, because of the operation of this Part other than this paragraph, considered to have acquired from the insurer, that supply shall be deemed to be a taxable supply and the amount shall be deemed to be consideration for that supply that becomes due at that time, and

(ii) if the amount is not in respect of property or a service that the fund is, because of the operation of this Part other than this paragraph, considered to have acquired either from the insurer or another person, the insurer shall be deemed to have made, and the fund shall be deemed to have received, at that time, a taxable supply of a service and the amount shall be deemed to be consideration for the supply that becomes due at that time.

(2) Exceptions — Paragraph (1)(c) does not apply to an amount deducted from a segregated fund of an insurer if

(a) the amount is a distribution of income, a payment of a benefit, or the amount of a redemption, in respect of an interest of another person in the fund; or

(b) the amount is a prescribed amount.

123. (1) Definitions — In section 121, this Part and Schedules V to X,

"financial service" means:

(d) the issue, granting, allotment, acceptance, endorsement, renewal, processing, variation, transfer of ownership or repayment of a financial instrument,

(f) the payment or receipt of money as dividends (other than patronage dividends), interest, principal, benefits or any similar payment or receipt of money in respect of a financial instrument,

The documentation provided by XXXXX does not clearly mention that the early withdrawals are deducted from the policyholders segregated fund balance and transferred to the insurer's general fund. However, the following information is provided.

XXXXX

According to the information and documentation provided by XXXXX:

• The amount of the withdrawal by the policyholder is paid out from the segregated fund to the general fund of the insurer. This payment constitutes the amount of a redemption pursuant to paragraph 131(2)(a), and therefore paragraph 131(1)(c) does not apply. Accordingly, the amount transferred out of the segregated fund into the general fund is an exempt supply pursuant to paragraph 123(1)(f) of the definition of financial service.

• The redemption fee paid by the insured to the insurer by means of deduction from the general fund of the insurer constitutes consideration for "the transfer of ownership or repayment of a financial instrument" pursuant to paragraph 123(1)(d) of the definition of "financial service".

Should you wish to discuss this file further, please do not hesitate to contact me at (613) 941-2046.

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