2013-0506291R3 Characterization of a Remedial Payment

Principal Issues: 1.Whether the proposed remedial payment into a current member’s money purchase account is a "contribution” as defined under paragraph 147.2(1)(a) of the Act. 2.Whether the proposed remedial payment is considered income from employment. 3.Whether the proposed remedial payment made to a former member is a superannuation or pension benefit?

Position: 1.No 2. No 3. Yes.

Reasons: 1.The proposed remedial payment will not constitute a contribution to the plan within the meaning of paragraph 147.2(1)(a) of the Act and no amount of the proposed remedial payment will be deductible under subsection 147.2(1) and paragraph 20(1)(q) of the Act. 2. The proposed remedial payment to the plan in respect of a member or former member will not give rise to income from employment under either section 5 or 6 of the Act. 3. The proposed remedial payment made to a former member is required to be included in income in the year received as a superannuation or pension benefit under subparagraph 56(1)(a)(i) of the Act.

Author: XXXXXXXXXX
Section: s.204.4; 147.2(1); 20(1)(q); 56(1)(a);118(3); 147.1(15)

XXXXXXXXXX                                                                                                                                  2013-050629

XXXXXXXXXX, 2015

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling – XXXXXXXXXX (the “Employer”)

This is in reply to your letter dated XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the Employer and further to the correspondence provided by you on XXXXXXXXXX. We acknowledge the information provided in various telephone conversations between XXXXXXXXXX and XXXXXXXXXX in connection with your request.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the ruling request is:

(i)   in an earlier return of the Employer or a related person;

(ii)  being considered by a Tax Services Office or Taxation Centre in connection with a previously filed tax return of the Employer or a related person;

(iii) under objection by the Employer or a related person;

(iv)  before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; nor

(v)   the subject of a Ruling previously issued by the Income Tax Rulings Directorate to the Employer or a related person.

This letter is based solely on the facts and proposed transactions described below.  The documentation submitted with your request does not form part of the facts and proposed transactions and any references thereto are provided solely for the convenience of the reader.

Definitions:

“XXXXXXXXXX Plan(1)” means the Employer’s pension plan for members of the XXXXXXXXXX staff bearing registration #XXXXXXXXXX.

XXXXXXXXXX.

“Act” means the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended.

“XXXXXXXXXX Plan(2)” means the Employer’s pension plan for members of the XXXXXXXXXX staff bearing registration #XXXXXXXXXX.

“XXXXXXXXXX Funds” means the B1 Fund and the B2 Fund which are unitized accounts within the Master Trust for the Plans. The XXXXXXXXXX Funds hold investments in a diversified portfolio of bonds including units of the C Trust.

“XXXXXXXXXX Fund Overstatement” means the excess investment return applied to units of the XXXXXXXXXX Funds during the segregation of the XXXXXXXXXX in XXXXXXXXXX.

“B2 Fund” means the XXXXXXXXXX Fund.

“B1 Fund” means the XXXXXXXXXX Fund.

“Boards” means the XXXXXXXXXX Pension Board and the XXXXXXXXXX Pension Board that are the administrators of the Plans and standing committees of the Employer’s XXXXXXXXXX.

“CRA” means the Canada Revenue Agency.

“C Trust” means the XXXXXXXXXX, a mutual fund trust which is a registered investment pursuant to section 204.4 of the Act.

“C Trust Understatement” means the deficiency between the investment return of the C Trust and the investment return applied to the C Trust holdings as at XXXXXXXXXX during the segregation of the XXXXXXXXXX in XXXXXXXXXX.

“Former Member” means a person who was a contributor to a Plan and has terminated membership in a Plan.

“XXXXXXXXXX Trust” means the trust established to hold all direct interests in XXXXXXXXXX to facilitate an orderly disposition of XXXXXXXXXX.

“Member” means a person who is or has been a contributor to a Plan and has not terminated membership in the Plan.

“Net Understatement” means, for a Member or Former Member who was both a C Trust and a XXXXXXXXXX Fund unit holder, the amount by which the C Trust Understatement exceeds the XXXXXXXXXX Fund Overstatement as at XXXXXXXXXX.

“Plan” means the XXXXXXXXXX Plan(1) and/or the XXXXXXXXXX Plan(2) (collectively referred to as the “Plans”).

“XXXXXXXXXX” means a note issued in connection with the restructuring of certain holders’ XXXXXXXXXX in exchange for the holder’s XXXXXXXXXX.

“Trustee” means XXXXXXXXXX, the trustee of the Plans.

“XXXXXXXXXX Error” means that described in paragraph 9.

FACTS:

1.    The XXXXXXXXXX Error is in respect of the defined contribution (DC) provisions of the Employer Plans.

2.    The Employer and the Trustee have entered into a series of agreements which establish trusts for the purposes of investing the assets of the Plans, including:

*     a master trust agreement relating to the master trust for the Plans (the "Master Trust");
*     a participating trust agreement for each of the Plans; and
*     the C Trust.

3.    The Trustee is the carrier of a registered retirement income fund (“RRIF”) offered exclusively to Former Members of the Plans if they remain Canadian residents and choose to transfer their accounts in the Plans to a RRIF on retirement.  The Employer acts as an agent for the Trustee in connection with the RRIF program.

4.    A menu of investment options is made available by the Boards to Members and Former Members who are RRIF annuitants.  Three relevant investment options available to Members are: the C Trust, the B1 Fund, and the B2 Fund. Only the C Trust is available to Former Members who are RRIF annuitants.

5.    The B1 Fund and the B2 Fund are unitized accounts within the Master Trust for the Plans. XXXXXXXXXX percent of the B2 Fund is comprised of units of the C Trust. XXXXXXXXXX percent of the B1 Fund is comprised of units of the C Trust.

6.    Prior to XXXXXXXXXX, the C Trust held units of third party investment trusts (“Investment Trusts”) managed by XXXXXXXXXX  These Investment Trusts had exposure to XXXXXXXXXX in XXXXXXXXXX when XXXXXXXXXX ceased trading. Industry-led restructuring efforts in early XXXXXXXXXX culminated in a court order approving an arrangement under which holders of XXXXXXXXXX received XXXXXXXXXX in exchange for their XXXXXXXXXX holdings.

7.    In XXXXXXXXXX, the Boards caused all units of the Investment Trusts held by the C Trust to be redeemed. Since the XXXXXXXXXX held in the Investment Trusts were not marketable, the units were redeemed “in specie”. This transaction resulted in the C Trust holding XXXXXXXXXX directly. The B1 Fund and B2 Fund, through their holdings of C Trust units, had an indirect interest in the XXXXXXXXXX.

8.    In order to segregate the illiquid XXXXXXXXXX from other investments held by the C Trust, the Boards amended the Plans to consolidate the XXXXXXXXXX under the Plans into a single XXXXXXXXXX Trust held by the Trustee. The RRIFs were similarly amended. 

9.    In XXXXXXXXXX, during the consolidation of the XXXXXXXXXX, administration errors were made in determining the unit values and investment return for the C Trust and the XXXXXXXXXX Funds. Efforts were made to correct the errors as at XXXXXXXXXX. However, there remained uncorrected errors, not fully identified and quantified until XXXXXXXXXX, in the investment return applied to the holdings of the C Trust and the XXXXXXXXXX Funds held in the Members’ and Former Members’ DC accounts or RRIF accounts as of XXXXXXXXXX (the “XXXXXXXXXX Error”).

10.   The total value of the XXXXXXXXXX Error is estimated to be approximately $XXXXXXXXXX as of XXXXXXXXXX. The XXXXXXXXXX Error had an impact of XXXXXXXXXX% on the C Trust’s rate of return representing an average understatement of $XXXXXXXXXX per C Trust unit holder as of XXXXXXXXXX. Approximately XXXXXXXXXX Members and RRIF annuitants had chosen the C Trust as an investment option at the relevant time.

11.   Approximately XXXXXXXXXX Members and Former Members held, both C Trust and XXXXXXXXXX Fund units as of XXXXXXXXXX. The XXXXXXXXXX Error had an impact of XXXXXXXXXX% and XXXXXXXXXX% representing an average overstatement valued at $XXXXXXXXXX and $XXXXXXXXXX per B1 Fund and B2 Fund unit holder, respectively, as of XXXXXXXXXX.

PROPOSED TRANSACTIONS:

12.   The Employer proposes to pay a lump sum amount to each affected Member’s account under a Plan and pay a lump sum cash amount to each affected Former Member (the “Remedial Payment”). The Remedial Payment is to correct the XXXXXXXXXX Error as adjusted to include the C Trust investment return to the date of payment.

13.   Where a Member is both a C Trust and a B1 Fund or a B2 Fund unit holder as at XXXXXXXXXX, the Remedial Payment will be made only to the extent that a Net Understatement existed as at XXXXXXXXXX. 

14.   Where a Former Member was both a C Trust and a B1 Fund or a B2 Fund unit holder as at XXXXXXXXXX, the Remedial Payment will be made to the Former Member only to the extent that a Net Understatement existed as at XXXXXXXXXX. 

15.   As of XXXXXXXXXX, the total estimated Remedial Payment required to be paid to the XXXXXXXXXX and XXXXXXXXXX Plans on behalf of Members is $XXXXXXXXXX and $XXXXXXXXXX, respectively. The total estimated Remedial Payment required to be paid to Former Members is $XXXXXXXXXX.

PURPOSE OF PROPOSED TRANSACTIONS

16.   The purpose of the proposed transactions is to mitigate the negative impact of the XXXXXXXXXX Error on Members and Former Members of the Plans.

17.   The lump sum cash payment to Former Members is proposed due to the anticipated administrative complexity associated with transferring payments to other retirement vehicles and the fact that the Former Members have terminated their membership in the Plans.

RULINGS GIVEN:

Provided that the preceding statements of facts and proposed transactions are correct and constitute a complete and accurate disclosure of all the relevant facts and proposed transactions, and provided the proposed transactions are completed as described above, subject to the caveats set out below, we rule as follows:

1.    No amount of the proposed Remedial Payment to be made to a Member’s DC account of the Plan will constitute a contribution to the Plan within the meaning of paragraph 147.2(1)(a) of the Act and no amount of the proposed Remedial Payment will be deductible under subsection 147.2(1) and paragraph 20(1)(q) of the Act.

2.    Sections 5 or 6 of the Act will not apply to include the proposed Remedial Payment paid to the Plans in the income of a Member or Former Member as income from employment and no amount of the proposed Remedial Payment will be deductible under subsection 147.2(4) and paragraph 8(1)(m) of the Act.

3.    The proposed Remedial Payment will be included in a Former Member’s income as a superannuation and pension benefit in accordance with subparagraph 56(1)(a)(i) of the Act, in the year the proposed Remedial Payment is received by the Former Member.

The above rulings which are based on the Act in its present form and do not take into account any proposed amendments thereto, are given subject to the general limitations and qualifications set out in Information Circular 70-6R6 Advance Income Tax Rulings and Technical Interpretations, dated August 29, 2014, and are binding on the CRA with respect to an amount paid as a Remedial Payment as described in the proposed transactions provided that the proposed transactions are completed by XXXXXXXXXX.

CAVEATS

Nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or made any determination in respect of any tax consequences relating to the facts, the Plans, the proposed transactions or any transaction or event taking place either prior or subsequent to the implementation of the proposed transactions, whether described in this letter or not, other than those specifically described in the rulings given above.

Nothing in this letter should be construed as implying that the CRA has reviewed or agreed to the valuation of the XXXXXXXXXX Error.

Yours truly,

XXXXXXXXXX
for Director
Deferred Income Plans Section II
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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