Background
The Taxpayer, an insurance company, established two segregated funds (Fund 1 and 2), which used portions of the premiums paid by Fund 1 Policyholders and Fund 2 Policyholders before that time under the terms of their policies to invest in mutual fund trust units. The deemed trusts under s. 138.1(1)(a) respecting Fund 1 and Fund2 are referred to as Trust 1 and Trust 2.
From a commercial law perspective, the Taxpayer is the legal and beneficial owner of each of the properties in Fund 1 and Fund 2, notwithstanding that the Taxpayer allocates such properties, for accounting and administrative purposes, to Fund 1 and Fund 2. However, pursuant to paragraph 138.1(1)(b), for the purposes of Part I of the Act, property that has been allocated to Fund 1 or Fund 2 that remains part of Fund 1 or Fund 2, as the case may be, is deemed to be property of Trust 1 or Trust 2, as applicable, and not property of the Taxpayer.
Proposed transactions
Although all the Fund 1 and Fund 2 properties will continue to be legally and beneficially owned by the Taxpayer, a combination of the two Funds will be effected by the Taxpayer changing the allocation of properties for accounting and administrative purposes, so that all of the properties in Fund 1 will be allocated to Fund 2, with no consideration being paid. Given the different Fund sizes, the number of notional units held by a Fund 1 Policyholder and Fund 2 Policyholder may change. However, each policyholder will have the same economic entitlement as before, and the income which is allocated to each policyholder, which was the same for both Fund 1 Policyholders and Fund 2 Policyholders prior to the combination, will remain the same following the transaction.
Rulings
The reallocation of the properties in Fund 1 to Fund 2 will result in Fund 1 ceasing to exist and Fund 2 as continuing to exist for s. 138.1(1)(a) purposes and be considered to be a transfer by Trust 1 of all of its property to Trust 2 for the purpose of s. 107.4, with s. 107.4(3)(j) applying to deem each of the Fund 1 Policyholders to have disposed of their capital interests in Trust 1 for proceeds equal to the cost amount of such capital interests immediately before the disposition and to have acquired capital interests in Trust 2 at a cost equal to the amount determined by subparagraph 107.4(3)(j)(ii).