KPMG report: Treatment of foreign insurance segregated funds for Article XXI Treaty and FIRPTA exemption purposes
IRS private letter ruling
IRS private letter ruling
The IRS on October 27, 2023, released a private letter ruling* [PDF 104 KB] that addresses the treatment of certain Canadian variable insurance policies held by Canadian registered pension plans (“Pension Investors”) that are treated as qualified foreign pension funds (“QFPFs”) under section 897(l) of the Internal Revenue Code and other Canadian charitable investors (“Charitable Investors”) eligible for benefits under Article XXI of the Canada-US Tax Treaty (the “Treaty”). Article XXI of the Treaty provides an exemption from tax on certain income for Charitable Investors and Pension Investors. Section 897(l) provides an exemption from the Foreign Investment in Real Property Tax Act (FIRPTA) for holders that are QFPF and for trusts all the interests in which are owned by qualified holders.
The ruling was issued to a Canadian corporate taxpayer that issues insurance and annuity contracts and provides investment management services to a broad range of investors including pension funds. The taxpayer requested the ruling in respect of its plan to establish and administer contracts (“Segregated Fund Contracts”) for “New Segregated Funds.” Under the terms of these contracts, the investors will pay premiums that are invested through the segregated funds into a portfolio of investments including stocks, bonds, mortgages, and other types of investments. The taxpayer is the legal owner of the assets that comprise the portfolio. Certain investors that are qualified holders will only invest in a segregated fund of which all the investors are QFPFs (a “897(l) Seg Fund”).
The taxpayer represented that for purposes of Canada’s income tax laws each segregated fund will be considered a trust resident in Canada, investors will be considered the beneficiaries of such trust and the property and income of the fund will be considered property and income of the deemed trust. Moreover, each segregated fund will be deemed to distribute all its income to its beneficiaries each year such that it will not be subject to tax.
The description of the Canadian tax treatment suggests that the Segregated Fund Contracts may be subject to section 138.1 of the Canadian Income Tax Act. This section applies in respect of life insurance policies for which all or any portion of an insurer’s reserves vary in amount depending on the fair market value of a specified group of properties (such as the segregated funds described in the ruling) and deems such a segregated fund to be a trust notwithstanding that legally a trust does not exist.
The ruling does not directly address how US tax law or the Treaty attributes ownership of the assets that the taxpayer holds in the New Segregated Funds to the holders of the Segregated Fund Contracts for purposes of the Treaty or section 897(l), or the extent to which it relies on the Canadian Income Tax treatment in reaching the ruling’s results. Nonetheless, the ruling concludes that:
Any U.S.-source dividends and interest derived by a New Segregated Fund for the benefit of the Pension Investors or Charitable Investors will be exempt from U.S. income taxation pursuant to Article XXI(3) of the Treaty (other than that described in Article XXI(4) of the Treaty involving income from a trade or business or a from a related person).
For purposes of Article XXI(4) of the Treaty, the phrase “related person” in Article XXI(4) of the Treaty will be applied in relation to the Pension Investors and the Charitable Investors.
Gain or loss realized by an 897(l) segregated fund from any disposition of United States real property interests will be exempt from US income taxation pursuant to section 897(l) and will not be subject to withholding under section 1445.
As is the case with all IRS private letter rulings, the ruling applies only to the taxpayer who requested it and may not be used or cited as precedent.
Foreign tax-exempt investors, including qualified foreign pension funds, as well as insurance companies and fund sponsors may wish to consider the implications of this ruling on their existing and contemplated means of investing in US real property.
If you would like to obtain more information about this topic, please contact a member of our Sovereign Wealth and Pension Funds tax team:
Sam Riesenberg | sriesenberg@kpmg.com
Dan Winnick | danielwinnick@kpmg.com
Josh Kaplan | jskaplan@kpmg.com
Janice Russell | janicerussell@kpmg.com
* Private letter rulings are taxpayer-specific rulings furnished by the IRS Office of Chief Counsel in response to requests made by taxpayers and can only be relied upon by the taxpayer to whom issued. Pursuant to section 6110(k)(3), written determinations such as private letter rulings are not intended to be relied upon by third parties and may not be cited as precedent. These written determinations may, however, offer an indication of the IRS’s position on the issues addressed.
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