The Canada Revenue Agency’s long period of scrutiny of so-called “10/8” leveraged-loan insurance programs appears to be slowly moving toward some kind of resolution, perhaps as soon as early in the new year.

A senior CRA official, speaking at a recent tax conference in Vancouver, said that although the CRA was still reviewing the leveraged-loan structures, the agency was getting closer to identifying and communicating exactly what aspects of 10/8s it finds troublesome.

Firms that sell the products, as well as the wider financial services industry, have been seeking definitive guidance from the CRA on 10/8s ever since the agency first announced more than two years ago that it was taking a critical look at the structures to see whether or not they were abusive.

Says Peter Everett, vice president of planning and business development at Toronto-based PPI Financial Group Inc. , which sells 10/8 products: “Clarity is in everyone’s interest, whether you’re sitting on the government side of the table or the industry side of the table, because then there’s a clear structure [of what the CRA finds acceptable] that everyone can understand and abide by.”

In simple terms, a typical 10/8 arrangement involves a taxpayer buying an insurance policy and then using that policy as security against a loan of up to 100% of the cash-surrender value of the policy. Often, the insurance company and the lender are the same firm or are related firms.

The investment part of the policy earns a predetermined annual interest rate. In most arrangements, that rate has been set at 8%. Meanwhile, the taxpayer secures a loan set at 10%, with either the policy representing the security or the loan coming out of the insurance policy itself. The taxpayer invests the borrowed funds in an investment that allows the taxpayer to deduct the interest on the loan.

Speaking at the Canadian Tax Foundation’s annual conference in November, Wayne Adams, director general of the income tax rulings directorate of the CRA, appeared to suggest that the CRA’s primary issue with 10/8s remains the level of the interest rate — often set at 10% — on the loan, indicating that the CRA might find it too high.

However, some conference attendees say that Adams did seem to acknowledge that the interest on the loan in 10/8s probably could be considered deductible, because in most cases it appeared that the borrowed money had been used for an eligible purpose. That apparent acknowledgement of the deductibility of the interest was positively received by the financial services industry.@page_break@“It’s not like the CRA is saying this program doesn’t work and there’s no interest deductibility [available] whatsoever,” Everett says. “Rather, what the CRA seems to be saying is, ‘We think the rate should be lower’.”

If the CRA does say, definitively, that it considers the interest rate on the loan too high, the financial services industry will probably take steps to support the rates the CRA sets, says Kevin Wark, senior vice president of business development with PPI. “Some of the discussions, if and when they’re initiated, will be the industry providing information to the CRA representatives on how the rates were determined to begin with,” Wark says. “Then it’ll be about getting feedback from the CRA on why it thinks the number [should be] lower than that, and then having a discussion around that.”

At the CTF conference, Adams said that the CRA was still reviewing the program and had not decided on its position. He also said CRA representatives were planning to meet in January 2011 with financial services industry participants who had made submissions to the CRA regarding 10/8s.

A formal announcement on the CRA’s position might be available as soon as late January or early February, Adams said, but some financial services industry observers believe it will take some months longer than that.

The CRA first announced it was reviewing 10/8 structures in 2008. That year, at the annual CTF conference, Adams had indicated that the CRA had reviewed a particular 10/8 arrangement as part of a ruling request, but the agency’s general anti-avoidance rule committee could not approve of the arrangement.

That announcement had introduced a level of uncertainty into the sale of the product, which still continues.

“Everyone is being more cautious,” Wark says. “The sales process is taking longer than it probably did before. Some people are buying the insurance — because they need the insurance — and sitting back and waiting to see how the CRA [rules] on 10/8s before deciding to make use of the leveraging part of the program.”

Over the past two years, the CRA, in other comments on the topic, has backed off on some of its more negative signals regarding the product and appears now to be heading toward a decision.

Industry participants are hopeful that 10/8s, in some form, will receive the CRA’s endorsement, but remain cautious. Says Wark: “It’s still open to the CRA to say, ‘We believe in certain circumstances, GAAR might apply to these transactions.’ We can’t predict on how the CRA will respond until it has done its review.” IE