6 November 2001 External T.I. 2001-0100255 - PARTIAL SURRENDER OF INSURANCE POLICY

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Tax treatment of a partial surrender of universal life insurance policy with a policy loan.

Position: A policy loan results in a disposition of an interest in the policy and the amount of the policy loan in excess of the adjusted cost basis of the entire policy is included in income. On a partial surrender of the policy, element A of the calculation of proceeds of disposition in 148(9) refers to the cash surrender value of the taxpayer's entire interest in the policy, not the partial interest surrendered, and the taxpayer would be required to include an amount equal to the cash surrender value of the entire policy less any outstanding policy loans into income.

Reasons: Legislation

XXXXXXXXXX 							2001 - 010025
K. Cooper, LL.B.
November 6, 2001

Dear XXXXXXXXXX:

Re. Partial Surrender of Universal Life Insurance Policy with a Policy Loan

This is in reply to your letter of September 6, 2001 wherein you requested confirmation of the appropriate tax treatment of a series of transactions related to an interest in a universal life insurance policy.

The particular circumstances described in your letter on which you have asked for our views appears to be a factual situation involving a specific taxpayer. As explained in Information Circular 70-6R3, written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate district taxation office for their views. However, we can offer the following general comments that may be of assistance.

The series of transactions proposed in your letter begins with a policy loan of an amount equal to the adjusted cost basis (ACB) of the policy at the time of the loan. The next transaction proposed is a partial surrender of the policy of an amount equal to the policy loan. You have suggested that with respect to the second transaction the proceeds of disposition would be that portion of the cash surrender value returned to the policyholder which would be reduced to nil by virtue of the outstanding policy loans. If this interpretation were correct then an amount equal to twice the adjusted cost basis of the policy could be returned to the policyholder on a tax-free basis which, in our opinion, would be an unintended tax result.

With respect to the first transaction, we agree that a policy loan results in a disposition of an interest in the policy and that the inclusion in income under subsection 148(1) is the amount of the policy loan in excess of the adjusted cost basis of the entire policy. Similarly, in determining the proceeds of disposition as a result of the second transaction, it is our view that element A of the calculation refers to the cash surrender value of the taxpayer's entire interest in the policy, not the partial interest surrendered, and in the circumstances outlined in your letter the taxpayer would be required to include an amount equal to the cash surrender value of the entire policy less any outstanding policy loans into income by virtue of subsections 148(1) and 148(9).

As this result may also not be appropriate in policy terms, we will be bringing this matter to the attention of the Department of Finance for their consideration.

While we hope our comments are of assistance to you they do not constitute an advance income tax ruling and therefore are not binding upon the Department in respect of a specific situation.

Yours truly,

F. Lee Workman
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch