24 August 2005 External T.I. 2005-0125401E5 - Tiered partnerships, life insurance

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.

Principal Issues: Whether subparagraph 53(1)(e)(iii) operates in tiered partnerships to provide "bump up" to ultimate partner?

Position: Unlikely

Reasons: The words "in consequence of" in subparagraph 53(1)(e)(iii) is not wide enough to encompass the hypothetical situation and it is not established that the payment received by the partnership retained the character of "proceeds of a life insurance policy".

XXXXXXXXXX 2005-012540
S. Chua
August 24 2005

Dear XXXXXXXXXX:

This is in reply to your letter of March 28, 2002 wherein you requested a technical interpretation on the application of subparagraph 53(1)(c)(iii) of the Income Tax Act (the "Act") in a situation that involves tiered partnerships. The hypothetical facts you have provided are as follows:

1. A limited partnership is established under US laws and qualifies as a US limited partnership ("USLP").

2. The general and limited partners of USLP are a US Corporation ("USCO") and a partnership established under the laws of Canada that qualifies as a Canadian partnership ("CP"), respectively. All of the partners of CP are Canadian residents for purposes of the Income Tax Act (the "Act").

3. USLP will acquire various life insurance policies ("Foreign Policies") from life insurance corporations that do not do business in Canada. All death benefits received by USLP under the Foreign Policies will be first distributed to CP and will than be distributed to the Canadian resident partners of CP.

You suggest that under subparagraph 53(1)(e)(iii) of the Act, a Canadian resident partner of CP may add its share of the net proceeds from the Foreign Policies to the adjusted cost base of its partnership interest in CP. You base your argument on two grounds. First, you say that as subparagraph 53(2)(c)(v) would operate to reduce the adjusted cost base of a partner's partnership interest when it receives proceeds from the Foreign Policies on death, the corresponding effect in subparagraph 53(1)(e)(iii) should operate. Thus, the final effect would be that the mortality gain on the Foreign Policies would not result in a gain or loss. Your second argument is based on Canada Revenue Agency's ("CRA's") position regarding paragraph 89(1)(d), that involves the treatment of corporate partners of a partnership which received a death benefit from life insurance policy. You argue that CRA's position that the full amount of the insurance proceeds allocated to a corporate partner would form part of the corporation's capital dividend account, should be extended to this situation as the words in subparagraph 53(1)(e)(iii) are similar to those in paragraph 89(1)(d).

Our Comments

Written confirmation of the tax implications inherent in real transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5. However, we are prepared to provide you with the following general comments.

As you may be aware, the CRA has opined (1984 Round Table Question 25 Partner - Insurance Proceeds) that where a partnership agreement provided that the net life insurance proceeds would be allocable solely to the deceased partner, we do not consider subparagraph 53(1)(e)(iii) to apply to the deceased partner because the proceeds of a life insurance are received by the partnership after the deceased has disposed of his partnership interest immediately before his death. Furthermore, although the proceeds received by the partnership may be earmarked to be used by the partnership to fund a payment to the deceased's estate, the estate does not have a right to any direct share in the actual life insurance proceeds.

Where the partners in a partnership are corporations, the partners do not cease to exist on the death of the shareholder of a corporate partner and thus, all members of the partnership would normally share in the insurance proceeds. Therefore, the CRA position is that subparagraphs 53(1)(e)(iii) and 89(1)(d)(ii) would apply to the corporate partner to preserve the tax-free flow through of life insurance proceeds received as a consequence of the death of the person whose life was insured. This position has been stated to apply in the narrow circumstances described in our previous technical interpretations and Interpretation Bulletin IT-430R3. Briefly, those situations involved a partnership, all of the partners of which are corporations, that owned and was the beneficiary of insurance policies on the lives of each of the corporate partner's respective principal shareholders.

The combined effect of the preambles to subsection 53(1) and paragraph 53(1)(e) is that the adjustment to the cost base of property must occur in the partnership interest held by the taxpayer, i.e., "the partnership" referred to in clause 53(1)(e)(iii)(A) must be that in which the taxpayer held an interest. In the hypothetical situation you described, only the Canadian resident partner of CP is a "taxpayer" as defined in subsection 248(1). Therefore, in applying the words in clause 53(1)(e)(iii)(A), the reference to "partnership" must be to CP.

In order for subparagraph 53(1)(e)(iii) to apply, the facts must show the amount constituted "any proceeds of life insurance policy", "received by the partnership...in consequence of death". The rationale in the CRA position regarding corporate partners as described above, is not difficult to justify on the words of the legislative provision because in those cases, the partnership was the beneficiary of the insurance policy and the "taxpayer" was the corporate partner. Therefore the condition that the partnership received proceeds of life insurance policy in consequence of death would be met. On the hypothetical facts, CP did not have a right to any direct share in the actual life insurance proceeds. Therefore, subparagraph 53(1)(e)(iii) would not apply.

The words in subparagraph 53(2)(c)(v) refer to "any amount received...as, on account, or in lieu of payment of, or in satisfaction of, a distribution of the taxpayer's share...of the partnership profits or capital". The application of subparagraph 53(2)(c)(v) is much wider than subparagraph 53(1)(e)(iii) as the words in subparagraph 53(2)(c)(v) are distinctly broader. Consequently, our view is that Parliament cannot have intended subparagraph 53(1)(e)(iii) apply in all cases where subparagraph 53(2)(c)(v) applied.

We make no comment regarding the application of the foreign investment entity provisions in the July 2005 Legislative Proposals from the Department of Finance.

We trust our comments have been helpful.

Yours truly,

for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch