6 May 2014 May CALU Roundtable, 2014-0523341C6 - CALU - Insurance Death Benefit received by FA

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: a) When a foreign affiliate receives the proceeds of an exempt life insurance policy, which surplus account of the foreign affiliate will such proceeds go into?
b) Assuming the foreign affiliate does not otherwise have an exempt, hybrid, or taxable surplus balance, if the proceeds of the life insurance policy are distributed by way of dividend, will the full amount of the dividend result in a capital gain to the Canadian parent?

Position: a) Pre-acquisition surplus pool.
b) Yes

Reasons: a) Since the proceeds received by the foreign affiliate are exempt from taxation in the foreign country and the facts do not otherwise indicate that the insurance policy was related to the active business of the foreign affiliate, such proceeds are not included in the earnings from an active business of the foreign affiliate. Moreover, since no capital gain or foreign accrual property income arises in respect of such life insurance proceeds, there is no adjustment to the foreign affiliate's surplus balances.
b) Since the Canadian parent's adjusted cost base in the shares of the foreign affiliate is nominal, a capital gain will result by virtue of paragraph 113(1)(d), subsection 92(2) and subsection 40(3) of the Act equal to the amount of dividend paid by the foreign affiliate to the parent (less foreign withholding tax, if any) less the nominal ACB of the shares of the foreign affiliate.

THE CONFERENCE FOR ADVANCED LIFE UNDERWRITING

2014 Annual Conference

Question 7

Assume that Mr. X, a Canadian resident, owns 100% of Canco which owns 100% of Foreignco. Canco's adjusted cost base in the shares of Foreignco is nominal. Canco is a corporation resident in Canada, and Foreignco is a non-resident of Canada. It is assumed that Foreignco carries on an active business in the country in which it is resident and that it is required by the income tax law in that country to compute its income or profit from that business.

Foreignco acquires a life insurance policy on the life of Mr. X and Foreignco is also the beneficiary of the policy. The policy is considered a "life insurance policy in Canada" as defined in subsection 138(12) of the Act. The policy is also an exempt policy pursuant to subsection 12.2(11) of the Act and section 306 of the Regulations. It is assumed that proceeds received by Foreignco upon the death of Mr. X for tax purposes in the foreign country would be treated in a manner similar to the way Canada would treat such proceeds (i.e. received tax free) under the Act.

a) When Foreignco receives the proceeds of the exempt life insurance policy upon the death of Mr. X, which surplus account of Foreignco will such proceeds go into?

b) Assuming Foreignco does not otherwise have an exempt, hybrid, or taxable surplus balance, if the life insurance proceeds in (a) are distributed by way of dividend from the pre-acquisition surplus pool, will the full amount of the dividend result in a capital gain to the Canadian parent?

CRA Response

a) If Foreignco is resident in a country with which Canada has entered into a tax treaty or tax information exchange agreement, the life insurance proceeds received on the death of Mr. X by Foreignco may be included in its exempt surplus if it could be established that the proceeds pertain to or are incident to its active business. In this respect it is conceivable that life insurance proceeds derived by a foreign affiliate on the death of Mr. X might in very rare cases be viewed as income that "pertains to or is incident to" its active business on the basis of principles established in cases such as:

• R. v. Ensite, [1986] 2 S.C.R. 509;
• Atlas Industries Ltd. v. Minister of National Revenue, [1986] 2. C.T.C. 2392.

In such case if the life insurance proceeds were not included in the earnings from an active business of the foreign affiliate under subparagraph (a)(i) of the definition of "earnings" in subsection 5907(1) of the Regulations as computed in accordance with the foreign tax law, they may be added under paragraph 5907(2)(f) of the Regulations. Paragraph 5907(2)(f) provides for adjustments to the earnings amount where a foreign affiliate derives revenue, income or profit from an active business carried on in the country to the extent that it is not otherwise required to be included in the earnings amount.

As it relates to the facts in this hypothetical question, there are no facts provided as to why a life insurance policy was acquired by Foreignco on the life of Mr. X and therefore no basis to conclude the policy was related to Foreignco's active business. If that is the case, the life insurance proceeds would not be added to "earnings" from an active business of Foreignco under paragraph 5907(2)(f) of the Regulations. The life insurance proceeds are also not included as part of Foreignco's FAPI or taxable surplus account as FAPI is computed pursuant to paragraphs 95(2)(f) and (f.11) as though Foreignco were resident in Canada in accordance with the provisions of the Act (subject to the adjustments set out in subparagraph 95(2)(f.11)(ii)). As no amount is included in the computation of income under the provisions of the Act, no amount could be included as FAPI. Therefore, the life insurance proceeds received by Foreignco would not be included in its taxable surplus pool.

Accordingly, the life insurance proceeds received by Foreignco upon the death of Mr. X would form part of Foreignco's pre-acquisition surplus pool.

b) If no exempt, hybrid, or taxable surplus is available any dividend paid by Foreignco will be determined to be paid out of Foreignco's pre-acquisition surplus and a capital gain will be triggered by virtue of subsection 40(3) of the Act since Canco's adjusted cost base in the shares of Foreignco is nominal. The amount of the capital gain will be equal to the full amount of the dividend less any withholding tax paid by Canco to the government of a country other than Canada as may reasonably be regarded as having been paid in respect of the dividend, less the nominal adjusted cost base.

H. Leung
2014-052334
May 6, 2014