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 Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
Whether the issuance of a life insurance policy along with an annuity contract and/or any agreement to lend money to a policy holder would cause us to consider whether the transactions are sufficiently inter-connected to result in our applying the general anti-avoidance rule (GAAR) found in section 245 of the Act.
Position:
Possibly. Depends on facts, circumstances and documentation.
Reasons:
See letter.
960642
XXXXXXXXXX Michael Cooke
Attention: XXXXXXXXXX
April 9, 1996
Dear Sirs:
Re: Advance Ruling Request
This is in reply to your letter of February 15, 1996, requesting an advance income tax ruling on behalf of the XXXXXXXXXX.
As discussed with you on February 26, 1996, the Department is unable to provide advance income tax rulings on transactions which are not seriously contemplated or are hypothetical in nature. Written confirmation of the income 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 ruling request submitted in the manner set out in Information Circular 70-6R2 dated September 28, 1990 and the Special release thereto dated September 30, 1992 (copies attached). However, we can provide you with the following general comments which may not be applicable to the circumstances of your particular situations.
Situation 1
A corporation will purchase an annuity contract the income of which will be used by it to fund the premiums on a company owned life insurance policy on the life of a shareholder for which the corporation will be the beneficiary. The corporation will then borrow funds from a corporation that is related to the insurer to replace the funds that were used to purchase the annuity and which are still needed in the business. Interest will be charged annually on the loan at market rates but the corporation may defer payment of the interest and add the unpaid amount to the outstanding loan balance. The insurance policy will be assigned to the lender as security for the loan. If the shareholder dies while any portion of the loan is outstanding the proceeds of the insurance will be used to repay the remaining balance of the loan, plus unpaid interest, with any excess being paid to the corporation as beneficiary.
Situation 2
An individual will purchase a life insurance policy which will be used as collateral on a series of annual loans from a corporation that is related to the insurer to provide additional cash flow to the individual upon retirement. Interest will be charged annually on the loans at market rates but the individual may defer payment of the interest and add the unpaid amount to the outstanding loan balance. It is intended that the amount of all outstanding annual loans and accrued and unpaid interest, if any, are not to exceed the cash surrender value (CSV) of the policy. If the outstanding balance of the loans, plus unpaid interest, equals the CSV of the policy the policy must automatically be surrendered to repay the loans. If the individual dies before repayment of the outstanding loans, the proceeds of the policy will be used to first repay the loans, plus any unpaid interest, and any excess will be paid to the individual's designated beneficiary.
Situation 3
A corporation will purchase a life insurance policy on the life of an executive employee for which the corporation will be a beneficiary. The corporation will use the policy as collateral for a series of annual loans from a corporation related to the insurer to pay the executive an annual income on retirement. Interest will be charged annually on the loans at market rates but the corporation may defer payment of the interest (until the executive's death) and add the unpaid amount to the outstanding loan balance. As in 2 above, the amount of all outstanding annual loans plus accrued and unpaid interest are not to exceed the CSV of the policy and the policy must automatically be surrendered to repay the loans if that occurs. If the retired executive dies before repayment of the annual loans, the proceeds of the policy will be used to first repay the balance of the loans, plus any unpaid interest, and any excess will be used to pay a benefit to the deceased's estate.
Situation 4
A corporation will purchase a life insurance policy on the life of its shareholder which will be used to fund a share redemption agreement in the event the shareholder retires or dies. If the shareholder retires, the corporation will use the policy as collateral for a loan from a corporation that is related to the insurer in order to fund the redemption of the shareholder's shares. Interest will be charged annually at market rates on the loan but the corporation may defer payment of the interest and add the unpaid amount to the outstanding loan balance. When the retired shareholder dies the proceeds of the policy will be used to repay the balance of the loans, plus any unpaid interest, and any excess will be paid to the corporation as beneficiary.
As noted, without an opportunity to review all of the relevant documentation and circumstances the Department is unable confirm the income tax implications with respect to the four situations described above under the Income Tax Act (the Act).
For example, if the terms of a life insurance policy and an annuity contract were such that neither contract would be issued without the other, (especially where both contracts are issued by the same insurer) it might be possible to conclude that they represent the issue of one non-exempt life insurance policy.
Moreover, for a taxpayer to be able to deduct premiums paid on a life insurance policy under paragraph 20(1)(e.2) of the Act the policy must be required to be assigned to a "restricted financial institution" (RFI), as defined in subsection 248(1) of the Act, as collateral in the course of a borrowing from that institution and the interest payable on that borrowing must be deductible by the borrower for the year, but for subsections 18(2) and (3.1) and sections 21 and 28 of the Act. The assignment must also satisfy a bona fide requirement of the lender and not merely be an accommodation to provide the borrower with a deduction (see current version of IT-309R2).
Where borrowed money is used to acquire an interest in an annuity contract, the amount of interest paid or payable in the year shall only be deductible pursuant to subparagraph 20(1)(c)(iv) of the Act, assuming the other conditions of paragraph 20(1)(c) of the Act are met. Any compound interest on borrowed money used to acquire an annuity contract would not be deductible under subparagraph 20(1)(c)(iv) although it might be deductible under paragraph 20(1)(d) of the Act when paid.
Subparagraph 20(1)(c)(iv) is applicable in respect of annuity contracts which are subject to the accrual rules contained in section 12.2 of the Act. Where the annuity is a "prescribed annuity", as defined in section 304 of the Regulations to the Act, the accrual rules in section 12.2 would not apply and no amount of interest would be deductible against any amount required to be included in income pursuant to paragraph 56(1)(d) of the Act (see current version of IT-355R2).
If the terms of the annuity contract, insurance policy and loan agreement were such that they would not be ordinarily issued without the other, this would be a factor to be taken into account in determining the deductibility of the life insurance premiums and any interest paid or payable on any loan. Even if such contracts can be issued on a "stand alone" basis, based on the obiter comments of the Supreme Court found on pages 5067 and 5068 of The Queen v. Bronfman Trust decision (87 DTC), consideration would be given as to whether the structure of the arrangements is designed to conceal the true purpose of the borrowing, which was to acquire an interest in a life insurance policy, in which case interest would not be deductible.
The Department would also have to consider the implications of the deferral of the payment of any interest payable on a loan. All the conditions of paragraph 20(1)(c) of the Act must be met in order for interest to be deductible. If the interest on the borrowed money is not deductible then any insurance premium paid on a life insurance policy used as collateral for such a loan would clearly not be deductible.
Ordinarily the pledging or assignment of a life insurance policy as collateral for a loan from the insurer, or a corporation related to the insurer, would not, by itself, cause us to conclude that a policy loan has been made. Nevertheless, a determination of whether a particular loan is a policy loan can only be made after a review of the terms and conditions governing the particular policy.
It appears that each of the situations described above are intended to either avoid the application of a particular provision of the Act (eg: definition of "policy loan" in subsection 148(9)), or to access a particular provision that might not apply without a step transaction (eg: paragraph 20(1)(c)). Accordingly, the Department would have to consider based on a review of all the facts, circumstances and supporting documentation of a particular situation whether the issuance of a life insurance policy along with an annuity contract and/or any agreement to lend money to a policy holder would cause us to consider whether the transactions would result in our applying the general anti-avoidance rule found in section 245 of the Act.
While we trust the above comments are useful they are not rulings and are given subject to the limitations and qualifications set out in Information Circular 70-6R2 and consequently they are not binding on the Department. Your deposit will be returned under separate cover.
Yours truly,
Section Chief
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
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