Citation: 2012 TCC 45
Date: 20120207
Docket: 2010-3217(IT)G
BETWEEN:
KARL KRATOCHWIL,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hogan J.
[1]
The appellant, Karl
Kratochwil, acquired a life insurance policy (the “Policy”) from The Northern
Life Assurance Company of Canada (“Northern Life”) on January 14,
1987. In August 1993, The Standard Life Assurance Company of Canada (“Standard Life”) assumed all of the obligations under
the Policy by virtue of an assignment.
[2]
Under the terms of the Policy,
the appellant paid a base premium of $421.75 per month or $5,061 annually for a
total of $75,915 over the 15‑year life of the Policy. He was also charged
an additional risk premium of $262.90 per month or $3,154.80 per year for a
total of $47,322 because he suffered from a heart condition, which increased
his mortality risk. The premiums paid in the early years of the Policy exceeded
the cost of insurance in those years, creating a capital reserve that generated
investment income for the policyholder. Following the assignment of the Policy
to Standard Life, the appellant was charged an additional monthly premium of
$172.15 per month for a period of 24 months. The appellant paid total premiums
of $127,368 over the life of the Policy.
[3]
The appellant enjoyed
two benefits under the Policy. First, he was insured for $300,000 over the life
of the Policy. The Policy had a cash surrender value. The total premiums paid
under the Policy exceeded the appellant’s cost of insurance, thus allowing the
establishment of a capital reserve to generate investment income.
[4]
In 2007, the appellant
surrendered the Policy and received the cash surrender value of $150,365.75
owed under the Policy. The appellant reported income of approximately $23,000
in connection with this transaction. He arrived at this gain by deducting his
estimate of the total premiums paid under the Policy from the cash surrender
value paid to him. He believed that the full amount of the premiums paid under
the Policy had been refunded to him because the death benefit had not been paid
out to him.
[5]
As the premiums were
paid with after-tax dollars, he believed that he could recover the same amount
without tax. He failed to appreciate that a large part of the premiums paid
under the policy was used to pay the cost of insurance, in much the same way
that premiums are paid to cover the cost of insurance under a term life
insurance policy.
[6]
After he filed his
income tax return for the 2007 taxation year, the appellant received a T5 slip from
Standard Life showing that he had earned $112,094 as a result of the surrender
of the Policy. The Minister of National Revenue (the “Minister”) reassessed the
appellant to include $89,094 in his income for the 2007 taxation year.
According to the Minister, that amount represents the additional policy gain
that the appellant failed to report. In determining the appellant’s liability
for the 2007 taxation year, the Minister made the
following assumptions:
a)
prior to August 2, 2007, the appellant held an
interest in the Policy;
b)
the Policy was issued by Standard Life on or
about January 14, 1987;
c)
the appellant terminated the Policy on or about
August 2, 2007;
d)
upon termination of the Policy, the appellant
received the amount of $150,365.75, being the cash surrender value of the
policy;
e)
prior to the termination of the Policy, the
appellant had paid total premiums in the amount of $127,368.60;
f)
of the total premiums paid by the appellant, the
amount of $47,322.00 was on account of supplementary premiums due to the
appellant’s insurance risk rating;
g)
prior to the termination of the Policy, the Net
Cost of Pure Insurance
for the Policy was $41,771.26;
h)
the total adjusted cost base of the Policy was
$38,275.34, calculated as follows:
|
total premiums paid
|
$127,368.60
|
|
less – supplementary premiums
|
$47,322.00
|
|
less – net cost of pure insurance
|
$41,771.26
|
|
total adjusted cost base
|
$38,275.34
|
i)
the income received by the appellant upon
termination of the Policy was not less than $112,090.41 (“Investment Income”)
calculated as follows:
|
surrender value as at Aug 2/07
|
$150,365.75
|
|
less – total adjusted cost base
|
$38,275.34
|
|
Investment Income
|
$112,090.41
|
j)
Standard Life reported the Investment Income on
the T5 Slip and issued a copy of the T5 Slip to the appellant; and
k)
in his return of income for the 2007 taxation
year, the appellant failed to report the full amount of the Investment Income
received from Standard Life in that year.
[7]
I have reviewed the
Minister’s calculations in paragraph (h) and (i) above and have determined that
they are accurate.
[8]
The Income Tax Act
(the “ITA”) contains complex rules which allocate premiums paid under an
insurance policy first to the taxpayer’s cost of insurance. The balance left
over, defined as the taxpayer’s “adjusted cost base” of the policy, is used to
determine the gain on the disposition of the policy. That gain is equal to the
excess of the taxpayer’s proceeds of disposition over his adjusted cost base of
the policy. Under those rules the appellant’s total cost of insurance is equal
to $89,093. This amount is made up of the aggregate of the annual net cost of
insurance and the sum of the additional risk premiums.
[9]
In very general terms,
the appellant is considered to have paid $89,093 over the 15-year term of the Policy
in order to benefit from a $300,000 death benefit over that period. This
premium amount is insured to cover the cost of insurance in much the same way
as it would have been had the appellant acquired a term life insurance policy
with a $300,000 death benefit. The appellant paid total premiums of $127,368
and bore an insurance cost of $89,093. This means that only $38,275.34 in
premiums was left over to be refunded to the appellant as part of the cash
surrender value of the Policy. The difference between $150,365.75 and $38,275.34
is $112,090.41, which is the exact amount of the policy gain or income reported
by Standard Life on the appellant’s T5.
[10]
For these reasons, the
appellant’s appeal is dismissed without costs.
Signed at Montreal, Quebec,
this 7th day of February 2012.
“Robert J. Hogan”
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