7 October 2016 APFF Financial Strategies and Instruments Roundtable Q. 3, 2016-0651761C6 F - Transfer of a Life Insurance Policy -- translation

Principal Issues: A) Mr. X is a policyholder of an interest in a life insurance policy which has no cash surrender value. Mr. X wants to transfer the policy to its wholly-owned corporation for no consideration. Whether the deemed proceeds of the disposition of the interest in the policy to Mr. X would be equal to the ACB pursuant to subsection 148(7) as proposed in the Legislative Proposals Relating to Income Tax, Sales Tax and Excise Duties released on July 29, 2016 and would take precedence over subsection 69(1)? B) In documents 2005-0116631C6 and 2015-0573841C6, we stated that in the case of a winding-up of a corporation to which subsection 88(2) applies, there is no clear indication as to which of subsection 69(5) and subsection 148(7) is applicable to the distribution of an interest in a life insurance policy. While we would generally expect subsection 69(5) to take precedence over subsection 148(7) in such circumstances, this approach is subject to a review of the particular facts and circumstances of an actual case to ensure that it provides for a reasonable result. Whether this position is still valid?

Position: A) and B) Yes.

Reasons: A) Application of subsection 148(7) as proposed which is more specific than subsection 69(1). B) The limited scope of the modifications to subsection 148(7) does not support a change of position.

Financial Strategies and Financial Instruments Roundtable, October 7, 2016

2016 APFF Conference

Question 3

Transfers of life insurance policies for less than FMV

In the Federal Budget of March 22, 2016 (footnote 1), changes were announced to the tax rules for transfers of life insurance policies wheew consideration is paid, in particular as part of a transfer by the owner to a non-arm's length person.

Section 17 of "Legislative Proposals Relating to Income Tax, Sales Tax and Excise Duties" (footnote 2) dated July 29, 2016 (the "Proposals"), would amend paragraph 148(7)(a) to read as follows:

“Disposition at non-arm's length and similar cases

(7) If an interest of a policyholder in a life insurance policy is, at any time (referred to in this subsection as the disposition time), disposed of (other than a disposition under paragraph (2)(b)) by way of a gift, by distribution from a corporation, by operation of law only, or in any manner whatever to any person with whom the policyholder was not dealing at arm's length,

(a) the policyholder is deemed to become entitled to receive, at the disposition time, proceeds of the disposition equal to the greatest of

(i) the value of the interest at the disposition time,

(ii) an amount equal to

(A) if the disposition time is before March 22, 2016, nil, and

(B) if the disposition time is after March 21, 2016, the fair market value at the disposition time of the consideration, if any, given for the interest , and

(iii) an amount equal to

(A) if the disposition time is before March 22, 2016, nil, and

(B) if the disposition time is after March 21, 2016, the adjusted cost basis to the policyholder of the interest immediately before the disposition time;”

For example, if an individual transfers their interest in a life insurance policy with a fair market value ("FMV") of $100,000, a cash surrender value of $20,000 and an adjusted cost basis ("ACB") of $30,000 to a corporation which the individual controls and the corporation pays consideration of $100,000, the "deemed" proceeds of disposition under subsection 148(7) would be $100,000, whereas they would have been $20,000 before the budget announcement.

On the other hand, paragraph 69(1)(b) provides that "except as expressly otherwise provided in this Act", a taxpayer who disposed of property to a person with whom the taxpayer was not dealing at arm’s length at an amount less than the fair market value or by way of gift inter vivos, is deemed to have received consideration equal to the FMV.

As a result, proposed subsection 148(7) refers to consideration given, whereas paragraph 69(1)(b) refers to a consideration deemed to have been received.

It is not uncommon in practice that a policyholder wishes to transfer their interest without any consideration given by the acquirer corresponding to the FMV. This may be the case for a donation, a transfer between a subsidiary and a parent, or simply where an individual wishes to transfer their interest in a policy to their corporation in order that the latter can become the beneficiary and assumes the obligation for premiums. In addition, this approach will avoid many problems and costs associated with valuing the FMV of interest in the policy.

Consider the following simple example. Mr. X has been the holder a 100-year term life insurance policy (with no cash surrender value) for a number of years. The ACB for Mr. X's interest is $10,000. He wishes to transfer it to ABC Inc., of which he is the sole shareholder, without any consideration being given by ABC Inc. to Mr. X. The corporation will now be the holder and beneficiary of the policy and will assume payment of the annual premiums.

Questions to the CRA

(a) Can the CRA confirm, in light of the previous example, that Mr. X will have deemed proceeds of disposition of $10,000 for the purposes of proposed paragraph 148(7)(a) since no consideration was given by ABC Inc.?

In short, can the CRA confirm that paragraph 69(1)(b) will have no effect on proposed paragraph 148(7)(a) in such a case?

(B) At the Roundtables for the Conference for Advanced Life Underwriting ("CALU") Roundtable in May 2005 and for the Canadian Life and Health Insurance Association ("CLHIA") in May 2015, CRA indicated that subsection 69(5) (which provides that, respecting a winding-up under subsection 88(2), a corporation is deemed to have disposed of its property at FMV for the purpose of computing its income) prevails over subsection 148(7). Thus, the transfer of a life insurance policy in connection with the outright winding-up of a corporation (and not on the winding-up of a subsidiary into its parent corporation) could result in an inclusion in the income of the corporation. The CRA indicated that subsection 69 (5) was a more specific provision than subsection 148(7).

Many practitioners do not agree with the CRA. Indeed, subsection 148(7) specifically applies to life insurance policies while subsection 69(5) is a general provision covering all property of the corporation. Subsection 148(7) is also applicable on a winding-up because it specifically deals in that subsection with a distribution made by a corporation of an interest in a life insurance policy.

Thus, many practitioners consider that subsection 148(7) is clearly more specific than subsection 69(5) in the particular case of a property that is an interest in a life insurance policy. Furthermore, in Technical Interpretation 920437 (footnote 3), the CRA indicated that subsection 148(7) prevailed over the "more general rule" in subsection 52(2) when it came to determining the cost of an interest in a policy.

Is the CRA prepared to consider changing its 2005 and 2015 positions or to request the Department of Finance to clarify the legislation so that there is specific provision for priority to be accorded to subsection 148(7) given the existing ambiguities?

CRA response to Q.3(a)

Since the preamble to subsection 69(1) provides that it is applicable "except as expressly otherwise provided in this Act," it follows that proposed paragraph 148(7)(a) prevails over paragraph 69(1)( b).

Given the above, Mr. X is deemed to have become entitled to receive proceeds of disposition equal to $10,000 under proposed paragraph 148(7)(a).

CRA response to Q.3(b)

In the two Roundtables referenced above, the CRA stated that, as a general rule, where there is a conflict between two provisions of the same statute, the specific provision prevails over the more general provision. In this case, there was no clear indication to allow the CRA to determine which of these two provisions was the most specific. Although at first glance the CRA was inclined to consider that subsection 69(5) would apply if the disposition of an interest in a life insurance policy occurs during a winding-up governed by subsection 88(2), the CRA wished to examine this question in light of all facts and circumstances surrounding the given particular situation, such as in the context of a request for a tax ruling, to ensure that there was a reasonable result.

Furthermore, the Explanatory Notes accompanying the Proposals state that "[s]ubsection 148(7) is amended to ensure that amounts are not inappropriately received tax-free by a policyholder as a result of a disposition of an interest in a life insurance policy.”

Given the above and the limited scope of the proposed amendments with respect to the disposition of an interest in a life insurance policy, the CRA is of the view that the comments made at the two Roundtables are still valid.

Jean Lafrenière
(613) 670-9013
October 7, 2016
2016-065176

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 CANADA, Department of Finance, Budget 2016, Tax Measures: Notice of Ways and Means Motion.
2 CANADA, Department of Finance, Legislative Proposals Relating to Income Tax, Sales Tax and Excise Duties, July 29, 2016.
3 CANADA REVENUE AGENCY, Technical Interpretation 920437, March 12, 1992.
4 CANADA, Department of Finance, Explanatory Notes Relating to the Income Tax Act, Excise Tax Act, Excise Act, 2001 and Related Legislation (Ottawa: Department of Finance, 2016), Section 17.