21 March 2002 Internal T.I. 2001-0113777 - M.K. Endowment Policy

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Whether a foreign tax credit or a subsection 20(12) deduction is available for UK tax paid by a Canadian resident policyholder on the investment income of a UK endowment policy?

Position: Yes

Reasons: The UK tax is considered to be an income or profits tax even though the investment income accrued in the policy might be exempt from the application of subsection 12.2(1) of the Act.

March 21, 2002

	Bill Holmes	International Section I
	Appeals Division	S. Leung
	Vancouver  Tax Services Office	952-4666

2001-011377

United Kingdom Endowment Policy

This is in reply to your e-mail of December 4, 2001, in which you requested our view on the tax treatment of the maturity of an UK endowment policy to a resident of Canada (the taxpayer) and the availability of a Canadian foreign tax credit or a deduction from computing the income of the taxpayer where the taxpayer has paid UK tax on the investment income of the policy.

General Comments

Before dealing with the specific facts of the particular situation outlined in your e-mail, we would like to provide some general comments on the tax implications with respect to the UK endowment policy which would generally be considered a life insurance policy as defined under subsection 138(12) of the Income Tax Act (the "Act").

When an individual immigrates to Canada and becomes resident in Canada, subsection 128.1(1) of the Act generally deems that individual to have disposed of each property owned by him or her immediately before that time for proceeds of disposition equal to the fair market value of the particular property at that time and to have reacquired each such property so disposed of for a cost equal to the amount of the deemed proceeds. The intended effect of these rules is not to tax gains which accrued prior to immigration.

The rules in subsection 128.1(1) of the Act would generally apply to a taxpayer's interest in a life insurance policy that is not a "taxable Canadian property". For the purposes of section 128.1 of the Act, the term "taxable Canadian property" is defined to include an interest in a "life insurance policy in Canada". A "life insurance policy in Canada" is defined in subsection 138(12) of the Act as meaning a life insurance policy issued or effected by an insurer upon the life of a person resident in Canada at the time the policy was issued or effected.

Where subsection 128.1(1) of the Act is applicable, a policyholder will be deemed to have last acquired the policy at the time the policyholder became resident in Canada for the purposes of subsection 12.2(1) of the Act. Pursuant to that latter subsection, the accrued income under a non-exempt life insurance policy last acquired after 1989 is generally taxed on an annual basis.

The amount of the accrual is based on the excess of the policy's "accumulating fund" (as defined in section 307 of the Income Tax Regulations) each year, over its "adjusted cost basis" (as defined in subsection 148(9) of the Act). The accumulating fund is essentially a measure of the accumulating investment growth or build-up over time. The adjusted cost basis is essentially the cost of the policy adjusted for certain items such as premiums paid under the policy and any amount of accrued income previously included in computing the policyholder's income. Where UK tax was paid by the policyholder on the "investment income", a foreign tax credit or a subsection 20(12) deduction would be available to the policyholder in Canada.

In addition, under subsection 148(1) of the Act, a policyholder is required to include in income in respect of the disposition of an interest in a life insurance policy an amount by which the proceeds of the disposition of the policyholder's interest in the policy that the policyholder, the beneficiary or assignee is entitled to receive exceeds the policyholder's adjusted cost basis (i.e., taking into consideration the deemed acquisition cost under subsection 128.1(1) of the Act) of that interest immediately before the disposition. Subsection 148(9) of the Act provides that a disposition will occur in respect of a life insurance policy upon the dissolution of the interest by virtue of the maturity of the policy. As discussed in Interpretation Bulletin IT-87R,² the determination of the accumulating fund and the adjusted cost basis of a policy generally requires information that is available only in the accounts of the issuer.

Facts of the Situation

The facts set out in your facsimile transmission are as follows:

Some time around 1965, the taxpayer took out an endowment policy from XXXXXXXXXX when he was resident in the UK. It is understood that the policy provided life insurance coverage until a specified date at which time a lump-sum payment was to be made and the policy terminated. The policy matured in 1998. This type of policy enjoyed a special tax status in the UK as holders of this type of policy were not taxed on the proceeds at the maturity of the policy. However, the insurance company was required to pay tax on the investment income of the policy (note that we have assumed the tax that was required to be paid by the insurance company was actually paid on behalf of the policyholder). The taxpayer immigrated to Canada on XXXXXXXXXX 1976.

Specific Comments

At the time of the taxpayer's immigration into Canada in 1976, there would be no deemed disposition and reacquisition of the endowment policy immediately before or immediately after that time, as the case may be, because the policy was not a capital property and the rule in former subsection 48(3) of the Act did not apply.¹

For the purposes of subsection 12.2(1) of the Act, since the policy was last acquired before 1983 or 1990, there was no requirement to report any accrued income of the policy on a triennial basis (under former subsection 12.2(3)) or on an annual basis (under subsection 12.2(1)), as the case may be. In this regard, we have assumed that no premium under the policy was paid after 1982. If the "investment income" of the policy was taxed in the UK annually prior to the year of disposition of the policy, there would be a timing problem with respect to the claim for a Canadian foreign tax credit for those years as there was no UK source income reported in Canada in those years. However, a subsection 20(12) deduction would be available. In the year of the final disposition of the policy as a consequence of the dissolution of the interest by virtue of the maturity of the policy, since the UK did not tax the proceeds on maturity of the policy, no Canadian foreign tax credit or deduction was available as there was no UK tax paid (except for that UK tax paid on the "investment income" for the year of the disposition noted below).

On the maturity of the endowment policy in 1998, the taxpayer was considered to have disposed of the policy and he or she was required to report income under paragraph 56(1)(j) of the Act equal to the amount by which the proceeds of disposition exceeds the adjusted cost basis of the policy to the policyholder pursuant to subsection 148(1) of the Act. It should be noted that there was no capital gain or loss involved on such disposition because of the operation of subparagraphs 39(1)(a)(iii) and 39(1)(b)(ii) of the Act. Where UK tax was paid on the investment income of the policy in the year of disposition, a subsection 20(12) deduction or a subsection 126(1) foreign tax credit in Canada would be available for such UK tax. Since the policy was issued prior to 1971, the adjusted cost basis of the policy would reflect, among other things, its cash surrender value as at December 31, 19702 and the premiums paid after that date.

We trust you will find the above to be of assistance.

for Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch

ENDNOTES

¹ See Vila Nova Carvalho v. MNR, 80DTC 1236 (TRB).

² See Vila Nova Carvalho, supra and paragraph 7 of the cancelled IT-87R, dated February 28, 1986.

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