2 December 2003 External T.I. 2003-0011625 - EXEMPTION TEST POLICY DEATH BENEFIT

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: Calculation of death benefit in Regulation 306(3).

Position:

If the death benefit under the life insurance policy has not changed, there is no legislative basis to adjust the death benefits of the exemption test policies.

Reasons: Legislation.

XXXXXXXXXX 							2003-001162

December 2, 2003

Dear XXXXXXXXXX:

Re: Exemption Test Policy - Death Benefit

This is in reply to your facsimile letter of April 2, 2003 wherein you requested our views as to the interpretation of subsection 306(3) of the Income Tax Regulations (the "Regulations"). In particular, you have asked us to confirm whether the death benefit for each exemption test policy as calculated in your example is consistent with the legislation.

In your example, a 45 year old male non-smoker purchased a universal life policy with a $100,000 death benefit on April 2, 2002. On June 1, 2003, the policyholder added an additional $50,000 of death benefit to the universal life policy bringing the total death benefit for the policy to $150,000. In applying subsection 306(3) of the Regulations, your example shows an exemption test policy ("ETP1") being established on the first policy anniversary (i.e., April 2, 2003) with a death benefit of $100,000 and an issue date of April 2, 2002. On the second anniversary (i.e., April 2, 2004), the death benefit on ETP1 is increased to $108,000 and a second exemption test policy ("ETP2") is established with a $42,000 death benefit and an issue date of April 2, 2004. Assuming that there is no change in the death benefit under the life insurance policy in the subsequent policy year, your example shows that on the third policy anniversary (i.e., April 2, 2005) the death benefit on ETP1 is increased to $120,000 and the death benefit on ETP2 is reduced to $30,000. You note that the increase of $12,000 of death benefit on ETP1 is computed as 8% of the death benefit under the life insurance policy on the previous policy anniversary (8% of $150,000).

Pursuant to section 306 of the Regulations, the exempt status of a particular life insurance policy (other than an annuity contract or a deposit administration fund policy) is generally determined by reference to the accumulating fund of an exemption test policy at various points in time. Paragraph 306(3)(a) of the Regulations provides that an initial exemption test policy will be deemed to have been issued to the policyholder in respect of a life insurance policy on the date of its actual issue. Where the amount of the benefit on death on the life insurance policy is subsequently increased and on a policy anniversary the amount of the increased benefit on death exceeds 108% of the benefit on death under the life insurance policy on the later of the date of issue of the policy or the date of the previous anniversary, an additional exemption test policy will be deemed to be issued pursuant to paragraph 306(3)(b) of the Regulations. The additional exemption test policy will be deemed to have a benefit on death equal to the excess of the increase over the 8% added to the initial exemption test policy by virtue of subparagraph 306(3)(c)(ii) of the Regulations.

With regard to your example, we agree that paragraph 306(3)(a) of the Regulations would apply to deem ETP1 to have been issued on April 2, 2002. We also agree that as a result of the increase in the death benefit from $100,000 to $150,000 on June 1, 2003, paragraph 306(3)(b) of the Regulations would apply to deem ETP2 to have been issued on the second anniversary. Pursuant to paragraph 306(3)(c) of the Regulations, on the second anniversary the death benefit on ETP1 is increased to $108,000 and ETP2 is deemed to have a death benefit of $42,000. However, we disagree with the result as shown in your example with respect to the third policy anniversary. In our view, on the third anniversary the death benefits on ETP1 and ETP2 remain at $108,000 and $42,000, respectively. Where there has been no increase to the death benefit under the life insurance policy in the subsequent policy year, there is no legislative basis for the view that the death benefit on ETP1 can be increased by 8% with a corresponding reduction to the death benefit on ETP2.

In summary, pursuant to subsection 306(3) of the Regulations, the death benefit of the initial exemption test policy will be adjusted to reflect an increase in the death benefit of a life insurance policy of up to 8% during a policy year. However, where the increase is greater than 8%, a separate exemption test policy will be deemed to be issued and the excess of the increase over 8% will be reflected in the death benefit of the separate exemption test policy. We note that the total death benefits of all the exemption test policies will equal the death benefit under the life insurance policy on each policy anniversary. In our opinion, the death benefit under the second and subsequent exemption test policies is a constant amount and the death benefit under the initial exemption test policy will only increase when there has been an increase in the death benefit under the policy.

While we hope our comments are of assistance to you, they do not constitute an advance income tax ruling and therefore are not binding upon the CCRA in respect of a specific situation.

Yours truly,

F. Lee Workman
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings Directorate