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.
Principal Issues: 1. What is the tax treatment of income accruing in an indexed side account where the investment return is based on an index return such as the S&P/TSX Composite Total Return Index.
2. What is the insurer's reporting obligation in respect of the income from in the indexed side account?
Position: 1. See Q&A
2. See Q&A
Reasons: See Q&A
CALU - Conference for Advanced Life Underwriting (2005 )
Question 6
Indexed Side Account
In connection with a universal life insurance product, an insurer offers a side account facility. This account is used to hold amounts which the policyholder pays to the insurer, to the extent that the amounts would result in the policy ceasing to be an exempt policy if they were credited as premiums under the policy. Also, if any amounts must be withdrawn under the policy in order to maintain its exempt status, the withdrawn amounts are credited to the side account. Amounts are automatically transferred from the side account and credited to the policy to the extent that this is possible without causing the policy to lose its exempt status. The policyholder is permitted to withdraw all or any part of the balance in the side account at any time. The balance in the side account at any particular time will be the total of all deposits and transfers to the side account, plus all positive return amounts credited to the side account, minus all withdrawals and transfers from the side account, minus all negative return amounts credited to the side account prior to that time. Withdrawal will also be subject to the insurer's administrative rules and fees.
The terms relating to the side account are set out in an appendix to the life insurance policy. The appendix states that the side account has been established to accompany the policy, but is separate from and external to the policy. It also provides that amounts placed in the side account are not premiums under the policy until withdrawn from the side account and credited to the policy.
The insurer offers several investment options for the side account. In selecting a particular investment option, the policyholder is choosing a method for determining the investment return to be credited to the portion of the side account to which the particular option applies. For example, the policyholder may select the daily interest option for the whole side account, in which case interest would be credited to the side account at a rate that varies daily. The investment options include the S&P/TSX Composite Total Return Index and certain other indexes. When the policyholder selects an index as the investment option, each day's percentage change in the index is used to determine the return (which may be negative) to be credited to the side account.
Assume that an individual deposits an amount into a side account to a UL policy and selects the S&P/TSX Composite Total Return Index as the investment option. The account balance fluctuates daily based on the performance of the index. From time to time, amounts are automatically withdrawn from the side account and credited as premiums under the policy.
Questions:
(a) Does the CRA agree that income and losses that result from the S&P/TSX Total Return Composite Index are to be reported for tax purposes as gains and losses on income account and only in the year in which amounts are withdrawn from the side account?
(b) Does the CRA agree that the insurer has no reporting obligation in the above example?
Agency's Response
Generally, amounts credited to an investor are included in income in the year in which they are credited to the investor rather than in the year they are withdrawn from the investor's account. With regard to this particular arrangement, several issues need to be considered to determine the tax consequences to the investor. First, it would be necessary to determine whether the side account is a debt obligation at law. Then it must be determined whether the amounts credited to the side account constitute interest, an amount paid in lieu of or in satisfaction of interest, or some other type of income. The reporting obligations of the insurer in respect of the side account will also flow from the determination of the nature of the return earned in connection with the side account.
The determination of the legal nature of the indexed side account and the characterization of the return thereon for income tax purposes, may vary depending upon the terms of each particular agreement between the insurer and the holder of the indexed side account. We would be willing to consider this issue further in the context of specific situations where all of the relevant documentation has been provided to us.
Alison Campbell
Sr. Rulings Officer
Income Tax Rulings Directorate
Policy & Planning Branch
(613) 957-3496
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