26 August 2005 External T.I. 2005-0130561E5 - Disposition -Interest in a Life Insurance 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.

Principal Issues: The taxpayer required clarification on whether the calculation of a gain on the disposition of a policy with a "return of premium" benefit is correct.

Position: Appears correct

Reasons: Our review of relevant provisions and information provided by the insurer and taxpayer.

XXXXXXXXXX Manjula Vethanayagam
2005-013056
August 26, 2005

Dear XXXXXXXXXX:

Re: Disposition of an interest in a Life Insurance Policy

This is in reply to your letter of April 5, 2005, in which you requested our comments on whether the calculation of a gain of $XXXXXXXXXX as reported in box 13 of the T5 information slip prepared by your insurer is correct. The information you provided shows that on the disposition of your life insurance policy you received a "return of premiums" benefit in the amount of $XXXXXXXXXX.

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an Advance Income Tax Ruling request. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to comment on whether the tax consequences reported by the insurer are consistent with the application of the provisions of the Income Tax Act (the "Act") that define the proceeds of disposition of a policy and the adjusted cost basis (ACB) of a policy. We note that we are not in a position to verify the accuracy of any of the figures provided by the insurer, such as the amount of the "net cost of pure insurance" (NCPI). Based on our review of the information provided, including your correspondence with the insurer, it is our view that the calculation of the taxable gain on your policy is consistent with the information provided.

General Comments

A "disposition" of an interest in a life insurance policy is defined in subsection 148(9) of the Act to include "a surrender thereof" or "the dissolution of that interest by virtue of the maturity of the policy." When a policy is surrendered or matures, subsection 148(1) of the Act will apply to require the policyholder to report a gain for tax purposes to the extent that the proceeds of disposition of the policy exceed the ACB of the policy immediately before the disposition. Any gain resulting from the disposition is required to be included in the policyholder's income by virtue of paragraph 56(1)(j) of the Act.

Proceeds of Disposition

The "proceeds of the disposition" of an interest in a life insurance policy is defined in subsection 148(9) of the Act as the amount of the proceeds that the policyholder is entitled to receive on the disposition. Where the terms of a policy provide for a benefit to be paid out on the surrender or maturity of the policy, such benefit would be included in the computation of the proceeds received by the policyholder. In this case, the terms of your policy provide for a payout of a "return of premiums" benefit as determined by reference to the total premiums paid in respect of the policy.

ACB of a Life Insurance Policy

The ACB of a policyholder's interest in a life insurance policy is determined by a formula under subsection 148(9) of the Act. In very general terms, the ACB to the original policyholder will be the amount by which the cash premiums paid by the policyholder, and any income in respect of the policy that has previously been reported for tax purposes, exceeds the NCPI under the policy.

The NCPI represents the cost the policyholder has paid to be covered by insurance during the time that he or she has held the policy. Since the NCPI is determined by the insurer, we are not in a position to assess the correctness of the NCPI amount provided by the insurer as only the insurer has the necessary information to compute this amount. In your case, it appears that a large portion of the premiums paid has been consumed by the cost of providing insurance as represented by the NCPI of $XXXXXXXXXX.

Based on the information provided, the total premiums paid of $XXXXXXXXXX exceed the NCPI of $XXXXXXXXXX resulting in an ACB of the insurance policy of $XXXXXXXXXX.

Gain on Disposition

As referred to above, the application of subsection 148(1) of the Act results in a gain where the proceeds of disposition of the policyholder's interest in the policy exceed the ACB to the policyholder of that interest.

In general, life insurers are subject to tax on investment income accruing to fund life insurance policies. When the insurers pay the investment income to policyholders in the form of proceeds on the disposition of the policies, the insurers will generally claim a deduction for the amount paid. That amount is included in computing any gain on disposition of the policy which is then taxed in the hands of the policyholder.

In this case, the proceeds of disposition are $XXXXXXXXXX, and the ACB is $XXXXXXXXXX. Therefore, the gain realized on the disposition of your life insurance policy is $XXXXXXXXXX which must be included in income in accordance with subsection 148(1) and paragraph 56(1)(j) of the Act.

Finally, we note that a gain on the disposition of a life insurance policy should be reported in "Box 14- Other income from Canadian sources" on the T5 information slip.

We hope that our comments will be of assistance to you.

Yours truly,

F. Lee Workman
Section Manager
Charitable and Financial Institution Sectors
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Policy and Legislation Branch