5 November 2007 External T.I. 2006-0181641E5 - Reversing Premiums on an 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: Does the reversal of premiums in a universal life insurance policy constitute a disposition under section 148 of the Income Tax Act?

Position: Yes.

Reasons: A partial withdrawal from a life insurance policy appears to constitute a partial surrender of the policy.

								2006-018164
XXXXXXXXXX 							Helen Zelobowski
(519) 571-6987
November 5, 2007

Dear XXXXXXXXXX:

Re: Reversing Premiums to Maintain Exempt Status of Life Insurance Policy

We are writing in response to your letter dated April 12, 2006 requesting confirmation that the reversal of premiums in a universal life insurance policy does not constitute a disposition under section 148 of the Income Tax Act (the "Act"). You have also asked for confirmation that the reversal of premiums is not taxable under any other provision of the Act.

Facts

Based on our understanding, the universal life insurance policy stipulates that in order to keep the policy exempt from accrual taxation, the insurer may place all or part of any deposit in excess of the amount that may be deposited into the policy into the Side Account. In some cases the insurer does not discover that excess deposits were placed in the policy until performing the anniversary exempt test within the 60 day grace period provided for in paragraph 306(4)(d) of the Income Tax Regulations ("Regulations"). In these cases the insurer may remove, at that time, the excess deposits plus or minus any investment income, gains or losses associated with these deposits, from the insurance policy. The withdrawal or "premium reversal" is recorded such that the effective date of the reversal is the date that the deposit was placed in the policy.

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 of an advance income tax ruling request submitted in accordance with the guidelines established in Information Circular 70-6R5. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, as requested, we are prepared to provide you with our view on the general tax consequences resulting from the reversal of a deposit in a universal life insurance policy.

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". When a policy is surrendered, 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 "adjusted cost basis" ("ACB") of the policy immediately before the disposition. When a policy acquired after December 1, 1982 is partially surrendered, the ACB of the policy is usually prorated under subsection 148(4). Any gain resulting from the partial disposition is required to be included in the policyholder's income by virtue of paragraph 56(1)(j) of the Act.

A partial withdrawal from a life insurance policy would appear to constitute a partial surrender of the policy. In such circumstances, where a partial withdrawal is made from a policy, the policyholder is considered to have disposed of a portion of the policy. Accordingly, in our view, a "premium reversal" as described above appears to result in a partial disposition of the policy under section 148 of the Act. There is no legal basis to reverse transactions that have previously occurred, including deposits into a universal life insurance policy, and to treat those transactions as though they have never taken place.

We trust that these comments will be of assistance.

Yours truly,

F. Lee Workman
Manager
Charitable and Financial Institutions Sectors
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch