11 January 2007 External T.I. 2006-0182591E5 - life insurance and eligible funeral arrangements

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: What is the tax treatment of transferring funds from an eligible funeral arrangement to an insurer to pay for a life insurance policy to fund a funeral?

Position: Any accrued income will be taxable to the individual to the extent provided by 148.1(2) on the withdrawal of the funds from the EFA

XXXXXXXXXX 								2006-018259
									Annemarie Humenuk
Attention:  XXXXXXXXXX 

Dear XXXXXXXXXX:

Re: Eligible Funeral Arrangements

This is in reply to your letter of March 20, 2006, in which you ask about the tax implications on the transfer of funds held in an eligible funeral arrangement on deposit with a financial institution to an arrangement funded by a life insurance policy. We apologize for the delay in our response.

All statutory references in this letter are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended (the "Act") or the Income Tax Regulations (the "Regulations").

As stated in CRA document 2003-004268, a copy of which was sent to you previously, it is not clear how an arrangement funded by an insurance policy would qualify as an eligible funeral arrangement as defined in subsection 148.1(1). Because of the uncertainty of whether such an arrangement would qualify as an eligible funeral arrangement, any qualifying person considering establishing such an arrangement that purports to be an eligible funeral arrangement or transferring funds to such an arrangement that purports to be an eligible funeral arrangement should request an advance income tax ruling in the manner set out in Information Circular 70-6R5. However, we are prepared to provide the following general comments.

An eligible funeral arrangement must, among other things, be established and maintained by a qualifying person who is licensed or otherwise authorized to provide funeral or cemetery services for individuals under the laws of a province and the funds must be held by a custodian, as that term is defined in subsection 148.1(1), solely for the purpose of funding the funeral or cemetery services. The custodian can be either the qualifying person, as defined in subsection 148.1(1), who receives the contribution or a trustee of a trust that is governed by the eligible funeral arrangement. While the Act does not limit the manner in which a custodian may invest the funds so held, the funds must be held solely for the purpose of funding the funeral or cemetery services. You have advised that the Funeral Directors and Establishments Act of Ontario provides that funeral directors cannot use the funds acquired from a customer to purchase life insurance on the life of that individual to cover the cost of the funeral expenses to be incurred in the future. If we understand your comments correctly, it seems clear that the funds held in an eligible funeral arrangement established by a qualifying person providing services in Ontario could not be invested in life insurance. An arrangement under which a policy owner makes the funeral home a beneficiary of the death benefits payable under a life insurance policy would not qualify as an eligible funeral arrangement because the policy would not be held by the custodian. Additionally, the terms and conditions of the policy, including the amount of any benefit available under the policy, such as the death benefit, would be relevant in determining whether the sole purpose of the arrangement is the funding of funeral or cemetery services.

Distinct from an eligible funeral arrangement, a person may purchase a life insurance policy to fund funeral and cemetery costs. A policyholder holding an interest in a life insurance policy that qualifies as an "exempt policy" with the meaning of section 308 of the Regulations is not subject to taxation on the accumulating income earned by the policy. As a practical matter, an overwhelming majority of life insurance policies sold in Canada are exempt policies as defined in the Regulations.

Pursuant to subsection 148(9), a "disposition" of an interest in a life insurance policy excludes a payment made as a consequence of the death of a person whose life is insured under the policy if the policy is an exempt policy or if the interest in the policy was last acquired before December 2, 1982. Consequently, when an individual chooses to use a life insurance policy to ensure that his or her estate has sufficient funds to cover funeral and cemetery costs, the amount received under such a policy as a result of that person's death will normally not be subject to tax. In addition, since no amount of the accrued investment income will be included in the policy holder's income during the period in which the life insurance policy is an exempt policy as defined in the Regulations, a life insurance policy that is an exempt policy at all times during the lifetime of the policyholder, will generally not give rise to any tax in the hands of the policyholder who is the person whose life is insured under the policy. However, any disposition or deemed disposition of an interest in a life insurance policy prior to death will result in an income inclusion to the extent that the proceeds of disposition exceed the adjusted cost base of the interest in that policy that has been disposed of or deemed to have been disposed of at that time, whether or not the policy is an exempt policy.

If an individual wishes to withdraw the funds from an existing eligible funeral arrangement in order to purchase a life insurance policy to pay for the cost of a funeral, the individual will be required to include an amount in income pursuant to the formula set out in subsection 148.1(3). In this regard, it should be noted that the payment of the premiums in respect of an interest in a life insurance policy is not considered to be a payment for funeral or cemetery expenses within the meaning of subsection 148.1(1). The fact that the individual may direct the funds to be paid to an insurance company and may not receive the funds directly does not alter the tax consequences imposed by subsection 148.1(3). Example 1 in paragraph 15 of Interpretation Bulletin IT-531, Eligible Funeral Arrangements, available on the CRA website at the following address:

http://www.cra-arc.gc.ca/tax/technical/incometax/menu-e.html provides an example of how the amount to be included in the individual's income is to be calculated. For greater certainty, paragraph 17 of that bulletin does not apply to the transfer of funds from an existing eligible funeral arrangement to an insurance company to be used as a payment of a premium on an insurance policy.

Thus, in the first three scenarios described in your letter in which an individual withdraws funds from an eligible funeral arrangement in order to pay a lump sum premium for a life insurance policy, the individual would be taxable to the extent provided by subsection 148.1(3) as explained above. We are unable to comment on the fourth scenario described in your letter in which an arrangement funded by a life insurance policy purports to be an eligible funeral arrangement because, as stated above, we do not have sufficient information to establish whether such an arrangement would qualify as an eligible funeral arrangement.

This opinion is provided in accordance with the comments in paragraph 22 of Information Circular 70-6R5.

We trust our comments will be of assistance.

T. Murphy
Section Manager
for Division Director
International & Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch