26 January 2009 External T.I. 2007-0233631E5 - Gain on Disposition of 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: What are the tax implications of the disposition of a term life insurance policy that provides for a return of part of the premiums if the policy is surrendered or cancelled prior to the end of the term.

Position: General comments provided. Taxable gain arises to the extent the proceeds of disposition exceed the adjusted cost basis of the policy at the time of the disposition.

Reasons: The legislation.

XXXXXXXXXX 								2007-023363
									Alison Campbell
January 26, 2009

Dear XXXXXXXXXX :

Re: Disposition of a Life Insurance Policy

We are writing in reply to your letter of April 30, 2007 wherein you requested our views on the tax implications of the disposition of a hypothetical term life insurance policy. The policy you described would be issued with level premiums payable for 20 years and at the end of 10 years the policyholder would have the option under the policy to continue the policy at the same premiums for the next 10 years, or cancelling the policy and receiving a payment from the insurer. The amount of the payment would be the difference between the amount of premiums that had been paid by the policyholder to the end of year 10, and the amount that the policyholder would have paid if they had instead purchased a 10 year policy with renewal guaranteed at higher premiums for the next 10 years.

Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R5, dated May 17, 2002. Questions concerning completed transactions should be addressed to the local taxation service office.

The tax implications arising upon the disposition of any particular life insurance policy can only be determined after a review of the terms and conditions of the particular insurance contract. However, we are prepared to provide the following comments regarding the general tax consequences of the disposition of life insurance policies other than on the death of the life insured under the policy.

A "disposition" of an interest in a life insurance policy is defined in subsection 148(9) of the Income Tax Act (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 "adjusted cost basis" ("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.

The "proceeds of the disposition" of an interest in a life insurance policy is defined in subsection 148(9) of the Act. In general terms, the proceeds of the disposition are defined to be the amount that the policyholder is entitled to receive from the insurer on the disposition. In our view, this would include a payment made by the insurer to a policyholder upon the surrender or maturity of a term 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 "net cost of pure insurance" (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 and as such reduces the amount that can be returned to the policyholder on a tax free basis when the policy is surrendered. Section 308 of the Income Tax Regulations to the Act sets out the rules for calculating the NCPI of a taxpayer's interest in a life insurance policy.

The above comments represent our general view with respect to the subject matter and are not binding on the CRA, as explained in paragraph 22 of Information Circular 70-6R5. We trust that the foregoing 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
Legislative Policy and Regulatory Affairs Branch