6 November 2007 External T.I. 2007-0257601E5 - 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: General comments on the tax consequences of the disposition of a life insurance policy with a "return of premium" benefit. This was a follow up to document 2007-023032.

Position: Based on the information provided the disposition of the policies will result in an amount being included in the income of the policyholders.

Reasons: The legislation

XXXXXXXXXX 							2007-025760

November 6, 2007

Dear XXXXXXXXXX:

Re: Disposition of an Interest in a Life Insurance Policy

This is in reply to your letter of October 5, 2007, which was in response to our letter to you dated May 1, 2007, regarding the tax implications of the disposition of life insurance policies by two of your clients. When your clients disposed of the life insurance policies that had been issued to them by XXXXXXXXXX, your clients received payments equal to the amount of the premiums that had been paid under the policies during the years that the policies had been in force. You have provided us with information from XXXXXXXXXX and calculations of the "proceeds of disposition", the "adjusted cost basis" and the income inclusion arising from the disposition of the policies and have asked that we confirm that your calculations, which show that no amounts are to be included in income from the disposition of the policies, are correct.

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 provide you with the following comments regarding the calculation of taxable gains from the disposition of life insurance policies.

As we noted in our previous letter to you, the amount to be included in a policyholder's income from the disposition of a life insurance policy is determined pursuant to the provisions of section 148 of the Income Tax Act (the "Act"). In general terms, the amount to be included in income from the disposition of a life insurance policy is determined by the formula:

Income Inclusion = Proceeds of Disposition - Adjusted Cost Basis

The computation of the "proceeds of disposition" and the "adjusted cost basis" of a life insurance policy are found in their definitions in subsection 148(9) of the Act. In general terms, where a policyholder's interest in a policy has been surrendered or has matured, the "proceeds of disposition" to be used in calculating the amount to be included in income from the disposition of the interest will be equal to the amount that the policyholder is entitled to receive from the insurer. In the case of the type of life insurance policy you described, the "proceeds of disposition" would be equal to the amount of the "refund of premiums" that was received by your clients. The definition of "proceeds of disposition" in subsection 148(9) of the Act, does not make any reference to the "net cost of pure insurance" ("NCPI") of the policy. Accordingly, we disagree with the portion of your calculations which show that the "proceeds of disposition" to be used in calculating the amount to be included in income from the disposition of the policies is determined net of the NCPI of the policies, and is therefore zero. The Act provides that in your clients' circumstances, the proceeds of disposition that must be used in calculating the amount to be included in income from the disposition of the life insurance policies is the amount of the "refund of premiums" that were paid to your clients by XXXXXXXXXX.

The NCPI is a factor in the calculation of the "adjusted cost basis" of a policy, and in particular, the definition of "adjusted cost basis" in subsection 148(9) of the Act provides, among other things, that the adjusted cost basis of a life insurance policy is computed by deducting the NCPI under a policy from the amount of the premiums that were paid to acquire the life insurance policy. Based on the information that was provided to you by XXXXXXXXXX, the NCPI calculated by the insurer in connection with each of your client's policies, exceeded the amount of premiums that were actually paid under the policies. As a consequence, the "adjusted cost basis" was zero in the case of both of your clients' policies. The letter provided to you by XXXXXXXXXX confirmed the fact that the adjusted cost basis of the policies was zero.

Given that the adjusted cost basis of your clients' policies are zero, it is our view that based on the information provided in your letter to us, and the provisions of the Income Tax Act, the full amount of the "refund of premiums" received by your clients are to be included in computing their income pursuant to subsection 148(1) and paragraph 56(1)(j) of the Act, in the year that they disposed of the life insurance policies. This position is consistent with the interpretation that the CRA has provided to all other taxpayers who have disposed of this type of insurance policy.

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
Legislative Policy and Regulatory Affairs Branch