8 December 2008 External T.I. 2008-0268631E5 - Transfer of life insurance policy to a "child"

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:

Tax liability arising from ;
1. (a) The transfer of a life insurance policy on the life of the policyholder's grandchild to a parent of the grandchild, and
(b) The subsequent transfer of the policy to the grandchild when he/she attains a certain age.

2. (a) The transfer of a life insurance policy on the life of the policyholder's grandchild to an aunt or uncle of the grandchild, and
(b) The subsequent transfer of the policy to the grandchild when he/she attains a certain age.

3. (a) The transfer of a life insurance policy on the life of the policyholder's grandchild to a "trust" in which the grandchild is the beneficiary, and
(b) The subsequent transfer of the policy to the grandchild when he/she attains a certain age.

Position:

1. (a) No tax liability,

(b) No tax liability.

2. (a) If aunt or uncle is a "child" of the policyholder, then no tax liability,

(b) Generally, would result in a tax liability to the aunt or uncle.

3. (a) Tax liability to the policyholder, since trust not considered a "child" of the policyholder,

(b) Generally, no tax liability to either the trust or beneficiary.

Reasons:

S.148(8) allows the transfer of a life insurance policy to a "child" of the policyholder for deemed proceeds of disposition equal to the adjusted cost basis of the policy; 1.(a), 1.(b) and 2.(a).

S.148(7) allows for the transfer of a life insurance policy, for no consideration, to a non arm's length person for a deemed proceeds of disposition equal to the cash surrender value of the policy; 2.(b) and 3.(a).

S.107(2) allows for the transfer of property (life insurance policy) to a beneficiary of the trust, in satisfaction of all or part of their interest in the property of the trust, for deemed proceeds of disposition equal to the cost amount (to the trust) of the property; 3.(b)

XXXXXXXXXX 									2008-026863
W. King

December 8, 2008

Dear XXXXXXXXXX :

Re: Tax Liability on Transfer of Life Insurance Policy

We are writing in reply to your letter dated January 30, 2008 in which you requested information regarding the potential tax liability arising from the transfer by you of life insurance policies on the lives of your grandchildren to other persons and the subsequent transfer of the policies to those grandchildren when they attain a certain age.

The particular situation outlined in your letter appears to relate to a factual one, involving a specific taxpayer. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on transactions involving specific taxpayers other than in the form of an advance income tax ruling, if the transactions are proposed and not yet undertaken. However, we are prepared to offer the following general comments, which may be of assistance.

The basic rule for the taxation of the disposition of a life insurance policy is that a policyholder is taxed on the excess of the proceeds of disposition over the adjusted cost basis of the policy, as required by subsection 148(1) of the Income Tax Act (the "Act"). The terms "proceeds of disposition" and "adjusted cost basis" are defined for these purposes in subsection 148(9) of the Act. There are certain circumstances however, in which a life insurance policy can be transferred to another person on a tax-free basis.

In this regard, subsection 148(8) of the Act, applies where a policyholder transfers an interest in a life insurance policy to a "child" of the policyholder for no consideration, and a child of the policyholder or a child of the transferee is the person whose life is insured under the policy. If subsection 148(8) of the Act applies to a transfer of a life insurance policy, the policy is deemed to have been disposed of by the policyholder for proceeds of disposition equal to the adjusted cost basis to the policyholder of the policy immediately before the transfer. The child who acquires the life insurance policy from the policyholder will be deemed to have acquired the policy at the same adjusted cost basis that the policyholder had in the policy immediately before the transfer. "Child" for the purposes of section 148 of the Act is defined in subsection 148(9) of the Act, and subsection 252(1) of the Act provides an extended meaning of "child" which applies for purposes of the Act. In respect of a particular individual, the definition of "child" for purposes of subsection 148(8) of the Act would generally include, among other persons, the individual's children and grandchildren (by birth or adoption), the children or grandchildren (by birth or adoption) of the individual's spouse or common-law partner, and the spouse or common-law partner of a child of the individual (e.g., a son-in-law or a daughter-in-law). To determine whether any particular individual would be a "child" of another individual for purposes of applying subsection 148(8) of the Act, it would be necessary to consider the relationship between the two individuals on a case by case basis.

The rules in subsection 148(8) of the Act would generally apply where an individual transfers a life insurance policy on the life of a grandchild of that individual to the parent of that grandchild, or a person who is an aunt or uncle of that grandchild provided the aunt or uncle is a child of the individual. Similarly, a subsequent transfer of that life insurance policy by the parent of the grandchild, to the grandchild whose life is insured under the policy, would also generally be a transfer to which subsection 148(8) of the Act applies such that no tax liability would arise on the transfer. However, because the grandchild whose life is insured under the policy would not generally be a "child" of an aunt or uncle for purposes of these rules, a subsequent transfer of the policy from the aunt or uncle to the grandchild is not a transfer to which subsection 148(8) of the Act would apply.

A transfer of the policy by the aunt or uncle to the grandchild is a transfer to which subsection 148(7) of the Act would generally apply. When an individual transfers an interest in a life insurance policy to another person by way of gift or by operation of law only, or where the policy is transferred in any manner to a person with whom the policyholder does not deal at arm's length, subsection 148(7) of the Act will generally apply to the transfer. When subsection 148(7) of the Act applies to a transfer of a life insurance policy, the policyholder is deemed to have received proceeds of disposition equal to the "value" of the policy at the time the policy is transferred. To the extent that the "value" exceeds the adjusted cost basis of the policy at that time, the policyholder will have a gain that must be included in computing their income for tax purposes. Subsection 148(7) will also deem the person who acquired the policy to have acquired it for an amount equal to that "value". The term "value" as defined in subsection 148(9) of the Act generally equals the cash surrender value of the policy. The life insurance company that issued a life insurance policy should be able to provide the policyholder with the cash surrender value and adjusted cost basis of the policy at the time of such a transfer.

Generally, subsection 148(7) of the Act will apply when an individual transfers a life insurance policy to another person for no consideration. Whether, in any particular circumstance, a policy has been transferred by way of gift or operation of law only or to a person not at arm's length with the policyholder, is a question of fact and law that can only be answered after a review of the specific facts surrounding the transfer. To assist in the determination of whether or not persons deal with each other at arm's length under the Act, please refer to Interpretation Bulletin 419R2 "Meaning of Arm's Length"; copy enclosed.

Where a life insurance policy is transferred to a trust that is treated as a separate taxpayer for purposes of the Act, the rules in subsection 148(8) of the Act would not generally apply. This is because a trust does not fall within the definition of 'child' for purposes of applying subsection 148(8) of the Act, nor would an individual be considered a "child" of a trust for these purposes. Subsection 148(7) of the Act would generally apply a transfer of a life insurance policy to a trust for no consideration, where a child or grandchild of the policyholder is beneficially interested in the trust. Where a life insurance policy has been transferred to a trust and the policy is subsequently transferred to a beneficiary of the trust in satisfaction of all or part of their interest in the property of the trust, the transfer will generally not result in a tax liability to either the trust or the beneficiary at the time of the transfer.

We hope that our comments will be of assistance to you however, as indicated in paragraph 22 of Information Circular 70-6R5 entitled Advance Income Tax Rulings, this opinion is not a ruling and accordingly it is not binding on the Canada Revenue Agency. We would recommend that independent legal and tax advice be retained to assist in making determinations as to whether subsections 148(7) or 148(8) of the Act would apply in any particular situation.

Yours truly,

Sharmini Ratnasingham
Assistant Director
for Acting Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

Encl.