26 January 2009 External T.I. 2008-0301371E5 - 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: Guidance requested with respect to the taxation of a disposition of an interest in a life insurance policy.

Position: Generally, the disposition of an interest in a life insurance policy will result in an amount being included in the income of the policyholder.

									2008-030137
XXXXXXXXXX								Sylvie Danis
(613) 957-3496
January 26, 2009

Dear XXXXXXXXXX :

Re: Disposition of an Interest in a Life Insurance Policy

This is in response to your request for guidance with respect to the taxation of a disposition of an interest in a life insurance 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 matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we offer the following general comments.

General Comments

When an interest in a life insurance policy is surrendered, subsection 148(1) of the Income Tax Act (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 at the time of surrender.

Gain on Disposition

As indicated above, the application of subsection 148(1) of the Act results in a gain where the proceeds of disposition of the policyholder's interest in the policy exceed the ACB to the policyholder of that interest. The gain computed under subsection 148(1) must be included in computing the income of the policyholder in the year the disposition takes place, pursuant to paragraph 56(1)(j) of the Act.

The insurer with whom the policy was held prior to its maturity or surrender should report the amount of the gain on the policy in "Box 14 - Other Income from Canadian Sources" on a T5 information slip it issues to the policyholder and as such, the amount will be fully taxable. We understand that some insurers have been reporting the gain in "Box 13 - Interest from Canadian Sources" but in either case the full amount is included in income as required under the Act.

Proceeds of Disposition

The "proceeds of the disposition" of an interest in a life insurance policy is defined in subsection 148(9) of the Act as the amount of the proceeds that the policyholder is entitled to receive on the disposition. Where the terms of a policy provide for a benefit to be paid out on the surrender or maturity of the policy, such benefit would be included in the computation of the proceeds received by the policyholder.

ACB of a 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 (excluding premiums for accidental death benefits), 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.

Net cost of pure insurance

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 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.

Regulation 308 requires that the mortality data set out in the 1969-75 mortality tables of the Canadian Institute of Actuaries be used in computing the NCPI of an interest in a life insurance policy. The Regulation provides that the NCPI of a taxpayer's interest in a life insurance policy shall be computed by multiplying the applicable rate of mortality from the tables by the difference between either the benefit payable on death in respect of the interest at the end of the year and the accumulating fund at the end of the year (determined without regard to any policy loan outstanding) or, the cash surrender value of the interest at the end of the year, depending upon which method is regularly followed by the life insurer.

The accumulating fund is an amount prescribed in section 307 of the Regulations and is essentially the greater of the cash surrender value of the contract and the present value of all future payouts under the policy net of all future premiums to be paid under the policy.

Subsection 148(3) and proposed subparagraph 148(1)(e)(i.1)

You've asked us to look at subsection 148(3) and subparagraph 148(1)(e)(i.1) to see if these exceptions to the income inclusion rules under 148(1) could be applied to your particular situation. Subsection 148(3) provides that for purposes of the income inclusion in 148(1), the adjusted cost basis and proceeds of disposition relating to an interest in segregated funds are to be excluded in computing the gain on the disposition of a life insurance policy. The term segregated fund refers to a pool of assets which the insurer holds to back a specified liability (either through a life insurance policy or an annuity contract) to a policyholder or group of policyholders. An interest in a segregated fund is taxed under separate provisions of the Income Tax Act and is generally subject to tax on an annual basis. Based on the information you've provided us, it does not appear that you held an interest in a segregated fund as part of your life insurance policy.

Proposed subparagraph 148(1)(e)(i.1) provides an exception to the income inclusion rules under 148(1) where an annuity contract is a qualifying trust annuity with respect to a taxpayer and the amount paid to acquire it was deductible under paragraph 60(1). Paragraph 60(l) of the Act allows a deduction to an individual who receives specified amounts of retirement income paid on death of an RRSP annuitant and transfers a designated portion of such income to a registered retirement savings plan (RRSP), a registered retirement income fund (RRIF) or to acquire a specified annuity. This exception would not be available on the disposition of an exempt policy that was not held in an RRSP or did not meet other criteria noted in paragraph 60(l).

We trust the above comments are of assistance. However, as stated in paragraph 22 of Information Circular 70-6R4, the above comments do not constitute an income tax ruling and accordingly are not binding on the Canada Revenue Agency in respect of any particular situation.

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