28 January 2010 External T.I. 2009-0319451E5 - Capitalization of Policy Loan Interest

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: Whether the payment of interest owing to the insurer by way of additional policy loan results in a disposition of an interest in the policy.

Position: Yes

Reasons: 148(9), 148(1)

									2009-031945
XXXXXXXXXX 								Sylvie Danis
(613) 957-3496
Attention:  XXXXXXXXXX 

January 28, 2010

Dear XXXXXXXXXX :

Re: Capitalization of policy loan interest

This is in response to your fax dated April 25, 2009, wherein you requested confirmation of the tax implications with respect to a situation where a policyholder has received a policy loan, the proceeds of which have been used for the purpose of earning income such that the interest paid on the loan is deductible under paragraph 20(1)(c) of the Income Tax Act (the "Act"), and that interest is paid to the insurer by way of an additional policy loan.

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 can offer the following general comments that may be of assistance.

Where the proceeds of a policy loan are used for the purpose of gaining or producing income such that the interest on the policy loan is deductible by the policyholder under paragraphs 20(1)(c) or (d) of the Act and the interest is satisfied by the insurer issuing a new policy loan equal to the amount of the interest, the capitalization of the policy loan interest results in a disposition pursuant to paragraph (b) of the definition of "disposition" in subsection 148(9). The "proceeds of disposition" in respect of a policy loan is defined in subsection 148(9) as the amount that is the lesser of the amount of the loan other than an amount to pay a premium and the amount by which the cash surrender value of the policy immediately before the loan is made exceeds the total outstanding loans at that time.

Subsection 148(1) of the Act requires the inclusion in income of the amount of proceeds of disposition in excess of the adjusted cost basis ("ACB") of the policy. ACB is defined in subsection 148(9) of the Act. Where the ACB of the policy is $NIL immediately before the capitalization of policy loan interest, the amount required to be included in income with respect to the capitalized interest and reported on a T5 information return as required by section 217 of the Regulations is the amount of the interest capitalized.

In order for the interest to be deductible in a taxation year pursuant to subsection 20(2.1) of the Act, Form T2210 which is prescribed by Regulation 4001 is to be completed by the policyholder and the insurer on or before the date that the policyholder's income tax return is due in respect of the taxation year in which the policy loan interest was paid.

We trust the above comments are of assistance. However, as stated in paragraph 22 of Information Circular 70-6R5, 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