8 May 2012 Roundtable, 2012-0435681C6 - CALU CRA Roundtable Q2

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: Ownership of insurance in a spouse trust

Position: General comments provided

CALU CRA Roundtable – May 2012

Question 2 – Ownership of Insurance in a Spouse Trust

Background

There may be circumstances where it is appropriate and desirable for an inter vivos or testamentary spousal trust to acquire, pay the premiums and/or be the beneficiary of an exempt life insurance policy on the life of the spouse. For example, the spousal trust may own assets, such as the shares in a private corporation, with significant accumulated capital gains that will be realized on the death of the spouse. Life insurance under which the spousal trust is the owner and/or beneficiary can ensure there is sufficient liquidity in the trust to pay any resulting taxes. This is particularly beneficial when the trust property is illiquid or the trust beneficiaries want the property to be retained and distributed in specie to them.

The following series of questions deal with the tax treatment of an exempt life insurance policy on the life of the surviving spouse where a spousal trust is both the owner and beneficiary of the policy, or is merely the beneficiary of such policy.

In TI 2006-0174041C6 and 2006-0185551C6 the following question was asked:

Question

If a testamentary trust is obligated to fund a life insurance policy on the life of the surviving spouse and the trust is the beneficiary of the policy, would this taint the trust and preclude it being a spousal trust pursuant to subsection 70(6) of the Act? If trust income is used to pay the premium, would this cause the trust to fall offside? If the trust capital is used to pay the premium, would this cause the trust to fall offside?

CRA Response

“For purposes of our reply we have assumed that the insurance policy is not an annuity or segregated fund contract and that the policy provides only benefits in respect of pure life insurance (i.e. benefits arising only on the death of the life insured) such that no part of the policy premium payments relates to any benefit other than pure life insurance protection.

Principles of insurance law and trust law both would apply in informing our understanding of the nature of the legal relations involved in the circumstances described in your question. These principles may vary from province to province. Therefore, to provide a detailed reply to your question we would require additional information, including: (1) the applicable provincial law governing the policy and the trust, (2) the nature of the life insurance provided under the policy (e.g., an annuity, segregated fund, or pure life insurance), (3) whether the premiums are fully paid, (4) whether policy beneficiaries have been designated by the owner or named in the contract and, if so, whether the designations are irrevocable, (5) an analysis of whether under the applicable law a trustee can acquire an ownership interest in the policy and, if so, (6) whether the policy beneficiaries are trust beneficiaries.

We are prepared, however, to offer some general comments on the potential income tax consequences in the circumstances you describe.

We have limited our analysis to the application of subparagraph 70(6)(b)(ii) of the Act.

In order for property to be transferred on a tax-deferred (“rollover”) basis from a deceased taxpayer to a trust, subparagraph 70(6)(b)(ii) requires that the trust be one under which no person except the surviving spouse or common-law partner (“survivor”) of the taxpayer may, before survivor’s death, receive or otherwise obtain the use of any of the income or capital of the trust. Our position is that the mere possibility of a person other than the survivor receiving or obtaining, before the survivor’s death, use of the trust capital or income is sufficient to disqualify the property transfer from the rollover.

A duty to fund a life insurance policy out of trust capital or trust income would, in our view, be one under which a person may obtain the use of the trust capital or trust income. This is because the premium payment is assumed to maintain, for the period covered by the premium, the rights to receive insurance proceeds. Therefore, the existence of such a trust term would be relevant in determining whether a rollover of property can occur to the trust under paragraph 70(6)(b) of the Act.

In the circumstances contemplated by your question, as a result of the duty to pay insurance premiums out of trust property it would appear that persons other than the survivor may, before the survivor’s death, obtain the use of the trust income or capital. Therefore, we are of the view that the trust would not satisfy the conditions of subparagraph 70(6)(b)(ii) of the Act.

As a final comment, whether the trust is one that seeks to satisfy the requirement of paragraph 70(6)(b) of the Act or not, and whether the duty to pay the premium out of trust income or trust capital, it would appear that the policy beneficiary would have a benefit, from the trust’s payment of the policy premium, resulting in the application of section 105 of the Act.”

(Note – CRA TI 2008-030188, dated October 9 2009, confirmed that no benefit under subsection 105(1) arises for beneficiaries of a trust when the trust owns and is the beneficiary of a life insurance policy).

Question 2.1

Could the CRA confirm who, other than the surviving spouse, it considers may be entitled to the capital or income of the trust before the surviving spouse’s death, as a result of the duty on the trust to fund the life insurance policy? Would placing a positive duty on the trustee of a spousal trust to retain and maintain any property (for example, a duty to retain the shares of a private corporation until the death of a survivor, or retain and maintain rental property until the death of the survivor) automatically taint an inter vivos or testamentary spousal trust?

CRA Response

In order for property to be transferred on a tax-deferred (“rollover”) basis from a deceased person to a trust pursuant to paragraph 70(6)(b) of the Act, subparagraph (i) of that provision requires that the surviving spouse or common-law partner (“survivor”) is entitled to receive all of the income of the trust that arises before the survivor’s death, and subparagraph (ii) requires that the trust be one under which no person except the survivor may, before his or her death, receive or otherwise obtain the use of any of the income or capital of the trust.

As stated in documents 2006-0174041C6 and 2006-0185551C6, the CRA is of the view that a duty to fund a life insurance policy out of trust capital or trust income would be one under which a person other than the survivor may obtain the use of trust capital or trust income for purposes of subparagraph 70(6)(b)(ii). This is because the premium payment is assumed to maintain, for the period covered by the premium, the rights to receive the insurance proceeds by the policy beneficiary – which will never be the surviving spouse.

A trustee’s duty to retain and/or maintain certain income producing properties (for example, shares of a private corporation or a rental property) is not, in our view, analogous to the payment of insurance premiums by the trustee to maintain rights to receive the insurance proceeds by the policy beneficiary after the death of the spouse. However, with that said, we would caution that it is always a question of fact whether the terms of any trust will meet the requirement of subparagraph 70(6)(b)(ii) of the Act.

Question 2.2

Assume that the trust document provides the trustees of an inter vivos or testamentary spouse trust with the ability to purchase an exempt life insurance on the life of the spouse (or jointly on the lives of the spouses in the case of an inter vivos trust) but there is no absolute obligation to purchase and retain such insurance.

Could the CRA confirm that if there is no “duty” on the trustees to acquire and/or fund life insurance on the lives of the spouses or the life of the surviving spouse and where such trust is the beneficiary of any insurance proceeds, that the trust is not “tainted” for purposes of the rollover of property under subsection 73(1) and subparagraph 70(6)(b)(ii) of the Act.

CRA Response

For purposes of the rollover provisions in subsections 73(1) and 70(6) of the Act, subparagraphs 73(1.01)(c)(i) and 70(6)(b)(ii) of the legislation require the trust be a trust under which no person except the spouse or common-law partner may, before the spouse's or common-law partner's death, receive or otherwise obtain the use of any of the income or capital of the trust.

The CRA is of the view that the mere possibility of a person other than the survivor receiving or obtaining, before the survivor’s death, use of the trust capital or income is sufficient to disqualify the property transfer from the rollover. This view is consistent, whether the trustee has an obligation or a mere power to encroach on the capital of a trust for the benefit of persons other than the surviving spouse or common-law partner.

Question 2.3

Assume Mr. B owns all the shares in a private corporation (Opco B) and these shares have a significant capital gain. Under Mr. B’s will, on his death the shares are to be transferred to a testamentary spousal trust, and upon the death of Mrs. B, the trust is to hold and/or distribute the shares to the surviving children who are active in Opco B.

Opco B has acquired life insurance on the life of Mr. B and Mrs. B under which it is the beneficiary and premium payor. The purpose of the insurance is to create liquidity in the corporation on the death of the survivor of them, which may be accessed by the trustees of the spousal trust to fund taxes arising on the deemed disposition of the testamentary trust’s assets including the shares of Opco B. The directors of Opco B have signed a resolution requiring Opco B to maintain the insurance policy until the death of the survivor, and to pay out the insurance proceeds to the testamentary trust as a capital and/or taxable dividend.

Could the CRA confirm that in these circumstances the insurance held by Opco B would not taint the testamentary trust for purposes of the rollover of property under subparagraph 70(6)(b)(ii) of the Act?

CRA Response

The CRA is unable to confirm that such a structure would not taint the status of a testamentary trust and also impact on the rollover of property under subparagraph 70(6)(b)(ii) of the Act.

This determination is a question of fact and would require a review of all relevant factors.

Question 2.4

Assuming a positive response to Question 2.2 and/or 2.3, can the CRA confirm that its response will be the same if the owner of the insurance policy makes additional deposits to create a cash reserve that is accessible to the trust (in Question 2.2) or Opco B (under Question 2.3) on the disposition of the policy or added to the insurance proceeds upon the death of the life insured(s).

CRA Response

As the CRA is unable to confirm its acceptance of the scenarios presented in either Question 2.2 or 2.3 in relation to the obligation to acquire or fund a life insurance policy in the circumstances, we are therefore, unable to comment on the tax implications in a situation where the trust, or Opco B (in relation to scenario 2.3) as the owner of the insurance policy makes additional deposits to create a cash reserve accessible on the disposition of the policy or added to the insurance proceeds upon the death of the life insured(s).

Note however, that we have previously opined that it is a question of fact as to whether a particular payment would result in a contribution to the trust for purposes of the definition of a testamentary trust in subsection 108(1) of the Act and it is our view that a contribution of property to a trust generally implies that the trust receives the property without any value being given to the contributor.

Kim Duval
2012-043568