8 November 2012 External T.I. 2012-0464781E5 - Cost of Insurance

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: Taxpayer requesting clarification on the rules relating to the calculation of the cost of a life insurance policy and the tax treatment of life insurance policy loans.

Position: Provided general comments.

Reasons: 148(1); 148(7); 148(9)

XXXXXXXXXX
2012-046478
Sylvie Danis
(613) 957-3496
November 8, 2012

Dear XXXXXXXXXX:

Re: Cost of a Life Insurance Policy

This is in response to your letter dated September 12, 2012 to Mrs. Lynda Lizotte-MacPherson, former Commissioner of the Canada Revenue Agency (“CRA”), a copy of which was forwarded to us for reply. In your letter, you requested clarification of the rules relating to the calculation of the cost of a life insurance policy and the tax treatment of life insurance policy loans. We understand that you are contemplating taking out a policy loan of $52,500 on 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. However, we can offer the following general comments that may be of assistance.

Disposition

A "disposition" of an interest in a life insurance policy is defined in subsection 148(9) of the Income Tax Act (the "Act") to include a surrender of that interest, the dissolution of that interest by virtue of the maturity of the policy, or a policy loan made after March 31, 1978. A "policy loan" is defined in subsection 148(9) of the Act to mean "an amount advanced by an insurer to a policyholder in accordance with the terms and conditions of the life insurance policy". An assignment of all or any part of an interest in the policy for the purpose of securing a debt or a loan other than a policy loan is not considered a disposition.

Where there is a disposition, subsection 148(1) of 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 interest in the policy exceed the "adjusted cost basis" ("ACB") of the policy immediately before the disposition. Any gain resulting from the disposition is required to be included in the policyholder's income by virtue of paragraph 56(1)(j) of 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 disposition is the result of a policy loan, the proceeds of disposition mean the lesser of the amount of the loan (other than the part applied to pay a premium under the policy) and the amount, if any, by which the cash surrender value of the policy immediately before the loan was made exceeds the total of balances outstanding at that time of any policy loans in respect of the policy.

ACB of a Life Insurance Policy

The ACB to a policyholder of an interest in a life insurance policy is determined by a formula under subsection 148(9) of the Act. In general terms, the ACB will be the amount by which the premiums paid by the policyholder (excluding premiums for accidental death benefits), and any income in respect of the interest in 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 (the “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 on disposition of the interest in the policy.

Section 308 of the Regulations 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.

Gain on Disposition

You have asked us for assistance in determining the exact amount of the cost of your insurance policy and to confirm the amount of the gain to report should you obtain a policy loan. However, we are not able to do so as the determination of such amounts generally requires information that is available only in the accounts of the insurer. We can confirm that generally, where there are no other policy loans outstanding and the amount of the policy loan is less than the cash surrender value of the policy, the proceeds of disposition will equal the amount of the policy loan as explained above. If, in your situation, a policy loan in the amount of $52,500 is less than the cash surrender value and there are no other policy loans outstanding, the proceeds of disposition will be $52,500. Based on an ACB of $1,733 as calculated by your insurer, the amount of the gain to be included in income will be $50,767.

The insurer with whom the policy is held is required to report the amount of a gain on the policy in "Box 14 - Other Income from Canadian Sources" on a T5 information slip issued to the policyholder where there is a disposition for tax purposes. As such, the insurer should also be able to provide you with information on how it calculated the proceeds of disposition, the ACB, and the anticipated gain on the disposition.

We trust the above comments are of assistance.

Yours truly,

Jenie Leigh
for Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch