17 May 2013 Roundtable, 2013-0481421C6 - Transfer of life insurance policy to a retiree

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: (1) Does subsection 148(7) apply when a corporation transfers a life insurance policy to a senior executive officer who is also a shareholder for no consideration? (2) The computation of the adjusted cost basis (ACB) of a life insurance policy, to an individual who is a beneficiary of an RCA trust, where the policy has been transferred to the individual by the RCA trust.

Position: (1) Yes. (2) The ACB, to the individual, of the policy is equal to the fair market value of the policy at the time of the disposition of the policy by the RCA trust. The response also includes our comments regarding the advantage rules in the context of the holding of a life insurance policy by an RCA.

Reasons: The legislation.

CLHIA Roundtable - 2013

Question 7 - Transfer of key person insurance policy to retiree

At the 2003 CALU CRA Roundtable the following question and Canada Revenue Agency (CRA) response was provided:

Question 4

A corporation is the owner and beneficiary of an insurance policy on the life of a senior executive officer, who is also a shareholder. The policy was acquired to provide key person coverage to indemnify the corporation for a potential loss of profits or additional costs that may be incurred in the event of death of the insured. The individual retires and the corporation no longer needs the policy. The corporation transfers the policy to the individual for no consideration. Immediately before the transfer, the details of the policy are as follows:

• Death benefit $1,000,000
• Cash surrender value $ 125,000
• Adjusted cost basis $ 50,000
• Fair market value $ 125,000

The income tax implications of the transfer for the corporation and the individual appear to be as follows:

i) Pursuant to subsection 148(7), the corporation is deemed to become entitled to receive proceeds of disposition equal to the cash surrender value (CSV) of the policy (i.e., $125,000)
ii) Pursuant to subsection 148(1), the corporation must include $75,000 in computing its income — the excess of the deemed proceeds over the adjusted cost basis (ACB) of the policy. (i.e., $125,000 — $50,000).
iii) Pursuant to either paragraph 6(1)(a) or subsection 15(1), the individual must include in income the fair market value of the policy (i.e., $125,000).
iv) Assuming that the corporation transferred the policy to the individual because of the individual´s position as a senior executive of the company and not because the individual was a shareholder, the corporation would be entitled to a deduction in computing its income for an amount equal to the fair market value of the policy (i.e., $125,000).
v) Pursuant to subsection 148(7), the individual is deemed to acquire the policy at a cost equal to the CSV of the policy (i.e., $125,000).
vi) Pursuant to the definition of "adjusted cost basis" in subsection 148(9), the ACB of the policy to the individual would include the cost of the policy as determined in (v) above and the amount included in computing the individual´s income as determined in (iii) above. Accordingly, immediately after the transfer, the ACB of the policy to the individual would be $250,000 ($125,000 by virtue of the description of A and $125,000 by virtue of the description of C in the definition of "adjusted cost basis" in subsection 148(9)).

Does the Agency agree with the above description of the income tax implications for the corporation and the individual?

Agency's Response

Based on the facts set out in the question, and provided the "value" of the policy at the time of transfer as determined under the definition of "value" in subsection 148(9) is equal to the CSV of the policy, we agree with the income tax implications as set out in (i) to (v) above. However, with respect to the determination of the adjusted cost basis of the policy to the shareholder/employee as described in (vi) above, we disagree. In a transaction where,

a) subsection 148(7) applied to a transaction,
b) the fair market value (FMV) of the policy exceeded the CSV of the policy, and
c) the transferee was required to include an amount in income under subsection 15(1), in respect of the transfer,

then, we would allow the addition of the excess of FMV of the policy over the CSV of the policy in computing the ACB of the policy to the transferee. Where the FMV and cash surrender value of the policy are identical, there is no amount to be added to the ACB of the policy under C of the definition of ACB in subsection 148(9).

Question A

Could the CRA confirm that the response provided in 2003 continues to be the CRA's position on the determination of the ACB of the policy to the transferee?

CRA Response

We confirm that the response provided to Question 4 at the 2003 CALU CRA Roundtable continues to be our position.

Question B

Could the CRA also confirm what its position is with respect to the computation of the ACB, to an individual, of a life insurance policy in the case where:

i) an RCA trust holds an insurance policy on the life of the individual
ii) the individual is a beneficiary of the RCA trust and is also a shareholder and senior officer of the corporate employer,
iii) the individual does not deal at arm's length with the RCA trust, and
iv) the custodian of the RCA transfers the policy to the individual for no consideration.

CRA Response

• Pursuant to paragraph 107.2(a) of the Act, the RCA trust is deemed to have disposed of the insurance policy for proceeds of disposition equal to the fair market value (FMV) of the policy at the time of that disposition. Therefore, for the purposes of determining the RCA's refundable tax, the RCA trust's income from the disposition would be calculated under subsection 148(1) based on that FMV.

Pursuant to paragraph 107.2(b), the RCA trust is deemed to have paid to the beneficiary as a distribution an amount equal to that FMV. Therefore, the income inclusion under paragraph 56(1)(x) to the beneficiary is equal to that FMV.

Pursuant to paragraph 107.2(c), the beneficiary is deemed to have acquired the policy at a cost equal to that FMV. Therefore, this amount would be the beneficiary's ACB of the policy (as determined under the definition "adjusted cost basis" in subsection 148(9)), at the time of that acquisition.

However, it is also important to note the new advantage rules in connection with RCAs. Those rules were introduced in the 2012 federal budget, and added to the Act by Bill C-45, to address tax planning arrangements that had developed using RCAs. The new definition "advantage" in subsection 207.5(1) of the Act describes amounts derived from several types of transactions or events in respect of which unintended tax benefits could be obtained. Under that definition, an advantage includes a benefit that is conditional in any way on the existence of the RCA. Although there are certain exceptions in the "advantage" definition, a benefit arising from the RCA holding a life insurance policy is not among them.

It is not clear under what circumstances an RCA would be holding a life insurance policy that provides for more than a nominal death benefit. The holding of such a life insurance policy would appear to have little to do with providing for benefits under the RCA in relation to retirement, a loss of an office or employment, or a substantial change in services rendered. The holding of such a life insurance policy by the RCA could give rise to an advantage and, therefore, advantage tax under section 207.62 of the Act.

If it is determined that a particular life insurance policy gives rise to an advantage, the RCA custodian may be able to avoid the advantage tax by making an in-kind distribution of the policy from the RCA. Under a transitional rule in paragraph 44(3)(a) of Bill C-45 that applies to property acquired before March 29, 2012, the amount of what would otherwise be an advantage will not be treated as an advantage if the amount is included in the income of a beneficiary of the RCA, or an employer in respect of the RCA, for the taxation year in which the amount arose or the following year.

Question A response prepared by: Bob Naufal

Question B response prepared by: Victor Pietrow

May 17, 2013
2013-048142