24 July 2013 External T.I. 2013-0497901E5 - Exempt 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: Questions with respect to the insurer's responsibilities in maintaining a life insurance policy's exempt status.

Position: General comments provided.

Reasons: See below.

XXXXXXXXXX
2013-049790
Sylvie Danis
(613) 957-3496
July 24, 2013

Dear XXXXXXXXXX:

Re: Exempt status of a life insurance policy

This is in response to your email dated June 27, 2013 and subsequent discussions (XXXXXXXXXX/Danis) wherein you requested information with respect to the rules relating to exempt life insurance policies.

In particular, you asked us whether an insurer has a legal or moral responsibility to advise a policyholder that action is required in order for a life insurance policy to maintain its exempt status. You also expressed concerns about the fairness of the income tax legislation since it does not require policyholder notification by the insurer.

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.

An "exempt policy" for income tax purposes, is a life insurance policy that satisfies certain criteria, set out in section 306 of the Income Tax Regulations ("ITR"). The primary income tax advantages for a policyholder who holds an interest in a policy that is an exempt policy are that the income earned within the policy is not subject to annual accrual taxation under section 12.2 of the Income Tax Act (the "Act"), and the death benefit under the policy is received on a tax-free basis.

The rules for determining whether any particular life insurance policy is an exempt policy under section 306 of the ITR are very complex. The application of the rules in section 306 of the ITR requires actuarial calculations and information that only the issuing insurer will possess.

The tests in section 306 of the ITR which determine whether any particular policy is an exempt policy, may be applied at any time but the tests are generally performed by the insurer that issued the policy on each policy anniversary date. The tests compare the "accumulating fund" of the actual policy to the accumulating fund of a hypothetical policy called the "exemption test policy" that is deemed to have been issued to the policyholder at the same time that the actual policy was issued. Such tests must be satisfied on each anniversary date of the policy and it must be reasonable to assume that those tests will continue to be met for the life of the policy, otherwise the policy may cease to be an exempt policy. The accumulating fund is an amount prescribed in section 307 of the ITR 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.

Where, on a particular policy anniversary date, an insurer determines that a policy it has issued has failed the exempt policy test in section 306 of the ITR, the policy may be deemed to be an exempt policy on that anniversary date if the insurer takes such action as is necessary, within 60 days after that anniversary date, to ensure that the policy does meet the exempt policy test on that 60th day. It is our understanding that, generally, there are provisions within life insurance policies in which the insurer undertakes to take whatever action is necessary to ensure that the policy remains an exempt policy. Accordingly, it is not surprising that situations where the 60-day period was considered inadequate rarely come to our attention.

You asked us to review the legislation relating to the exempt status of an interest in a life insurance policy, and in particular the 60-day grace period discussed above, to make sure it is fair to taxpayers. The Canada Revenue Agency ("CRA") is responsible for administering the tax legislation enacted by Parliament, while the Department of Finance Canada is responsible for developing and evaluating federal income tax policy and amending the Income Tax Act and the Income Tax Regulations. If you have concerns about the fairness of the provisions of the Act regarding life insurance policies, you can write to the Tax Policy Branch of the Department of Finance Canada at 140 O'Connor Street, Ottawa ON K1A 0G5.

The CRA's mandate is to administer the Act and does not include resolving disputes between policyholders and their insurers about the terms and conditions of a particular policy. In this regard, you may wish to contact the OmbudService for Life and Health Insurance ("OLHI"), which was created to help resolve disputes between insurers and their policyholders. You can find more information about the OLHI at www.olhi.ca. The Deputy Superintendent (Insurance) in Manitoba also can help with respect to consumer complaints in Manitoba. You can reach them at the Financial Institutions Regulation Branch (Manitoba Finance) at 1-800-282-8069.

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