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: Clarification on the income tax treatment of life insurance premiums and policy loans.
Position: General comments provided.
Reasons: The legislation.
XXXXXXXXXX
Bob Naufal
2013-051501
February 18, 2014
Dear XXXXXXXXXX:
Re: Corporate-owned life insurance policy
We are writing in response to your correspondence dated November 21, 2013 concerning the income tax treatment of a life insurance policy.
Briefly, you describe a situation where a corporation is the policyholder and beneficiary of a life insurance policy on the life of one of its key shareholders. The policy is an exempt universal life policy that was acquired in XXXXXXXXXX. The corporation pays the premiums on the policy but does not deduct such payments in computing income. During XXXXXXXXXX, the corporation requested and received a cash withdrawal from the policy, which the insurer advised was a policy loan. You have requested clarification on the income tax treatment relating to the policy loan and the premiums paid with respect to the policy.
Our Comments
This technical interpretation provides general comments about the provisions of the Income Tax Act (the "Act") and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R5, Advance Income Tax Rulings.
Disposition and gain
Generally, when a policyholder disposes of an interest in a life insurance policy, the policyholder is required to include in computing income a gain to the extent that the proceeds of the disposition of the interest in the policy exceed the adjusted cost basis ("ACB") of that interest immediately before the disposition. The full amount of the gain is included in computing income of the policyholder pursuant to paragraph 56(1)(j) and subsection 148(1) of the Act.
Subsection 148(9) of the Act defines a "disposition" of an interest in a life insurance policy and includes a policy loan made after March 31, 1978. A "policy loan" is defined in subsection 148(9) of the Act as an amount advanced by an insurer to a policyholder in accordance with the term and conditions of the life insurance policy.
Proceeds of the 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 the disposition is the lesser of the following amounts:
a) the amount of the loan, other than the portion of the loan used to pay a premium under the policy, as provided for under the terms and conditions of the policy, and
b) the amount, if any, by which the cash surrender value of the policy before the loan was made exceeds the total of the balances outstanding at that time of any policy loans in respect of the policy.
ACB of an interest in a life insurance policy
The ACB of a policyholder's interest in a life insurance policy is determined at any particular time by a formula under subsection 148(9) of the Act. In very general terms, the ACB will be the amount by which the cash premiums paid by the policyholder, and any income in respect of the policy that has previously been reported for tax purposes exceeds the net cost of pure insurance under the policy.
Furthermore, proceeds of the disposition in respect of a policy loan will reduce the ACB and a gain resulting from a policy loan will increase the ACB. Note that policy loan repayments that were not deductible under paragraph 60(s) of the Act (as described below) will be added to the ACB, to a maximum of the proceeds of the disposition in respect of the loan.
The insurer with whom the policy is held is required to report the amount of a gain on the policy on a T5 information slip issued to the policyholder where there is a disposition for tax purposes. As such, a policyholder can obtain information from the insurer on how it calculated the proceeds of the disposition, the ACB and any gain on the disposition.
Policy loan repayments
Where a policyholder repays an amount that has been included in income as a gain with respect to a policy loan, paragraph 60(s) of the Act permits a deduction in respect of the repayment of the policy loan. In general terms, the deduction in respect of the repayment is restricted to the amount by which the gains required to be included in income from policy loans exceed the amount deductible in previous years in respect of the policy loan repayments. Essentially, if a policy loan results in a gain, a deduction for a repayment will be permitted under paragraph 60(s) of the Act, to the extent of the gain.
Life insurance premiums
Generally, premiums paid under a life insurance policy are considered to be on account of capital, and are therefore not deductible pursuant to paragraph 18(1)(b) of the Act. However, premiums payable by a taxpayer under a life insurance policy used as collateral for a loan may be deductible in the computation of a taxpayer's income from business or property where all of the conditions of paragraph 20(1)(e.2) of the Act are met. Interpretation Bulletin IT-309R2, Premiums on Life Insurance Used as Collateral, provides further discussion on the detailed conditions and restrictions relative to the amount deductible under paragraph 20(1)(e.2) of the Act. This publication is available on the CRA website at www.cra-arc.gc.ca.
We trust our comments will be of assistance.
Yours truly,
Jenie Leigh
for Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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