20 January 2015 External T.I. 2014-0541941E5 - Disposition of a 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: Policyholder requested we verify the computation of the taxable policy gain on the disposition of his life insurance policy. More specifically, we were asked whether the policy premiums and policy dividends were correctly accounted for.

Position: Question of fact. Provided general comments.

Reasons: General comments based on section 148 of the Act. Specific concerns as to amounts reported must be referred to the insurer. Disputes between policyholders and their insurers may be referred to the OmbudService for Life and Health Insurance or Financial Services Commission of Ontario.

XXXXXXXXXX
2014-054194
Elaine Danilchenko

January 20, 2015

Dear XXXXXXXXXX,

Re: Taxable policy gain on the disposition of a life insurance policy

This is in response to your letter to us dated July 28, 2014, in which you requested clarification of the rules relating to the calculation of the taxable policy gain on the maturity of a life insurance policy. It is your view that tax has already been paid on the premiums you paid on your life insurance policy and such premiums should not be taxed again on the maturity of the policy. We acknowledge our telephone conversation on November 6, 2014 (XXXXXXXXXX/Danilchenko).

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 70-6R6, Advance Income Tax Rulings and Technical Interpretations.

Under the Act, the savings accumulated in a life insurance policy are generally taxable unless the policy is exempt and they are paid as part of a death benefit to a named beneficiary. In broad terms, an exempt policy is a policy that is primarily designed to fund a death benefit, rather than one designed to be an investment and savings vehicle. Even if a policy is exempt, the accumulated savings are taxable to the policyholder if it is disposed of prior to the death of the insured.

The taxation of insurance products can be complex due to the wide variety of products available in the marketplace, many of which are structured to meet individual preferences and needs.

Disposition and gain

A disposition of an interest in a life insurance policy is defined in subsection 148(9) of 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.

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.

Subsection 148(9) of the Act defines the proceeds of the disposition of an interest in a life insurance policy as the amount of the proceeds that the policyholder is entitled to receive on the disposition.

ACB of an interest in 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 is the amount by which the premiums paid by the policyholder, and any income in respect of the interest in the policy that has previously been reported for tax purposes, exceed the proceeds of the disposition of the policyholder's interest in the policy that the policyholder became entitled to receive before that time and the net cost of pure insurance (NCPI) of the policy. The reduction to the ACB for the NCPI is only applicable to insurance policies last acquired after December 1, 1982.

Paragraph 3 of IT-87R2, Policyholders' Income from Life Insurance Policies, a copy of which is enclosed, discusses the main components of the ACB.

Policy dividends

As noted in paragraph 19 of IT-87R2, paragraph 148(2)(a) of the Act applies when a policyholder is entitled to receive a policy dividend. It deems the policyholder to have disposed of an interest in the policy for proceeds equal to the amount of such a dividend.

The ACB of the policyholder's interest for tax purposes is reduced by the amount of the dividend entitlement. Where the policyholder's entitlement to dividends exceeds the ACB of the policy, the policyholder will have a taxable policy gain in the year to the extent of the excess.

You have asked us for assistance in verifying that the amount of taxable policy gain as calculated by your insurer is correct. However, we are not in a position to verify the correctness of any amount provided by the insurer as the determination of such amounts generally requires information that is available only in the accounts of the insurer. The insurer has the responsibility to report the portion of the proceeds that is subject to tax.

As discussed, you may wish to clarify with your insurer as to how they arrived at an ACB of nil for your life insurance policy. Specifically, you may wish to inquire about the total policy premiums paid on the policy and the total policy dividends you became entitled to during the entire period you held the policy as well as how these were factored into the computation of the ACB of your policy.

The CRA's mandate is to administer the Act and does not include resolving disagreements 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 reach OLHI at 416-777-9002 or 1-888-295-8112. Alternatively, you may wish to contact the Financial Services Commission of Ontario at (416) 250-7250 or 1-800-668-0128.

We trust our comments will be of assistance.

Yours truly,

Jenie Leigh
Manager
Financial Institutions Section
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

Enclosure