16 January 1990 External T.I. 58295 F - Taxation on Surrenders of Life Insurance Policies

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.

Subject:  24(1)  Individual Policyholders' Taxation on Surrenders of Life Insurance Policies

We are writing in connection with your memoranda of June 22 and July 31, 1989.  As discussed (S. Abdulhusein and B.Dodd, October 12, 1989), we are providing you with our comments on  24(1) April 20, 1989 letter and understand that you will reply directly to: 24(1) We apologize for the delay.

24(1)  has requested the Department's views in connection with a worksheet for the calculation of the amount to be included in income under subsection 148(1) of the income Tax Act (the "Act").

24(1)

Item 1)

The overall approach being taken by 24(1) (as evidenced by items 1), 2) and 3) collectively), appears to be based somewhat on the method described in the Department's paper on the calculation of the adjusted cost basis ("ACB") for life insurance policies (prepared by G. Pottage, dated March 6, 1987).  The method set out in the Department's paper is to first establish the ACE of the policy as of-the policy's first anniversary date after March 31, 1977, and then to adjust this amount by any subsequent premiums, policy loans, etc. as set out in paragraph 148(9) (a) of the Act. (A policy's "first anniversary date after March 31, 1977" is hereinafter referred to as "MTA")

Where this method is used, to give effect to the "bump" in subparagraph 148(9)(a)(v) of the Act, the ACB at MTA must be calculated as the greater of:

A.       The amount by which:

a)        the cost of the policy to MTA, plus premiums paid to MTA, exceeds

b)        (i)   proceeds of disposition to which the policyholder was entitled prior to MTA, minus -

(ii)       such part of the proceeds in i) as was required to be included in income; and

B.       The cash surrender value ("CSV") of the policy at MTA.

24(1)

Item 2)

Item 2) represents additions to the ACB at MTA.

The only component included under this item on the worksheet is premiums paid "after 3/31/77".  This should more properly refer to premiums paid "after MTA"

Pursuant to subparagraph 148(9)(a)(i) of the Act, provision should also be made to include as an addition other costs of acquiring an interest in the policy.

24(1)

The relevant legislative provisions or policy loans are as follows:

Pursuant to subparagraph 148(9)(a)(iv) of the Act, (certain) repayments after March 31, 1978 of policy loans are additions to the ACB.  Pursuant to subparagraphs 148(9)(a)(vii) and (vi) of the Act respectively, policy loans outstanding on March 31, 1978 and subsequent policy loans (being dispositions) are reductions to the ACB.  In addition, pursuant to subparagraph 148(9)(a)(iii) of the Act, policy-related income inclusions, which include those resulting from policy loans made after March 31, 1978, are additions to the ACB.

24(1)

Item 3)

Item 3) represents deductions from the ACB at MTA.

The first component on the worksheet is PUA withdrawals, which we would have assumed to be a reference to the cashing in, or surrendering of, a PUA for its CSV.  However 24(1) We realize that policy dividends may be used to purchase a PUA, (in which case the amount of the dividend would be included both as a premium in Item 2) and a dividend in the third component of Item 3) of the worksheet) and that the PUA may later be surrendered for its CSV; however we are unable to relate this to "dividend withdrawals of PUA's".  You may, therefore, wish to have 24(1) clarify this.

The second component of Item 3), being policy loans after March 31, 1978 was discussed above in connection with item 2)

The third component of Item 3), being annual dividends after March  31, 1977 (the date should actually be the MTA), including, termination dividends, and the descriptions thereof contained in 24(1) letter, reflect the appropriate treatment for policy under the Act.  In this respect, by virtue of paragraph 148(2)(a) of the Act, a policy dividend is deemed to be a disposition, with the proceeds deemed to be the amount of the dividend.  As such, policy dividends are ACB reductions pursuant to subparagraph 148(9)(a)(vi) of the Act.

We note that neither the worksheet nor the letter provide for the ACB decreases which are set out in subparagraphs 148(9)(a)(vi.1), (viii), (ix), (x), and (xi) of the Act.  Again, these may not be applicable to any of 24(1) policies but you may wish to mention them.

Item 4)

Item 4) represents the ACB, which 24(1) letter indicates could be a negative amount. It is our opinion, however, that ACB is defined in such a manner that it cannot become negative (i.e. the amount, if any, by which the various additions exceed the various deductions).

Item 5)

24(1)

We would note initially that while 24(1) is concerned with determining proceeds of disposition only in the case of surrenders, other transactions or events, such as policy loans and policy dividends, can also give arise to "dispositions" (defined in paragraph 148(9)(c) and subsection 148(2) of the Act).  The "proceeds of the disposition" are determined as set out in paragraph 148(9)(e.2) and subsection 148(2) of the Act.

In the case of a surrender, provided that "basic cash value" at surrender is the equivalent of CSV at surrender, as the latter term is defined in paragraph 148(9)(b) of the Act, method (1) is consistent with the "proceeds of the disposition" on surrender as defined in subparagraph 148(9)(e.2)(i) of the Act.  However, pursuant to clause 148(9)(e.2)(i)(b) of the Act, provision should be made for a reduction by the amount of any premium that is due but unpaid at the time of surrender.

With respect to method (2), without knowing the makeup of the cheque issued by 24(1) on a surrender, we are unable to provide any meaningful comment.

In summary, the 24(1) proposal is not in all respects consistent with the provisions of the Act.  We are not, however, in a position to determine whether the effect of those differences is a larger or smaller ACB than would otherwise be calculated and whether this would be acceptable from an audit perspective.

We hope the foregoing will be of assistance.

for DirectorFinancial Industries DivisionRulings Directorate