9 March 1992 Income Tax Severed Letter 9129745 - Partnership and Proceeds from 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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Subject: PARTNERSHIP AND PROCEEDS FROM A LIFE INSURANCE POLICY Section(s): 53(1)(e), 53(2)(c), 70(6), 100(3), 98.1(1)(c)]

XXX 912974 C. Tremblay (613)952-1361

Attention: XXX

March 9, 1992

Dear Sirs:

Re: Partnership and Proceeds from a Life Insurance Policies

This is in reply to your letter of October 21, 1991 concerning the above subject in the following hypothetical situation:

• 1. Partnership XYZ a partnership of professionals has three arm's length individuals X, Y, and Z partners.
• 2. According to the partnership agreement, each of the partners share income equally. 3. Life insurance has been purchased on each of the three partners' lives. The life insurance premiums are not deducted for income tax purposes.
• 4. The beneficiaries of the proceeds of the life insurance policy are set out in examples A, B and C below.
• 5. Partner Z has passed away and the proceeds of the life insurance policy are due and payable.
• 6. The fair market value of the partnership interest is composed mostly of personal goodwill which disappears upon the death of partner Z and reduces the fair market value of the partnership by 1/3.

Although you have asked for a technical interpretation, it would appear that a transaction by a particular taxpayer is involved. Thus this matter would be more appropriately the subject of a District Taxation Office review. Although we are unable to provide any opinions in respect of the specific transactions described in your letter, we have set out some general comments which may be of some assistance.

Example A

The life insurance beneficiary is the partnership. X, Y, and Z have agreed that after the death of one of the partners, in this case Z, the remaining two partners, X and Y ,would each receive 50% of the total payout. X and Y would use all of the proceeds from the life insurance policy to purchase the 1/3 partnership interest from Z.

You request a confirmation that partner X and Y would increase their partnership adjusted cost base (“ACB”) by their share of the proceeds from the life insurance policy pursuant to subparagraph 53(l)(e)(iii) of the Income Tax Act (the “Act”) and that the receipt of the cash for the life insurance proceeds by each of X and Y would reduce their ACB pursuant to subparagraph 53(2)(c)(v) of the Act. You also request us to confirm that the purchase of the 1/3 interest from Z would result in the disposition of a capital property by Z for proceeds of disposition equal to the proceeds from the life insurance policy.

Our Comments

In our view, the net proceeds of a life insurance policy, if received by a partnership, increase the surviving partners' adjusted cost base in the partnership pursuant to paragraph 53(1)(e)(iii) of the Act. The receipt of cash for life insurance proceeds by surviving partners where the beneficiary is the partnership would reduce their ACB pursuant to subparagraph 53(2)(c)(v) of the Act.

In our view, the death of a partner would result, pursuant to subsection 70(5) of the Act, in the disposition of a capital property, the partnership interest, by the deceased partner for proceeds equal to the fair market value, unless it is transferred to a spouse or a spouse trust under the conditions of subsection 70(6) of the Act, in which case the proceeds are the adjusted cost base. The estate or beneficiary of the deceased acquires either a partnership interest or a residual interest in the partnership. See paragraph 7 of IT 278R [IT-278R]. As stated in paragraph 16 of IT 278R [IT-278R], a residual interest is a capital property and a capital gain or loss would arise on the disposition by the estate or beneficiary of a residual interest in a partnership.

Example B

The beneficiary of the proceeds from the life insurance policy is the partnership and the partners have agreed that Z would receive all of the proceeds of the life insurance policy. Z would surrender his 1/3 partnership interest to the partnership for proceeds of an amount equal to partner Z's capital account balance, which is the fair market value of the partnership interest.

You seek our confirmation that Z would increase his ACB by the amount of the proceeds from the life insurance policy and would reduce his ACB upon receipt of those proceeds by the same amount. Further, you also request us to confirm that Z would be considered to have disposed of his partnership interest for proceeds of disposition equal to the capital account and that considering the reduction in the fair market value of the partnership, the provisions of section 69 would not apply.

Our Comments

In our opinion, the provisions of subparagraph 53(l)(e)(iii) apply only to the surviving partners, as that subparagraph refers to the taxpayer's share of any proceeds of a life insurance policy received by a partnership in consequence of the death of any person insured under the policy. As the adjustment can only take place once the proceeds are received by the partnership, and as the deceased partner is deemed to have disposed of his interest immediately before his death and is no longer a partner at the time the proceeds are received, no adjustment is possible with respect to the deceased's former interest in the partnership. Although the proceeds received by the partnership may be earmarked to be used by the partnership to fund a payment to the deceased's estate, the estate does not have a right to any direct share in the actual life insurance proceeds.

Where the estate does not become a member of the partnership, it is deemed, pursuant to subsection 100(3) of the Act, to have acquired a right to receive partnership property at a cost equal to the deceased partner's ACB and he is deemed to have disposed of his partnership interest immediately before his death for proceeds equal to the fair market value of his interest at the time. Accordingly, the payment made by the partnership to the estate will be considered to be in satisfaction of the estate's right to receive partnership property, and the right amount received by the estate must be compared with the cost of the right to the estate in order to determine any capital gain or loss.

Whether or not the deceased partner would be considered to have disposed of his partnership interest for proceeds of disposition equal to his capital account is a question of fact, Accordingly, the provisions of section 69 of the Act may apply. A residual interest is a capital property. A capital gain arises when the adjusted cost base becomes a negative figure at the end of the fiscal period of the partnership, pursuant to paragraph 98.1(1)(c) of the Act.

Example C

The proceeds from the life insurance policy will go directly to Z as beneficiary and not go through the partnership. Z would surrender his 1/3 partnership interest to the partnership for proceeds of an amount equal to partner Z's capital account balance, which is the fair market value of the partnership interest.

You seek our confirmation that the proceeds from the life insurance policy would be received by Z tax free and that Z would be considered to have disposed of his partnership interest for proceeds of disposition equal to his capital account and that considering the reduction in the fair market value of the partnership, the provisions of section 69 of the Act would not apply.

Our Comments

The proceeds from a life insurance policy would be received by the deceased partner's beneficiary tax free. Where the beneficiary does not become a member of the partnership, he or she is deemed, pursuant to subsection 98.2 of the Act, to have acquired a right to receive partnership property at a cost equal to the deceased partner's ACB of his partnership interest. The deceased partner is deemed to have disposed of his partnership interest immediately before his death for proceeds equal to the fair market value of his interest at the time. The payment made by the partnership to the beneficiary will be considered to be in satisfaction of the beneficiary's right to receive partnership property, and the amount received by the beneficiary must be compared with the cost of the right to the beneficiary in order to determine any capital gain or loss. If subsection 70(6) applies (transfer to spouse or spouse trust), then the proceeds to the deceased partner and the cost to the spouse are deemed to be an amount equal to the adjusted cost base of the partnership interest to the deceased.

Our comments are only an expression of opinion based on the limited information submitted, as such they are not an advance income tax ruling and, consequently are not binding on the Department.

Yours truly,

E. Wheeler,
for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch