28 July 1995 External T.I. 9503345 - REASONABLY SIMILAR METHOD FOR GROUP LIFE BENEFIT

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.

Principal Issues:

calculation of average daily cost of group term life insurance under reg 2702(2)

Position TAKEN:

while the enquirer's alternative methods are not intrinsically unreasonable, it is a question of fact as to whether any alternative method is reasonable in a particular set of circumstances

Reasons FOR POSITION TAKEN:

the intent of 2702(2)(b) was to allow employer flexibility in choosing a method of calculating the benefit that is both fair to all employees and easy for the employer to administer

A. Humenuk

XXXXXXXXXX 950334

Attention: XXXXXXXXXX

July 27, 1995

Dear Sirs:

Re: Group Term Life Insurance Policies

We are replying to your letter of January 18, 1995 concerning the calculation of the taxable benefit relating to group term life insurance for employees and pensioners under paragraph 2702(2)(b) of the draft Income Tax Regulations (the draft Regulations). We apologize for the delay in our response.

Subsection 2702(2) of the draft Regulations sets out the manner in which the average daily cost of insurance is calculated for the purpose of computing an employee's or pensioner's taxable benefit arising from the provision of life insurance under a group term life insurance policy. Paragraph 2702(2)(b) permits a policyholder to use any reasonable method that is substantially the same as the method set out in paragraph 2702(2)(a) of the draft Regulations. You describe two methods of calculating the benefit and ask whether the Department would consider such methods to be acceptable alternatives for calculating the average daily cost of insurance. For the purpose of your examples it is assumed that the policy year coincides with the calendar year.

The first method you describe calculates the average daily cost of insurance based on data applicable to the second preceding year. Using the formula found in paragraph 2702(2)(a) of the draft Regulations, the average daily cost of insurance for the current year under this method would be:

-the stated premium payable for the second preceding year

plus or minus

-any policy dividends or experience rating refunds received in respect of that year (received or paid in the immediately previous year),

divided by

-the total amount of term insurance in force on a day in the second preceding year on the lives of individuals covered under that premium category.

The taxable benefit to an employee under this method would be calculated by multiplying the amount of insurance in force for a particular employee for the current year by the average daily cost of the insurance as determined in the preceding paragraph and subtracting any amount paid by the employee in respect of term insurance under that policy for the current year. The advantage to this method as you see it, is that it calculates the actual cost of insurance for a particular year even though that year is not the year for which the benefit is being calculated. You submit that such a method is no less accurate than the method described in paragraph 2702(2)(a) of the draft Regulations because the method described in paragraph 2702(2)(a) uses policy dividends, experience rating refunds and additional premiums paid or received in respect of the previous year as well as the stated premium payable for the current year. Your reason for choosing the second preceding year rather than the immediately preceding year is that the policy adjustments in respect of the immediately preceding year are not necessarily known at the beginning of the year when the information is needed in order to withhold the correct amount of source deductions.

In the second method described in your letter, the average daily cost of insurance is based on the total premiums paid and payable in the second, third and fourth preceding years, the policy dividends and experience rating refunds received in those years as well as the total amount of term insurance in force on a day in those years on the lives of individuals covered under that premium category. It has been the experience of some of your clients that a premium category of retired employees can have extreme fluctuations in its mortality rate and thus, in the amount of experience rating refund received each year. The purpose of a three-year moving average is to level out the amount of taxable benefit to be included in a pensioner's income each year.

As it is a question of fact as to whether any particular method of determining the average daily cost of insurance is reasonable in the circumstances, we are unable to provide you with the assurance in principle for the methods described in your letter. The reasonableness of a particular method can be measured in part by whether the total amount of benefit as calculated over a number of years is substantially the same as the total amount of benefit as calculated for the same years under the method described in paragraph 2702(2)(a) of the draft Regulations.

The purpose of determining the average daily cost of insurance is to obtain a reasonable estimate of the actual cost of providing an employee or pensioner with life insurance for a particular taxation year where the coverage is provided through a group policy. The method used should be objective so that the benefit included in any particular employee's income is fair and reasonable in the circumstances, including the terms of the policy. While flexibility was introduced to ensure that the method used would be easy for employers to administer, it is generally expected that an employer will be consistent in the choice of methods used to determine the average daily cost of insurance. Where an alternative method is used to calculate the average daily cost of insurance, the onus is on the employer to ensure that the taxable benefit so determined is reasonable in light of the employer's actual cost to provide the coverage.

For example, where the average daily cost of insurance is calculated according to the first method described in your letter, an extreme fluctuation in the average daily cost of insurance for consecutive years as described in your second example would render the first method inappropriate in that circumstance. Where the level of premiums, experience rating refund and deficiency amounts are relatively stable however, this method would likely be acceptable.

In the second example you described, where experience rating refunds and deficiency payments fluctuate widely, it is our view that a method which uses a three-year moving average would not be unreasonable.

As discussed by telephone (XXXXXXXXXX/Humenuk), you no longer require a response to your question concerning premium categories as defined in the draft Regulations.

We trust our comments will be of assistance to you.

Yours truly,

P.D. Fuoco
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch