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.
Whether a terminal illness advance on the death benefit payable under a life insurance policy and the subsequent reduced death benefit are subject to tax.
A question of fact to be determined on a case by case basis. The limited information provided is not sufficient to base an opinion upon. The ultimate determination will depend upon factors such as whether death is imminent, whether the policy, under its terms and conditions, provides for such payments, whether the advance constitutes a policy loan or a disability benefit payment and the amount of the policy's cash surrender value, accumulating fund and adjusted cost basis.
Reasons FOR POSITION TAKEN:
Legislation and previous positions.
XXXXXXXXXX G. Donell
June 21, 1995
Re: Terminal illness advance - Life Insurance policy
This is in reply to your letter of February 24, 1995 to the Toronto District Taxation Office forwarded to us March 28, 1995. You have asked us to confirm whether a terminal illness advance on the death benefit payable under a life insurance policy and the subsequent reduced death benefit are subject to tax.
Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R2. However, we offer the following general comments with regard to the issues raised in your letter which we hope will be of assistance to you. Should you be concerned with any particular situation it will be necessary for us to review the terms of the particular policy and the conditions under which the advance payment will be made.
Paragraph 56(1)(j) of the Income Tax Act (the "Act") requires that any amount determined, in a taxation year, under subsection 148(1) of the Act be included in a taxpayer's income. Subsection 148(1) of the Act requires a policyholder to include in income, in respect of a "disposition" of an interest in a life insurance policy, an amount by which the "proceeds of the disposition" to which that policyholder, beneficiary or assignee is entitled to receive exceeds the policyholder's "adjusted cost basis" of that interest immediately before the disposition. Subsection 148(1) of the Act is thus predicated on a disposition of an interest in a life insurance policy.
A disposition is defined for this purpose in subsection 148(9) of the Act and includes among other things a surrender thereof (paragraph (a)) and a policy loan made after March 31, 1978 (paragraph (b)), but does not include a payment under a policy as a disability benefit (paragraph (h)), or a payment received as a consequence of the death of any person whose life was insured under a life insurance policy that is either last acquired before December 2, 1982 or is an exempt policy (paragraph (j)).
In addition if under the terms and conditions of the policy an advance payment cannot be made thus requiring a policy amendment or addition of a disability rider, such a change, depending upon the facts, could be considered so fundamental a change as to constitute a new policy. In this instance we would consider the policyholder to have disposed of the policy as it was before the change and to have acquired a new policy. Proceeds of disposition of the former policy and cost of the new policy would be considered, in our view, to be equal to the fair market value of the new policy.
Paragraph 148(10)(d) of the Act states that, unless otherwise provided, a disposition or acquisition is deemed not to occur as a result only of the exercise of any provision of the policy. In other words if the policy contains an existing provision to allow an advance payment or to specifically provide for an amendment of a policy to add a disability benefit rider for terminally ill life-insured the exercise of such a provision, by itself, would not be considered to give rise to the disposition of that policy and resultant acquisition of a new policy. Otherwise it is a question of fact whether a change to the terms and conditions of a life insurance policy is so fundamental as to result in the acquisition of a new policy. Such a determination can only be made on a case by case basis and the Department has no guidelines as such.
As indicated above a policy loan will also be considered a disposition. A policy loan is defined in subsection 148(9) and means "...an amount advanced by an insurer to a policyholder in accordance with the terms and conditions of the life insurance policy." This definition may be broad enough to encompass such an advance against the policy's death benefit. In this case the proceeds of disposition, as defined in subsection 148(9), paragraph (b) thereof, would generally equal the lesser of the advance or loan amount and the amount by which the cash surrender value of the policy immediately before the loan was made exceeds the outstanding balances, at that time, of any other policy loans.
The termination of a life insurance policy that was last acquired before December 2, 1982 or is an exempt policy, because of the death of the life insured, is not a disposition as indicated above. Therefore the death benefit is, in these instances, received tax-free. An exempt policy is defined in section 306 of the Income Tax regulations ("ITR"). The purpose of an exempt policy is to establish a basis to distinguish between policies designed to provide significant amounts of insurance protection from those designed primarily as an investment or savings vehicle with only ancillary insurance protection. The standard used to measure the savings or investment accumulation within a policy is the "accumulating fund" defined in section 307 of the ITR. Where an insurance policy is not exempt and was last acquired after December 1, 1982 the death of the life insured results in a disposition of that policy immediately before the death by the policyholder by virtue of paragraph 148(2)(b) of the Act. Paragraph (d) of the definition of proceeds of disposition in subsection 148(9) deems the policyholder to have received proceeds equal to the accumulating fund of the policy. In this manner any accrued investment gains to the date of death are included in the income of the policyholder to the extent that the deemed proceeds exceed the policy's ACB. The determination of a policy's status as exempt or non-exempt can be obtained from the insurance company which issued the policy.
We trust that the above comments are of assistance to you.
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Policy & Legislation Branch
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