16 November 1995 External T.I. 9528295 - ASSUMPTION REINSURANCE AND POLICY LOANS

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:

Whether or not the obligations which are referred to in subsection 138(11.92) are net of policy loans.

Position:

Yes

Reasons:

The policy loans are a prepayment of the policy benefits and are not separable from the insurance policies. They are not "loans".

            952829
XXXXXXXXXX  Michèle Trotier

Attention: XXXXXXXXXX

November 16, 1995

Dear Sirs:

Re: Policy loans and Assumption Reinsurance

This is in reply to your letter of October 23, 1995 wherein you requested our view as to the tax treatment of policy loans which are transferred by one insurer, the vendor, to another, the purchaser, pursuant to an assumption reinsurance arrangement to which subsection 138(11.92) of the Income Tax Act ("Act") applies. A "policy loan" is defined in subsection 138(12) of the Act as an amount advanced by an insurer to the policyholder in accordance with the terms and conditions of a life insurance policy in Canada. You have requested that we confirm that the amount of the policy loans transferred by the vendor to the purchaser is not to be included in the amount paid or payable by the vendor to the purchaser, which is referred to in subparagraph 138(11.92)(d)(i) of the Act, in respect of the obligations assumed by the purchaser.

As you indicated in your letter, policy loans basically represent prepayments of policy benefits and therefore reduce the insurer's obligations in respect of the life insurance policies. We refer to comments which were made in Norwood on Life Insurance Law in Canada, on page 193, that "a policy loan is not a "loan" in the true sense, since the insured is not legally obligated to repay it and since the insurer obtains no legal right to sue for its repayment." It is also noted that "...a policy loan is considered in the nature of an advance payment of the benefit of the policy to which the insured is entitled, and "interest" may be suggested to be really in the nature of a charge made by the insurer for the policy-loan privilege." These comments are consistent with the Supreme Court of Canada decision in the Equitable Life Assurance Society of the United States, 1942 S.C.R 205..

It is our understanding that policy loans are not separable or divisible from the life insurance policies under which they are made. Consequently, we are of the view that the obligations referred to in subsection 138(11.92) of the Act would be net of the amount of outstanding policy loans. We also note that any future repayments of these policy loans will have to be included in the income of the purchaser in the taxation year they are received pursuant to paragraph 138(4)(d) of the Act.

We are also of the view that this interpretation provides the appropriate result under the Act with respect to policy loans for both the vendor and the purchaser as you pointed out in the example in your letter. In this regard, the policy loans made by the insurer in the year and after 1977 may be deducted by the insurer in computing its income pursuant to paragraph 138(3)(e) of the Act. However, an amount received by the insurer in respect of the repayment of a policy loan must be included in the income of the insurer pursuant to paragraph 138(4)(d) of the Act. Paragraph 1401(1)(c) of the Income Tax Regulations provides that the amount of the policy reserve which may be deducted by the insurer pursuant to subparagraph 138(3)(a)(i) of the Act is to be reduced by the amount payable in respect of a policy loan outstanding at the end of a particular taxation year. Where a policy loan is repaid in a subsequent taxation year the amount of the policy reserve in that year in respect of the particular life insurance policy should be increased by an equivalent amount since the amount payable in respect of this policy loan outstanding at the end of that particular taxation year will have been reduced by the amount of the repayment.

We trust our comments will be of assistance to you.

Yours truly,

F. Lee Workman
Section Chief
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch