19 January 1996 External T.I. 9531875 - DISABILITY BENEFITS - 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.

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 amounts to be paid to a policyholder of a 	life insurance policy as disability benefits will be 	taxable.

Position:

can only be determined upon review of specific policies.

Reasons:

question of fact

		                                       953187
XXXXXXXXXX		                                     Michèle Trotier

Attention: XXXXXXXXXX

January 19, 1996

Dear Sirs:

Re: Disability Benefits

This is in reply to your letter November 29, 1995 wherein you requested our opinion with respect to the taxation of certain amounts to be paid to a policyholder of a life insurance policy where the policyholder becomes disabled.

You have indicated that it is being contemplated to add to your current life insurance policies two types of disability benefits. One type would be an income replacement benefit to be received on a monthly basis if the policyholder becomes disabled. The other type would be a lump sum benefit to be received by the policyholder upon his or her election if the policyholder becomes disabled.

You have also advised that there will be additional premiums to be paid with respect to the income replacement benefit but not with respect to the lump sum benefit.

You have requested that we confirm that the amounts received in each of these instances would not constitute a disposition of the policy and would therefore be received by the policyholder on a tax free basis.

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. The issues raised in your letter would be more appropriately dealt with in an advance income tax ruling since we have not examined the terms and conditions of the life insurance policies you are considering. However, we are prepared to give you the following general comments which may be of some assistance.

It is our understanding that the life insurance policies referred to above will be modified to enable the insurer to make these disability payments under such policies. Consequently, first it will have to be determined whether or not there will be a disposition of your current life insurance policies at the time they are modified. Such a determination can only be made by reviewing the specific life insurance policies being modified. A "disposition" of a life insurance policy is defined for this purpose in subsection 148(9) of the Income Tax Act (the "Act"). In this regard we note that whether or not insurance contracts combining both elements of death benefits and disability benefits would be considered to be "life insurance policies" within the meaning of that definition in subsection 138(12) of the Act can only be determined upon the review of the particular contracts. The cases that we considered thus far are those in which the disability benefits are ancillary to the life insurance coverage and in such cases it is our view that the policies are "life insurance policies" within the meaning of that definition in subsection 138(12) of the Act.

If under the terms and conditions of the policy the disability payments cannot be made thus requiring a policy amendment or an 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 the disposition of the former policy and the adjusted cost basis of the new policy would be considered, in our view, to be equal to the fair market value of the new policy.

We agree with you that the premiums payable with respect to the disability benefits under a "life insurance policy" are not included in the definition of "premium" in subsection 148(9) of the Act pursuant to subparagraph (c)(ii) of that definition and will therefore not be added to the adjusted cost basis of the policyholder's interest in the life insurance 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 for an amendment of a policy or for an addition of a disability benefit rider to cover the proposed disability benefits referred to above 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.

A disposition of a life insurance policy also includes among other things a policy loan made after March 31, 1978 (paragraph (b)), but does not include a payment under a policy as a disability benefit or accidental death benefit (paragraph (h)), or a transaction or event described in paragraph (k) where there is total and permanent disability of the individual whose life is insured under the policy. A payment under a life insurance policy as a disability benefit or as an accidental death benefit would be exempt from taxation under subsection 148(1) of the Act by virtue of subparagraph (h) of the definition of "disposition" found in subsection 148(9) of the Act. However, where the disability benefits are payable on a periodic basis, it is possible that they may be subject to paragraph 56(1)(d) of the Act. Subsection 248(1) of the Act provides that an "annuity" includes an amount payable on a periodic basis whether payable at intervals longer or shorter than a year and whether payable under a contract, will or trust or otherwise. Considering the very broad definition of "annuity" under the Act, it is arguable that the payments of the income replacement benefit could be required to be included in income of the policyholder pursuant to paragraph 56(1)(d) of the Act. One would also have to take into account the specific arrangements under which the annuity payments would be made to the recipient to determine the capital element, if any, pursuant to paragraph 60(a) of the Act. We are currently reviewing the potential application of paragraph 56(1)(d) of the Act to periodic disability payments.

A policy loan is defined in subsection 148(9) of the Act 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 a lump sum disability benefit referred to above where it is made against the policy's death benefit or the cash surrender value of the policy. In this case the proceeds of the disposition, as defined in subsection 148(9) of the Act, paragraph (b) thereof, would generally equal the lesser of the lump sum 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. This determination again can only be made on a case by case basis.

We refer you to Interpretation Bulletin It-428 for a detailed description of the various income tax implications with respect to wage loss replacement plans. We note that the application of paragraph 6(1)(f) of the Act, for example, would also have to be considered. As indicated previously, such a determination can only be made upon the review of the particular insurance arrangements and all the relevant facts and documentation.

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