30 June 1999 Ruling 9908430 - CALU CONFERENCE MAY 1999

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: see attached

Position: See attached. Except for question #12, positions in this document came from positions already taken by our Directorate and were reviewed by the Department of Finance XXXXXXXXXX .

Answer to Question #12 was provided by Assessment and Collections Branch. See attached

Reasons: see attached

1999 CALU ANNUAL MEETING
MAY 1999
CONFERENCE FOR ADVANCED LIFE UNDERWRITING

ALL REFERENCES TO STATUTE WILL BE TO THE INCOME TAX ACT UNLESS OTHERWISE SPECIFIED

Question 1

Life Insured Salary Continuation Plans

Pursuant to the terms of an executive benefit plan, in the event of the death of a member of the plan, the corporation must continue to pay all or a portion of the deceased executive's salary to his or her designated beneficiary or to the deceased's estate for a specified period up to normal retirement age. To indemnify itself against the risk of having to make such payments under the plan, the corporation acquires individual insurance policies on the lives of the executives who are members of the plan. The corporation is the owner and beneficiary of the policies and the amounts insured are sufficient to fund the salary continuation payments under the plan. Will the Department confirm that:

(a) the insurance policies acquired by the corporation will not be considered to be the "subject property" of a retirement compensation arrangement,

(b) the insurance proceeds received by the corporation as a consequence of the death of an insured executive will not be included in the corporation's income for tax purposes,

(c) the payment of the insurance premiums by the corporation will not be considered to be a taxable benefit conferred on the insured executives,

(d) the payment of the salary continuation benefits after the death of an executive will be deductible to the corporation in determining its income for tax purposes, and

(e) amounts received by a beneficiary or the deceased executive's estate pursuant to the salary continuation plan are included in income for tax purposes pursuant to subparagraph 56(1)(a)(iii).

Department's Position:

I would first caution that when considering the income tax consequences of compensation plans particular attention must be paid to the facts of each case. Having said that, where a life insurance policy is acquired by a corporation on the life of an employee solely to fund the payment of a "death benefit" as that term is defined in the Income Tax Act, the arrangement would generally not be viewed as an RCA. Salary continuation payments as described in the question would ordinarily be viewed as meeting the definition of "death benefit".

Absent other considerations, the normal rules for a corporation acquiring a life insurance policy would apply, that is, the premiums would not be deductible and the proceeds received on death would not be included in income.

Assuming the employee has no interest in the life insurance policy, there would be no taxable benefit to the employee. As stated earlier, the eventual payments would generally be taxable as a death benefit and thus would be deductible to the employer.

*********************************************************************

Question 2

Capital Dividends and the 25% Solution

The estate of a deceased shareholder owns shares in a private company that have an adjusted cost base and fair market value of $1 million. The paid-up capital of the shares is only a nominal amount.

The shares are redeemed from the estate and the company elects to treat the deemed dividend of $1 million as a capital dividend pursuant to subsection 83(2). However, immediately before the redemption, the balance of the company's capital dividend account was $350,000. To avoid a reduction of the capital loss triggered on the redemption of the shares under subsection 112(3.2), the estate and the company wish to reduce the amount of the capital dividend to $250,000.

Will Revenue Canada accept an election under subsection 184(3) to treat $750,000 of the deemed dividend arising on the share redemption as a separate taxable dividend?

Department's Position:

Since in determining the amount that may be treated as a separate dividend that is a taxable dividend, subsection 184(3) only deals with the excess of the full amount of the dividend ($1 million) over the capital dividend ($350,000) there is no scope for the Department to accept an election of a larger amount.

*******************************************************************

Question 3

Capital Dividend Account

A recent technical interpretation dealt with the situation where one company (Parentco) was the beneficiary of insurance policy on the life of its controlling shareholder. Another company (Subco) was the owner and paid the premiums on the policy. The department indicated that GAAR could be applied to reduce the amount of the life insurance proceeds to be included in Parentco's capital dividend account by the adjusted cost basis of Subco's interest in the policy unless there are bona fide reasons other than to obtain a tax benefit, for structuring the ownership and beneficiary designation of the policy as described.

In many succession planning arrangements, holding companies for individual shareholders may own and pay the premiums for insurance policies on the lives of the other shareholders. The operating company (Opco) would be designated as the beneficiary so that the proceeds received upon the death of a shareholder could be used by Opco to redeem the shares owned by the holding company of the deceased shareholder. The ownership of the policies might be structured in this manner for a variety of reasons including;

(a) to shield the insurance policies from possible seizure by creditors of Opco; and

(b) to ensure that each shareholder, through his or her holding company, bears the cost of insuring the lives of the other shareholders.

Will the Department apply GAAR in the circumstances as described in (a) and (b) above?

Department's Position:

In dealing with GAAR issues, for obvious reasons the Department cannot give general opinions as to whether or not GAAR will or will not apply in certain circumstances. What we can do is provide some guidance as to how we would approach the issue. In this case, there is clear legislative policy intent in paragraph (d) of the definition of the capital dividend account in subsection 89(1) that the proceeds from a life insurance policy that are received by a corporation in consequence of the death of any person must be reduced by the adjusted cost base of the policy. The issue would thus probably be decided by determining whether or not there is an avoidance transaction as defined in subsection 245(3) which, in this case since it is clear that there is a tax benefit, would seem to depend on whether or not the transactions were undertaken primarily for bona fide purposes other than to obtain this tax benefit. While we have not had any actual cases where the reasons for undertaking the transactions were as described in this question, they do initially appear to be secondary to the purpose of obtaining the tax benefit.

************************************************************************
Question 4

Grandfathering Rules

Has the Department modified its position in respect of the grandfathering issues dealt with in the CALU's 1997 annual meeting?

Department's Position:

No, and furthermore there have not to our knowledge been any significant concerns or issues raised since the introduction of these grandfathering rules.

************************************************************************

Question 5

Critical Illness Group Insurance Plans

Group sickness or accident insurance plans may include critical illness insurance benefits payable to plan participants should they be diagnosed with one of the covered illnesses or conditions. Benefits may be payable either in a lump sum or periodically as part of a wage loss replacement plan. Will the Department confirm that:

(a) premiums paid by an employer for critical illness insurance coverage under a group sickness or accident insurance plan will not result in a taxable benefit to employee participants;

b) the amount of such premium payments will be deductible in calculating the employer's income for tax purposes;

(c) a lump-sum benefit received by an employee pursuant to the plan as a consequence of being diagnosed with a critical illness will not be taxable; and

(d) a periodic benefit received by an employee pursuant to the plan as a consequence of being diagnosed with a critical illness will be included in the employee's income in accordance with paragraph 6(1)(f)?

Department's Position:

To our knowledge the income tax consequences with respect to benefits which may be provided under what the insurance industry refers to as "critical illness insurance" either on a group or non-group basis has not yet been the subject of a thorough review by this Department. As a result we are unable to confirm the income tax consequences of such plans without obtaining a complete understanding of all the relevant facts of a particular situation. In determining the income tax consequences it will first be necessary to conclude whether or not the insurance policy is a "sickness or accident insurance plan". This term is not defined in the Act.

Since this term is not defined in the Act, we have to consider definitions used for other purposes. In looking at these we note they are not necessarily consistent, particularly as it relates to whether or not the insurance must be intended to compensate for loss as a result of an accident or illness. The relevance of this factor is that it appears that paragraph 6(1)(f) type plans were predicated on there being a loss suffered by the employee.

The Insurance Institutes' Dictionary of Insurance defines accident and health (sickness) insurance generally as:

"A form of insurance compensating an individual for loss as a result of an accident or illness. It may pay certain or all expenses for medical and similar services and a weekly or monthly indemnity for loss of income. The amounts and items covered vary from policy to policy and depend to some extent on what coverage is purchased by the insured."

The Insurance Companies Act of Canada defines "sickness insurance" as meaning:

(a) insurance against loss resulting from the illness or disability of a person other than loss resulting from death,

(b) insurance whereby an insurer undertakes to pay a certain sum or sums of money in the event of the illness or disability of a person, or

(c) insurance against expenses incurred for dental care,

other than illness or disability or dental care arising out of an accident."

The Insurance Act of Ontario defines "sickness insurance" as meaning:

"insurance by which the insurer undertakes to pay insurance money in the event of the sickness of the person or persons insured, but does not include disability insurance."

It is our basic understanding that critical illness benefits may be paid on the happening of a specific medical event, such as a heart attack, and that once that event occurs the payments may not necessarily be conditional on the insured having incurred a specific loss or expense. Therefore, until we have had the opportunity to examine the details of a particular critical illness plan we are unable to comment on the income tax treatment of any premiums paid or benefits received in respect of such coverage. It may be that some critical illness insurance plans will be considered as sickness or accident insurance plans while others will not.

************************************************************************

Question 6

Wage Loss Replacement Plans

At the 1996 CALU annual meeting, the Department was asked to provide guidelines for determining whether the benefit of coverage under a wage loss replacement plan is provided to an individual who is both an employee and a shareholder because of the individual's employment or because of the individual's shareholdings. At that time, the Department indicated that additional guidelines could be forthcoming when Interpretation Bulletin IT-428 "Wage Loss Replacement Plans" is revised.

Will IT-428 be revised in the near future and will additional guidelines be provided at or before that time?

Department's Position:

We have not yet had cause to amend IT-428 to take into account this issue since no problems have been brought to our attention with respect to those guidelines, and therefore no additional guidelines have been developed.

For the benefit of those of you who were not at the 1996 meeting, we said then, and still hold, that the Department has always maintained that the determination of whether a benefit is received by an employee-shareholder in his or her capacity as an employee or as a shareholder involves a finding of fact. Furthermore, the Department has always started with the presumption that an employee-shareholder receives a benefit by virtue of his or her shareholdings, where the shareholder or shareholders can significantly influence business policy. When the benefit is being derived by participation in a group plan, such as a wage loss replacement plan, and each member of the group is a shareholder as well as an employee, the same presumption applies.

In examining a particular case, a negative answer to one or more of the following queries would suggest that the benefits are provided to the recipient in his or her capacity as a shareholder:

(a) Is participation in the plan made available to all employees, including those who are neither a shareholder nor related to a shareholder? If not, is there a logical reason to exclude some employees?

(b) Are the benefits available under the plan the same for all employees of the business, in their nature, quantum and cost-sharing ratio?

(c) When all participating employees are also shareholders, is the benefit coverage similar to coverage given to non-shareholder employee groups for similar size businesses who perform similar services and have similar responsibilities? For example, if wage loss replacement plans generally provide benefits of 70% of the disabled employee's salary and wages after a waiting period of 13 weeks, a similar plan for a company whose employees are all shareholders would be considered a benefit of employment. However, if the level of benefits was significantly higher for the plan in which all participating employees are shareholders or if the waiting period was less, it would be an indication that the coverage was being provided to the employee-shareholders in their capacity as shareholders. However, this is not to say that coverage must be limited to 70% of salary and wages.

These guidelines are necessarily phrased in broad terms because the particular circumstances of a specific situation must be taken into account.

************************************************************************

Question 7

Private Health Services Plans

The draft legislation proposed by the Department of Finance which allows a deduction for premiums paid to a private health services plan ("PHSP") for coverage for a proprietor or partner is extremely complex and some would argue that the cost of compliance will outweigh any tax benefit. In particular, determining "the cost of equivalent coverage" in respect of each employee is onerous, particularly if the plan has a number of benefits, co-insurance options and riders.

Is Revenue Canada considering issuing an Information Circular or Interpretation Bulletin to assist employers in determining if a deduction for PHSP premiums for proprietors or partners is allowable in certain circumstances?

Department's Position:

Proposed section 20.01 is intended to provide a deduction for PHSP coverage for a proprietor or partner in circumstances where such coverage is also provided to the regular full-time employees of the business.

With respect to the proposed deduction for PHSP coverage for a proprietor or partner (the "employer"), the meaning of "cost of equivalent coverage" is described in the Department's Business and Professional Income guide which is also available on our internet site, http://www.rc.gc.ca as Form T4002. Provided that the benefit coverage for the employer (i.e., the range of medical services covered under the plan, co-insurance options and riders) is the same as for all full-time employees of the business (as defined in the legislation), the employer's deduction under proposed section 20.01 is limited to the proportion of the premium that the employer pays on behalf of the employees of the business. For example, if the employer pays 50% of the cost of the employees' coverage under a group plan but incurs a greater cost for the same coverage for himself or herself because the employer is not eligible to be covered under the group plan, the employer would be entitled to deduct 50% of the cost of the coverage for the employer under proposed section 20.01. The remainder of the premium paid for the employer's coverage would qualify as a medical expense under subsection 118.2(2). Note that if it is more advantageous to the employer, the employer may claim the entire premium paid for his or her coverage (including coverage for the employer's dependants as defined in subsection 118(6)) as a medical expense, in which case no amount would be deductible under proposed section 20.01 (this may be the case if the employer is entitled to a refundable medical expense supplement as described in section 122.51). If the coverage for the employer is greater than that provided to any of the full-time regular employees of the business (i.e., a greater range of medical services covered, less co-insurance or less restrictive riders), the deduction under section 20.01 will normally be limited to the cost of coverage for the employee with the least amount of coverage (assuming the same number of dependants).

************************************************************************

Question 8

Share Valuation on Death

Mr. X and Mr. Y each own 50% of the common shares of Opco. Pursuant to the terms of their shareholders' agreement, upon the death of either Mr. X or Mr. Y, Opco will redeem the deceased's common shares from his estate. Opco is the owner and beneficiary of a life insurance policy on each of the shareholders' lives acquired for the purposes of funding the share redemption. However, the amount of the life insurance in force may be more or less than the actual amount required to redeem the shares.

Opco has also issued one special Class X share to Mr. X and one special Class Y share to Mr. Y. Such shares are non-voting and are redeemable by Opco for their issue price, namely $1 each. The shareholders' agreement provides that, in the event the life insurance proceeds received by Opco upon the death of a shareholder exceed the redemption price of the common shares owned by the estate of the deceased shareholder, Opco will pay a dividend equal to the amount of such excess to the estate on the Class X or Class Y shares, as the case may be. Except in these circumstances no dividends will be paid on the Class X or Class Y shares.

Will the Department confirm that the fair market value of the Class X or Class Y shares, immediately before the death of the respective shareholders, will be equal to the redemption price, namely $1?

Department's Position:

Subsection 70(5.3) provides that in determining the fair market value of shares of a corporation immediately before the death of a shareholder, an asset of the corporation that is a life insurance policy is to be assigned a value based on its cash surrender value rather than the amount of the death benefit. In our view where a shareholder owned more than one class of shares, the rights, restrictions and any relevant agreements would have to be considered in order to arrive at the appropriate allocation of the reduced fair market value of the assets of the corporation between the classes of shares. In this regard it is our view that notwithstanding subsection 70(5.3) the right to receive a special dividend on a particular class of shares (likely to be paid out as a capital dividend) may cause the shares to have a fair market value in excess of $1 in the example noted above.

************************************************************************

Question 9

Distribution of Insurance Policy to Trust Beneficiary

A life insurance policy owned by a trust is distributed to a beneficiary resident in Canada in satisfaction of all or a portion of the beneficiary's capital interest in the trust. In this case, the trust is a "personal trust" as defined in subsection 248(1) and subsection 107(4.1) does not apply to the distribution of property from the trust. Will the Department confirm that subsection 107(2) applies to treat the distribution as a tax-deferred rollover and that subsection 148(7) is not applicable?

Department's Position:

Yes, we confirm that in this situation subsection 107(2) takes precedence over subsection 148(7) such that there would be a tax-deferred rollover.

************************************************************************

Question 10

Premiums

For purposes of the deduction pursuant to paragraph 20(1)(e.2), you have asked how the premiums payable by the taxpayer in respect of a particular taxation year are to be determined with respect to universal life insurance policies. You have advised that premiums under universal life insurance policies are not specifically identified as having been paid in respect of any particular taxation year.

Department's Position:

It is our understanding that payments made by a policyholder, notwithstanding that they are in excess of specified minimum amounts necessary to cover the risk and administrative charges for a policy year, are treated by the insurer as premiums that are not prepaid premiums. The full amount of the payment is included in the insurer's income as a premium in the year of receipt, and such a payment is reflected in both the adjusted cost basis and cash value of the policy.

Based on this, it is our opinion that such payments are premiums that are payable in respect of the year in which they are made by the policyholder. The fact that mortality and administrative charges in subsequent years may be funded from the build-up in the accumulating fund of the policy is in our view not relevant to the determination of the year to which the premium relates. Unless a portion of the premium paid is in fact prepaid, we see no basis for treating it as other than in respect of the year in which it is paid.

************************************************************************

Question 11

Charitable Trust

A donor establishes a "charitable trust" for purposes of benefiting two unrelated charitable organizations. The donor purchases a $1 million Government of Canada bond and transfers it to the trust. The bond bears interest at 6% per annum.

Pursuant to the terms of the trust, Charity A is irrevocably designated as the income beneficiary of the trust for a period of 5 years. After 5 years the trust will be wound-up and the bond will be distributed to Charity B, which is irrevocably designated as the capital beneficiary of the trust. Will the Department confirm that:

(a) the donor will be considered to have made a charitable gift of an income interest in a trust to Charity A and a charitable gift of an equitable interest in a trust to Charity B,

(b) the fair market value of the income interest donated to Charity A will be determined as the present value of the stream of interest payments to be received by the trust and distributed to Charity A over the 5-year period, and

(c) the fair market value of the equitable interest donated to Charity B will be determined as the present value of the principal of the bond that will be distributed to Charity B at the end of the 5-year period?

Department's Position:

The Department's position with respect to gifts of equitable interests in trusts made to charitable organizations is set out in Interpretation Bulletin IT-226R. This Bulletin outlines the requirements that must be met for a donation of an equitable interest in a trust to qualify as a gift for income tax purposes. Having regard to these requirements, if it can be ascertained from the terms of the trust that a gift of an income interest has been made to Charity A and a gift of an equitable interest has been made to Charity B, the donor will be considered to have made charitable gifts for income tax purposes.

Once it is established that a gift has been made, the value of the gift at the time of the transfer must be determined before it can be claimed for income tax purposes. Paragraph 5 of IT-226R sets out some general principles in determining the value of an equitable interest in a trust.

While we are unable to provide confirmation with regard to the valuation of the gift of the income interest and the equitable interest as described above, it is nevertheless our view that the total of the gift of the income interest to Charity A and the gift of the equitable interest to Charity B should equal the fair market value of the bond at the time it is transferred to the trust.

We note that the Department is in the process of reviewing IT-226R. The focus of this review relates primarily to the Department's administrative position as set out in paragraph 8 of the bulletin, which allows for a subsection 118.1(6) election on the capital property transferred to the trust. Pending the completion of this review, the administrative position set out in paragraph 8 will be restricted to situations similar to those described in paragraph 3 of the bulletin.

************************************************************************

Question 12

Taxpayer Migration

The Backgrounder and Technical Notes accompanying the draft legislation on taxpayer migration released by the Department of Finance on December 23, 1998, indicate that Revenue Canada may be prepared to accept a collateral assignment of the shares of a private company as security for the tax arising on the deemed disposition of such shares when a shareholder ceases to be resident in Canada. The Backgrounder states that Revenue Canada will accept such a collateral assignment where "the shares value can be ensured". The explanatory notes (Clause 27) state that "the Minister will not exclude the possibility of accepting some or all of the shares as security".

Can the Department expand on the guidelines it may follow to determine whether and to what extent the shares of private corporations will be accepted as security for the payment of the departure tax. In particular, what covenants will be required from the shareholders and the Corporation?

Department's Position:

As with any security arrangement, each case must be reviewed on its own merits. In respect of the acceptance of shares in private corporations as security for tax arising upon a deemed disposition of those shares, it is difficult to provide specific criteria that will be applied to individual cases. Given the multitude of variations in corporate structures and the relationships of the taxpayer to the corporate entity various aspects of the corporation would be reviewed and considered. The information to be reviewed may include, but would not be limited to:

• the current financial status of the corporation (i.e. financial statements);
• the share structure;
• the taxpayer's relationship to directors, officers, and other shareholders of the corporation (i.e. arms length or not);
• any shareholder agreements; and
• the articles of incorporation.

All of these matters have the potential to impact upon both the value and liquidity of the shares. Such factors must be considered when evaluating the extent to which the shares may be considered as acceptable security in respect of tax debts.

With respect to covenants that will be required, it is anticipated that proposals acceptable to Revenue Canada will include provisions that reflect commercial reality. In other words, security arrangements must reflect the fact that the security is provided in lieu of payment and that interest and penalties do not accrue on the amount secured, therefore, the liquid value of such security must be protected.

In this regard, Revenue Canada's position is that accepted business practices will be followed. Such practices protect the value of the shares and prevent actions that may lead to the deterioration of the security. Therefore, when assigning private company shares as security, the Minister will be assigned the right, but will not be bound or required, to exercise any option or right which the assignor may have. The extent to which these rights will be exercised will depend on the individual circumstances of each case.