4 February 2013 External T.I. 2012-0473561E5 - Corporate-owned life insurance

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.

Principal Issues: Various questions regarding the taxation of a life insurance policy held by a CCPC and the QSBC share definition.

Position: General comments provided.

Reasons: The legislation.

XXXXXXXXXX
E. Danilchenko
2012-047356

February 4, 2013

Dear XXXXXXXXXX:

Re: Corporate-owned life insurance

We are writing in response to your letter dated December 15, 2012. In your letter, you asked several questions pertaining to the taxation of a corporate-owned life insurance policy and the impact of the policy on the status of the corporation's shares as qualified small business corporation ("QSBC") shares.

In the situation described, Opco, a Canadian-controlled private corporation ("CCPC"), is considering the purchase of a life insurance policy on the life of Mr. A, a shareholder of Opco. The policy is an exempt policy for income tax purposes and has a death benefit of $XXXXXXXXXX and a cash surrender value component. Opco pays the policy premiums and is the beneficiary under the policy. Opco does not deduct from its income the policy premiums for tax purposes.

Written confirmation of the tax implications inherent in a particular transaction may only be provided by this Directorate where the transactions are proposed and are the subject matter of an advance income tax ruling submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the Internet at http://www.cra-arc.gc.ca/formspubs/menu-e.html. We are, however, prepared to provide the following general comments.

Capital Dividend Account ("CDA")

Your first question was whether the life insurance proceeds received by Opco upon the death of the life insured may flow to the remaining shareholders via the CDA as a capital dividend. The CDA of a corporation is defined in subsection 89(1) of the Income Tax Act ("the Act"). Paragraph (d) of the CDA definition generally includes in the CDA the amount by which the proceeds received by the corporation as a consequence of death of a person whose life was insured exceed the corporation's adjusted cost basis ("ACB") of the policy immediately before that person's death.

The ACB to a policyholder of an interest in a life insurance policy is determined by a formula under subsection 148(9) of the Act. In general terms, the ACB will be the amount by which the premiums paid by the policyholder (excluding premiums for accidental death benefits), and any income in respect of the interest in the policy that has previously been reported for tax purposes, exceeds the net cost of pure insurance under the policy.

Generally, when the capital dividend election is made, a tax-free distribution of this amount can then be made to the shareholders of the corporation pursuant to subsection 83(2) of the Act. Whether Opco is able to pay a capital dividend depends on its CDA balance at the time. Interpretation Bulletin IT-66, Capital Dividends, discusses the procedures required to pay a dividend from a private corporation's CDA. General information can also be found in Interpretation Bulletin IT-430R3, Life Insurance Proceeds Received by a Private Corporation or a Partnership as a Consequence of Death.

Proceeds of Disposition

Your second question related to the tax treatment of a lump sum payment received by Opco upon maturity of the life insurance policy. Generally, a policyholder (in this case, Opco) is required to include in income any gain realized upon the disposition of the policyholder's interest in a life insurance policy pursuant to paragraph 56(1)(j) and subsection 148(1) of the Act. A "disposition" of an interest in a life insurance policy is defined in subsection 148(9) of the Act to include a surrender of that interest, the dissolution of that interest by virtue of the maturity of the policy, or a policy loan made after March 31, 1978. Where there is a disposition, the policyholder must include in income for the taxation year in which the disposition occurs the amount, if any, by which the proceeds of the disposition of the policyholder's interest that the policyholder is entitled to receive in the year exceed the ACB to the policyholder of that interest immediately before the disposition.

QSBC Shares

Lastly, you were asking whether the shares of Opco would still be considered QSBC shares if the cash surrender value of the life insurance policy before the death of the life insured exceeds 10% of Opco's assets. The term "QSBC share" is defined in subsection 110.6(1) of the Act. In order to determine whether shares of Opco qualify as QSBC shares, a number of tests relating to the fair market value of Opco's assets must be met. For the purposes of the QSBC share definition, paragraph 110.6(15)(a) of the Act provides that where a corporation holds a life insurance policy under which a shareholder of that corporation (or of any connected corporation or any corporation connected to a connected corporation) is the life insured, the fair market value of the policy is, at any time before the death of the life insured, deemed to be its cash surrender value (within the meaning assigned by subsection 148(9) of the Act) at that time. For a detailed discussion of the tests contained in the QSBC share definition, please refer to the attached severed version of document (E2012-0459741E5) issued by this Directorate. As noted in that document, the determination as to whether the shares of a particular corporation would meet all the conditions set out in the QSBC share definition would require a complete review of the relevant facts and circumstances.

We hope that our comments will be of assistance to you.

Yours truly,

Jenie Leigh
Section Manager
for Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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