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: General comments on the tax consequences of the disposition of a life insurance policy with a "return of premium" benefit.
Position: Generally results in a taxable gain.
Reasons: The legislation.
Terry Young, CA
May 24, 2011
Dear XXXXXXXXXX :
Re: Disposition of an Interest in a Life Insurance Policy
This is in reply to your request that was forwarded to us by XXXXXXXXXX on April 29, 2011. We also acknowledge our various conversations (Young / XXXXXXXXXX).
Based on the information provided to us, it is our understanding that in 1989 you purchased a "Return of Premium Life Insurance Policy" from an insurer. In 2009, you elected to terminate the policy in order to receive a Return of Premium Benefit of $XXXXXXXXXX . The Return of Premium Benefit was equal to the amount of premiums paid under the policy on the policy anniversary date immediately following your 65th birthday. You also received a 2009 T5 slip showing income of $XXXXXXXXXX . According to the insurer, this amount represents the taxable portion of the proceeds of disposition of the policy. You have asked us why you should have to pay tax on any part of the amount you received when the insurer was only returning premiums that had been paid under the policy.
We offer the following comments, which are general in nature and are not to be construed as binding on the Canada Revenue Agency with respect to a particular situation.
A "disposition" of an interest in a life insurance policy is defined in subsection 148(9) of the Income Tax Act (the "Act") to include "a surrender thereof" or "the dissolution of that interest by virtue of the maturity of the policy." When a policy is surrendered or matures, subsection 148(1) of the Act will apply to require the policyholder to report a gain for tax purposes to the extent that the proceeds of disposition of the policy exceed the "adjusted cost basis" ("ACB") of the policy immediately before the disposition. Any gain resulting from the disposition is required to be included in the policyholder's income by virtue of paragraph 56(1)(j) of the Act.
Proceeds of Disposition
The "proceeds of the disposition" of an interest in a life insurance policy is defined in subsection 148(9) of the Act as the amount of the proceeds that the policyholder is entitled to receive on the disposition. Where the terms of a policy provide for a benefit to be paid out on the surrender or maturity of the policy, such benefit would be included in the computation of the proceeds received by the policyholder. The type of policy in your case provides for a payout of a "Return Of Premium Benefit" as determined by reference to the total premiums paid in respect of the policy.
ACB of a Life Insurance Policy
The ACB of a policyholder's interest in a life insurance policy is determined by a formula under subsection 148(9) of the Act. In very general terms, the ACB to the original policyholder will be the amount by which the cash premiums paid by the policyholder, and any income in respect of the policy that has previously been reported for tax purposes, exceeds the "net cost of pure insurance" (NCPI) under the policy.
Net cost of pure insurance
The NCPI represents the cost the policyholder has paid to be covered by insurance during the time that he or she has held the policy and as such reduces the amount that can be returned to the policyholder on a tax-free basis when the policy is surrendered. Section 308 of the Income Tax Regulations to the Act (the "Regulations") sets out the rules for calculating the NCPI of a taxpayer's interest in a life insurance policy.
Section 308 of the Regulations requires that the mortality data set out in the 1969-75 mortality tables of the Canadian Institute of Actuaries be used in computing the NCPI of an interest in a life insurance policy. The Regulation provides that the NCPI of a taxpayer's interest in a life insurance policy shall be computed by multiplying the applicable rate of mortality from the tables by the difference between either the benefit payable on death in respect of the interest at the end of the year and the accumulating fund at the end of the year (determined without regard to any policy loan outstanding) or the cash surrender value of the interest at the end of the year, depending upon which method is regularly followed by the life insurer.
Gain on Disposition
As indicated above, the application of subsection 148(1) of the Act results in a gain where the proceeds of disposition of the policyholder's interest in the policy exceed the ACB to the policyholder of that interest. The gain computed under subsection 148(1) of the Act, must be included in computing the income of the policyholder in the year the disposition takes place, pursuant to paragraph 56(1)(j) of the Act.
The insurer with whom the policy was held prior to its maturity or surrender is required to report the amount of the gain on the policy in "Box 14 - Other Income from Canadian Sources" on a T5 information slip issued to the policyholder. The insurer should also be able to provide you with information on how it calculated the "proceeds of disposition", "adjusted cost basis" and the gain on the disposition. We note that the insurer did this in a letter dated XXXXXXXXXX .
We are enclosing copies of another letter that we wrote (document 2007-0230321E5) and a copy of the Tax Court of Canada judgement White v. The Queen (2007-3803(IT)I), which address situations similar to yours. Also, at your request, we are forwarding a copy of this letter to XXXXXXXXXX for his information.
We hope that our comments will be of assistance to you.
for Division Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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