10 May 2011 Roundtable, 2011-0398421C6 - CLHIA-May 2011- Q6 Life Insurance and Partnership

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: Confirmation of the income tax effect of a particular arrangement which involves the use of life insurance proceeds within a partnership to fund the disposition of a partnership interest held by a corporate partner.

Position: In the absence of a review of all the facts and circumstances relating to the particular situation, it is not possible for us to provide our views in a definitive manner. General comments provided.

Reasons: Confirmation of the income tax effect of a particular arrangement would normally be undertaken only in the context of an advance income tax ruling request.

CLHIA ROUNDTABLE - MAY 2011

Question 6 - Life Insurance and Partnership

Fact Situation:

Mr. A, a Canadian resident, is the sole shareholder of A Co, and Mr. B, a Canadian resident, is the sole shareholder of B Co. Mr. A and Mr. B, as well as A Co. and B Co., are not "related persons" for purposes of the Income Tax Act (the Act).

A Co and B Co, both Canadian corporations, carry on business in partnership under the firm name and style 'AB Partnership'.

The AB Partnership Agreement contains the following terms and conditions:

• AB Partnership is required to purchase sufficient insurance on the lives of Mr. A and Mr. B to equal the fair market value of AB Partnership to A Co and B Co respectively, adjusted on an annual basis.
• On the death of either Mr. A or Mr. B, AB Partnership must allocate and pay any life insurance proceeds received as a result of such death to the deceased's corporation.
• On the death of either Mr. A or Mr. B, the deceased individual's corporation will withdraw from the partnership and receive an amount from AB Partnership equal to the fair market of its partnership interest less the life insurance proceeds allocated by AB Partnership to the deceased principal's corporation.

Assume that Mr. A dies. At that time, the adjusted cost base of each corporate partner's interest in AB Partnership is $10,000. The fair market value of each interest is $25,000.

Pursuant to the terms of the Partnership Agreement, A Co is allocated and paid $25,000 of insurance proceeds. The adjusted cost basis (ACB) of the insurance policy at that time is nil.

Questions: Can the CRA confirm the tax results of this arrangement are as follows:

(i) The allocation of the $25,000 in life insurance proceeds to A Co increases its adjusted cost base in AB Partnership from $10,000 to $35,000 (subparagraph 53(1)(e)(iii) of the Act).
(ii) AB Partnership's allocation of the $25,000 in life insurance proceeds creates a capital dividend account credit of $25,000 to A Co.
(iii) The distribution of $25,000 by AB Partnership to A Co reduces A Co's adjusted cost base in AB Partnership to $10,000 (subparagraph 53(2)(c)(v) of the Act).
(iv) A Co's withdrawal from AB Partnership Agreement will result in A Co having a capital loss of $10,000 and B Co's adjusted cost base in AB Partnership will remain at $10,000.

If the CRA cannot confirm the tax results noted above, would the CRA's response be different if there were three or more corporate partners in AB Partnership that are controlled by individual shareholders, where the individual shareholders, and the corporate partners, are not "related persons" for purposes of the Act?

CRA Response:

The question requests confirmation of the income tax effect of a particular arrangement. In the absence of a review of all the facts, circumstances and documents pertaining to the particular situation, it is not possible for us to provide our views in a definitive manner. Such a review would normally be undertaken only in the context of an advance income tax ruling request.

However, we note that we did address some aspects of this question at a prior conference (2004 STEP Conference). Specifically, we noted that if the beneficiary of the life insurance policy is the partnership and the terms of the partnership agreement provide that the life insurance proceeds received by the partnership are to be paid to a particular corporate partner, subparagraph 53(1)(e)(iii) of the Act would apply to increase the ACB of that partner's interest by the amount of net life insurance proceeds allocated to the partner by the partnership. We also noted that subparagraph 53(2)(c)(v) of the Act would apply to reduce the ACB of the particular corporate partner's interest when the life insurance proceeds are paid to it from the partnership.

With respect to the capital dividend account of a corporate partner, we note that paragraph 7 of Interpretation Bulletin IT-430R3 provides that where an amount to which subparagraph 53(1)(e)(iii) of the Act applies is received by a partnership and allocated to a partner that is a private corporation, the corporation may add the amount so allocated to its capital dividend account as if the corporation had received the amount allocated to it at the time the partnership received it.

You note in your question that a mechanical application of subparagraphs 53(1)(e)(iii) and 53(2)(c)(v) together with the withdrawal from the partnership would seem to result in a capital loss to the exiting corporate partner. You imply that there is no effect to the ACB of the remaining corporate partner, thus seeming to suggest that the tax effect overall is neutral as tax is only deferred. However, it is arguable that such a tax result (if it is correct) may be inappropriate, particularly in the context of large professional partnerships that may never cease to exist.

Additionally, it appears that consideration should be given to the application of the at-risk and negative ACB rules to the corporate partner (footnote 1) and whether the provisions of section 69 or 103 or the GAAR would apply to this type of situation.

Chrys Tzortzis
2011-039842

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Note to reader: The at-risk rules [subsection 96(2.1)] and the negative ACB rules [subsection 40(3.1)] may apply to the corporate partner where the life insurance premiums on the life of its shareholder are paid by the partnership as the value of the life insurance policy may constitute an amount or benefit for the purposes of paragraph 96(2.2)(d) of the Act. It is noted that the carve-out under subparagraph 96(2.2)(d)(iii) for an entitlement that arises as a consequence of the death of the taxpayer would not apply as the taxpayer referred to therein is the corporate partner and not the individual. However, where the life insurance premiums are borne by the respective corporate partner (for example, as a draw), paragraph 96(2.2)(d) would not normally apply.