15 January 2003 Internal T.I. 2002-0168217 - LCT LIFE INSURANCE RESERVES

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

1. Whether for the purposes of 181.3(1)(c)(ii)(B)(II) and (III) the comparison of book reserves to the reserves claimed under 20(7)(c) and 138(3)(a)(i) is to be made on a line by line basis or a global basis.

2. Whether the capital of a resident life insurance corporation may be reduced as a result of the inclusion of a negative amount obtained as a result of the calculation prescribed in 181.3(1)(c)(ii)(B).

3. In situations where tax reserves exceed book reserves, should taxable capital be reduced as a result of the deduction of policy loans provided for in 181.3(1)(c)(ii)(B)(IV).

Position:

1. Global basis.

2. No.

3. In the situation where the tax reserves exceed book reserves to the extent that the total determined under subclause (III) is reduced because of the limitation internal to subclause (III), which limits the amount to the amount included by virtue of subclause (I), it is our view that the policy loans would not be deducted in computing the total determined under subclause (III).

Reasons:

1. Legislation.

2. Legislation.

3. Legislation

January 15, 2003

TORONTO EAST TSO					HEADQUARTERS
Soon Yee							Income Tax Rulings
Industry Specialist						  Directorate
K. Cooper, LL. B.
(613) 957-8984

								2002-016821
Part I.3 - Life Insurance Reserves

We are writing in response to your e-mail of October 15, 2002 requesting our comments with respect to the interpretation of clause 181.3(1)(c)(ii)(B) of the Income Tax Act (the "Act"), in particular the interaction between sub-clauses (I) and (III) and (IV). All references to statute in this memorandum are to the Act.

The first issue you asked us to discuss is whether for the purposes of subclauses 181.3(1)(c)(ii)(B)(II) and (III) the comparison of book reserves to the reserves claimed under paragraph 20(7)(c) and subparagraph 138(3)(a)(i) is to be made on a line by line basis or a global basis. In our view, the comparison is to be made on a global basis as the language in both provisions requires that the amounts calculated under the relevant Income Tax Regulations (the "Regulations") constitute a single reserve. Subclause 181.3(1)(c)(ii)(B)(III) which refers to multiple reserves under subparagraph 138(3)(a)(i) could have been amended to better reflect the amendment to subparagraph 138(3)(a)(i), but failure to do so does not allow for an argument that a line by line comparison can be made with respect to the various amounts calculated under section 1401 of the Regulations.

The second issue discussed is whether the capital of a resident life insurance corporation may be reduced as a result of the inclusion of a negative amount obtained as a result of the calculation prescribed in clause 181.3(1)(c)(ii)(B). In essence, the amount to be included in capital is the amount, if any, by which the amount of (I) the insurance corporation's reserves (statement/book reserves) for the year (other than segregated fund reserves and only in respect of its insurance business carried on in Canada) exceeds the total of (II) reserves other than life insurance tax reserves (ie. 138(3)(a)(i)), (III) tax reserves, and (IV) policy loans which have been deducted in determining (III). In our view, the opening language in clause 181.3(1)(c)(ii)(B), which states "the amount, if any, by which", prohibits the inclusion of a negative amount because the clause provides that the amount, if any, by which (I) exceeds the sum of (II), (III), and (IV) is included in the capital of a resident life insurance corporation and that if there is no excess, that is the calculation produces a negative amount, the inclusion is zero.

Your third concern is that in situations where tax reserves exceed book reserves an unwarranted reduction in taxable capital may occur as a result of the deduction of policy loans provided for in subclause 181.3(1)(c)(ii)(B)(IV) of the Act. On this issue, we note that while the language in subclauses 181.3(1)(c)(ii)(B)(II) and (III) provide a limitation on the amount deducted pursuant to both subclauses based on the amount included in subclause (I), the deduction in subclause (IV) is not directly limited to the amount included in subclause (I). Rather the determination of whether the taxpayer is entitled to a deduction from the calculation of taxable capital pursuant to subclause 181.3(1)(c)(B)(ii)(IV) for policy loans is based on the extent to which they were deducted in computing the amount under subclause 181.3(1)(c)(B)(ii)(III).

It could be argued that the policy loans have been deducted in computing the amount deductible under subclause (III) since the amounts in respect of tax reserves included in subclause (III) must be net of policy loans by virtue of the calculation required in paragraph 1401(1)(c) of the Regulations and that the entire amount is therefore deductible pursuant to subclause (IV). In our view, such an interpretation of subclause (IV) would render meaningless the words at the end of the subclause "to the extent that it [policy loan] was deducted in computing the total determined under subclause (III)" because in every case the full amount of outstanding policy loans will have been deducted in the calculation of tax reserves by virtue of paragraph 1401(1)(c) of the Regulations. We believe that the closing words in subclause (IV) refer to the situation where the taxpayer is not entitled to claim an amount in subclause (III) equal to the amount included in the amount determined under subclause (I) by virtue of the deduction of policy loans. It is only in such a situation that it can be said that the policy loan reduced the total amount which would otherwise be included by virtue of subclause (III) and was therefore "deducted in computing the total determined under subclause (III)." In the situation where the tax reserves exceed book reserves to the extent that the total determined under subclause (III) is reduced because of the limitation internal to subclause (III), which limits the amount to the amount included by virtue of subclause (I), it is our view that the policy loans would not be deducted in computing the total determined under subclause (III). We have included some very simplified examples in an appendix to this memorandum to illustrate the suggested calculations.

We trust that these comments are helpful. If you have any questions, or wish to discuss these issues in further detail, please do not hesitate to contact Karen Cooper (613-957-8984) or myself directly.

F. Lee Workman
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch

APPENDIX

Assumptions:					Book Reserve		Tax Reserve

Doubtful accounts				500			400
Life insurance					700			900*

* Net of policy loans of $50

Situation #1: Taxpayers' calculation under 181.3(1)(c)(ii)(B)
Situation #2: Suggested calculation under 181.3(1)(c)(ii)(B)

Situation #1		Situation #2
Subclause 181.3(1)(c)(ii)(B)		

(I) Book reserves
non-life		500			500
life			700			700
1200		          1200

(II) Tax reserves to the extent
included in (I)				400			400

(III) Tax reserves to the extent
included in (I)				700			700

(IV) Policy loans to the extent deducted
in computing total in (III)*		 50			   0

Total of (II), (III), and (IV)	   	          1150		          1100

Capital under (B)				 50			100

* MTAR before deduction of policy loans	950
Amount included in book reserve		700
Policy loan				  50
Amount determined under (III)		700

Clearly the amount determined under subparagraph 138(3)(a)(i) is to be determined net of policy loans and therefore is 900. However, the amount determined under (III) is 700 and this amount has not been reduced as a consequence of the policy loan. In other words, the amount under (III) would be 700 whether or not there were any policy loans outstanding. By contrast, if the MTAR before policy loans had been 700, the amount determined under (II) would have been 650. Since the amount that would have been determined under (III) but for the policy loans would have been 700 the policy loans of 50 would be included under (IV). Finally, if the MTAR before policy loans had been 725, the amount determined under (II) would have been 675. In this case, the amount of policy loans to be included under (IV) would be 25.