25 June 2004 External T.I. 2003-0042861E5 - Last-to-Die Life Insurance Policies

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: We are asked whether a disposition of an interest in a life insurance policy occurs in each of five arrangements involving universal life policies.

Position: The payment described in the first arrangement probably does not constitute a disposition as defined in subsection 148(9) of the Act. The terms and conditions of the particular polices would be relevant in determining whether or not dispositions result in any of the remaining arrangements.

Reasons: A "disposition" defined in subsection 148(9) excludes payments made as a consequence of the death of a person whose life is insured under the policy. The factual circumstances including the terms and conditions of the particular policy determine whether a particular payment is made as a consequence of a person's death.

XXXXXXXXXX 					2003-004286
R. Maley
June 25, 2004

Dear XXXXXXXXXX:

This is in reply to your letter of October 8, 2003 requesting our comments on five hypothetical insurance arrangements, each involving a universal life (UL) policy insuring two or more lives.

In the first arrangement, an amount becomes payable when the first insured dies and the amount is so paid to the stipulated beneficiaries. In the second, third and fourth arrangements, the policyholders have discretion whether or not a death benefit will be paid, in whole or in part, when a life insured under the policy dies. In each of these arrangements, you ask whether payments made when the first life insured dies would result in a disposition of an interest in the policy for purposes of subsection 148(9) of the Income Tax Act ("the Act"). We are assuming from the description of these arrangements that the persons whose lives are insured in each arrangement are also the named beneficiaries under the arrangements. We also assume that the policyholder(s) in each arrangement would be one or more of those persons.

In the fifth arrangement, a policy with last-to-die coverage is amended to add first-to-die coverage. You ask whether the amendment to the policy would result in a disposition of an interest in the policy for purposes of subsection 148(9) of the Act.

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an Advance Income Tax Ruling request. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to provide the following comments.

A "disposition" of an interest in a life insurance policy is defined in subsection 148(9) of the Act. Paragraph (j) of this definition clarifies that a disposition does not include a payment under an exempt life insurance policy (other than an annuity contract) last acquired after December 2, 1982 made as a consequence of the death of a person whose life was insured under the contract. For purposes of this opinion we will assume that the hypothetical arrangements all involve policies last acquired after December 2, 1982 that are exempt policies for purposes of the Act.

In our view, the factual circumstances at the time of a payment and in particular, the terms and conditions of the life insurance policy, would indicate whether or not the payment was made "as a consequence of the death of any person whose life was insured under the policy". UL policies, by their nature, are designed and intended to be flexible, with terms and provisions that can vary markedly to meet the requirements of the policyholders.

It seems to us that the payment made in the first arrangement is unlikely to result in a disposition of any interest in the policy as it would likely be made as a consequence of the death of a life that is insured under the policy. The second, third and fourth arrangements, however, all involve policyholder discretion as to whether a death benefit will be paid in the event that a life insured under the policy dies and there is a surviving life insured under the policy. It is not clear to us that such payments would necessarily be viewed as made as a consequence of the death of the life insured.

Certain characteristics common to universal life policies may complicate this question, in our view. The flexibility built into such a policy may well include broad access to the policy's funding. For example, the hypothetical policies may (or may not) otherwise accord the policyholders discretion to receive payments against their account value prior to the death of the life insured(s). Withdrawals and policy loans are dispositions of an interest in a life insurance policy pursuant to subsection 148(9) of the Act. Thus, the terms and conditions under a policy pertaining to withdrawals and policy loans may be relevant in assessing whether a payment is made as a consequence of the death of the first-to-die under the particular policy. It seems to us that a policyholder entitled to receive payments on request prior to the death of a life insured would not be viewed as receiving such payments as a consequence of the death of a life insured under the policy merely because the payments are requested after the death of a life insured. We believe that this may be an issue in circumstances where the policyholders are also the beneficiaries under a UL policy.

The fifth arrangement poses a different issue than the first four. A disposition of an interest in a life insurance policy is defined to include a surrender of an interest in the policy. A material change to a life insurance contract that results in a new contract at law generally results, for tax purposes, in a surrender of the policyholder(s)'s interest in the original contract and the acquisition of an interest in the new contract. Subsection 148(10) of the Act provides that a policyholder shall not be deemed to have disposed of or acquired an interest in a life insurance policy as a result only of the exercise of any provision of the policy other than the conversion of the policy into an annuity contract. We assume for the purposes of this opinion that subsection 148(10) does not apply in respect of the amendment proposed in the fifth arrangement.

It is a question of fact and law whether particular changes made to a life insurance policy are so fundamental as to result in a disposition of the policyholder(s)'s interest in the policy. Such a determination can only be made on a case by case basis and the Canada Revenue Agency (CRA) has no general guidelines as such. Thus, it is unclear whether a disposition would result from the changes proposed in the fifth arrangement.

While the foregoing comments are not binding on the CRA, we trust that they assist.

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