19 September 2001 Ministerial Correspondence 2001-0091864 - INSURANCE POLICYHOLDER TAXATION

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 Department.

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

Principal Issues: Questions raised respecting the taxation of amounts paid to policyholder on endowment of policy.

Position: Submission is brief and not entirely clear as to issues. Reply provides general comments on the taxation of accrued savings in insurance policies, the tax treatment of policy dividends and the computation of a policy's cost base.

Reasons: Comments are based on section 148 of Act. Specific concerns as to amounts reported to policyholder must be referred to insurer. Concerns respecting scheme of Act must be referred to Department of Finance.

Signed on September 19, 2001

XXXXXXXXXX

Dear XXXXXXXXXX:

The Honourable Martin Cauchon, Minister of National Revenue, has asked me to reply to a letter of June 27, 2001, written on your behalf by your Member of Parliament, XXXXXXXXXX, concerning the taxation of insurance policies.

The tax treatment of an insurance policy depends upon the specific terms and conditions of the particular insurance contract. In general, policyholders who are entitled to a payment, other than a death benefit, are taxable on that payment upon termination of their insurance, to the extent that it exceeds amounts paid into the policy or that have otherwise been taxed to them.

The letter from XXXXXXXXXX indicates that you are approaching the age of 65, at which time your insurance policies will expire. We assume that your policy is an endowment policy and that you will be paid an amount by the insurance company equal to the amounts you have paid into the policy plus an amount in respect of investment income generated in the policy during the period it was outstanding. You may receive this amount as a lump sum, or in the form of an annuity, depending upon the terms of your agreement with the insurance company.

Under the Income Tax Act, the savings accumulated in an insurance policy are generally taxable unless the policy is exempt and they are paid as part of a death benefit to a named beneficiary. In broad terms, an exempt policy is a policy that is primarily designed to fund a death benefit, rather than one designed to be an investment and savings vehicle.

Even if a policy is exempt, the accumulated savings are taxable to the policyholder if it is disposed of prior to the death of the insured. The amount taxable is the difference between the value of the policy at the time of disposition and the amount of the policy's cost base for tax purposes. When a policy is not exempt, the investment income realized is generally taxable on an accrual or annual basis. The amount of income accrued each year is added to the cost of the policy for tax purposes, ensuring that the income is not taxed again when the policy matures or is disposed of. Non-exempt policies are not subject to annual accrual taxation if they were issued prior to December 2, 1982. Policies issued prior to that date are known as grandfathered policies and are taxable on disposition in the same manner as exempt policies that are disposed of prior to death.

Your letter suggests that you are entitled to policy dividends that were not distributed to you but reinvested in the policy to accumulate further investment savings. However, it is difficult to know what the contractual arrangements were between you and the insurance company in this respect.

The entitlement to a policy dividend is considered to be a partial disposition of an interest in the policy for tax purposes. The cost of the policyholder's interest for tax purposes is reduced by the amount of the dividend entitlement. If the policyholder's entitlement to dividends exceeds the cost of the policy, the policyholder will have an income inclusion in the year to the extent of the excess.

When a policy dividend is used to offset a premium obligation, the treatment is different. When a premium is paid from after-tax income, the policyholder's cost base in the policy is increased by the amount of the premium, ensuring that the premium is not taxed upon disposition of the policy. When the premium is paid with a policy dividend, the increase to the policy's cost that would otherwise result from the premium payment is offset by the decrease resulting from the payment of the policy dividend, resulting in no change to its cost.

If you funded your premiums with after-tax dollars, you will not be taxed on the disposition of your policy to the extent your proceeds represent a return of those premiums. However, you will be taxed on any amounts that have accumulated in your policy that were not previously subject to accrual taxation and the amount of any premiums that were funded by policy dividends. Your insurance company has the responsibility to report the portion of the payment that is subject to tax. You should contact the insurer if you have any further questions concerning the amounts in respect of the policy's cost and value.

We appreciate that the taxation of insurance products can be complex due to the wide variety of products available in the marketplace, many of which are structured to meet individual preferences and needs.

The Department of Finance is responsible for matters of tax policy and may be able to provide further information. Should you have any questions or concerns about the current regime for taxing insurance products, I invite you to contact Mr. Stephen Richardson, Associate Deputy Minister for the Tax Policy Branch at the Department of Finance, 140 O'Connor Street, 16th Floor, East Tower K1A 0G5.

I appreciate the opportunity to address your concerns.

						Yours sincerely,

						Bill McCloskey
						Assistant Commissioner
						Policy and Legislation Branch

Robin Maley 957-9226 July 18, 2001