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The CCRA Responds: Tax Policy Roundtable CALU 2001

June 1, 2001

At the CALU Annual Meeting on May 8, 2001, Brian Darling, Director of the Financial Industries Division of the Tax Rulings and Interpretations Directorate of the Canada Customs and Revenue Agency, responded to questions concerning such issues as SERPs, RCAs, estate freezing, owner-manager remuneration and the taxation of commissions. All statutory references are to the Income Tax Act (Canada) unless otherwise specified.

Table of Contents

Question 1: Estate Freezing After Romkey

A conventional "estate freeze" typically involves a series of transactions whereby the owner of common shares of a company exchanges those shares for fixed value preferred shares. New common shares are then issued to the shareholder's children or perhaps to a trust established for the benefit of the children. The preferred shares would normally be redeemable at the option of the holder for a price equal to the fair market value of the common shares for which they were exchanged. The new common shares would typically be issued for a relatively nominal consideration. The purpose of the transaction would be to fix or "freeze" the value of the shareholder's equity interest in the company at its current fair market value so that any future increase in the value of the company would accrue for the benefit of the shareholder's children.

It is our understanding that, provided certain criteria are satisfied generally regarding the rights and restrictions attached to the preferred "freeze" shares, the Agency will agree that the fair market value of the preferred shares will be equal to their stipulated redemption price. Furthermore, the Agency will also generally agree that the shareholder will not be considered to have transferred property to or otherwise conferred a benefit on the children (or their trust) who subscribe for the new common shares.

In the case of Barry Romkey and Brian Romkey v. Her Majesty the Queen (2000 DTC 6047) the Federal Court of Appeal considered a situation where shares in a family-owned company were issued to trusts for children. (The Supreme Court has since denied leave to appeal.) While the Romkey decision dealt with the application of the income attribution rules, it may also have implications for estate freezing arrangements. In concluding that the income attribution rules were applicable in the Romkeys' situation, the Court stated that by causing shares to be issued to trusts for the children, "the appellants had already effected a transfer of property to their respective children, i.e. divesting themselves of the right to receive a measure of future dividends."

Will the Agency make any changes to its current assessing practices with regard to estate freezes in light of the decision of the Federal Court of Appeal in the Romkey case?

Agency's Response

We do not plan to make any changes to our current assessing practices with respect to estate freezes. More specifically, some practitioners have expressed concern that as a result of the Romkey decision, subsection 74.1(2) might be applied to an estate freeze transaction. It is our view that subsection 74.1(2) will generally not apply to attribute, to a freezor, dividends paid on shares held by a trust for minor children as part of a typical estate freeze, provided that the shares held by the trust are issued for an amount equal to their fair market value and are paid for with funds that are not obtained from the freezor.

CALU Comment: The potential application of the income attribution rules to typical estate freezes was not the only concern raised by the Romkey decision. By concluding that the Romkeys had in effect transferred to their children "the right to receive a measure of future dividends," the Court begs the question as to what is the value of such rights at the time the shares were issued to the children's trusts. By stating that the income attribution rules in subsection 74.1(2) will generally not apply, the Revenue Agency has also said, albeit indirectly, that a typical estate freeze will not be treated as a disposition of property in favour of the children.

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Question 2: Owner-Manager Remuneration

For over 20 years, many Canadian controlled private corporations (CCPCs), have followed a practice of paying salaries and bonuses to shareholder managers in amounts sufficient to reduce the taxable income of the corporation to or below the limits that qualify for the small business deduction. This issue was addressed at the annual conference of the Canadian Tax Foundation in 1981. In answer to question 42 of the Round Table session, it was stated that:

In general, the reasonableness of salaries and bonuses paid to principal shareholder-managers of a corporation would not be challenged when:

  1. the general practice of the corporation is to distribute the profits of the company to its shareholder-managers in the form of bonuses or additional salaries; or
  2. the company has adopted a policy of declaring bonuses to the shareholders to remunerate them for the profits the company has earned that are attributable to special know-how, connections or entrepreneurial skills of the shareholders.

The shares of many private companies are owned by family holding companies. One or more of the family members are typically actively involved in the business in senior management positions. Such individuals, members of their families or trusts established for the benefit of the individuals and/or family members may own the shares of the family holding company.

During 2000, two interpretation letters written by the Income Tax Rulings Directorate (documents 2000-001308 and 2000-001603) have created some uncertainty as to the Agency's position concerning the reasonableness of salaries and bonuses paid by an operating company to principals who are actively engaged in the business where the shares of the company are owned by family holding companies.

Will the Agency outline the criteria that must be met relative to the ownership and management structure of a CCPC before the Agency's position on the reasonableness of salaries and bonuses referred to above will be applied?

Agency's Response

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Question 3: Conversion of Bonus Plan to a SERP

An employer has a bonus compensation plan established for its executive personnel. Under the bonus plan, the executives may be paid additional cash compensation based on a formula and the achievement of specified objectives.

The employer, in consultation with the executives, has decided that the needs of the executives would be better served if the funds otherwise used to fund the bonus plan were used to fund a supplementary executive retirement plan ("SERP"). The SERP would be designed as a defined contribution plan whereby the employer would make annual contributions to a trust established to administer the SERP. The employer would use substantially the same criteria as the existing bonus plan in determining the amount that would be contributed to the SERP on behalf of a particular executive.

Would the SERP be a retirement compensation arrangement ("RCA") or a salary deferral arrangement ("SDA") for purposes of the Act? In making this determination, would the nature of the assets held within the SERP or the type of pension benefits (defined contribution versus defined benefit) be considered relevant?

Agency's Response

The determination of whether a specific arrangement would constitute an RCA or an SDA for purposes of the Act is a question of fact.

The Agency has provided its general comments regarding the conversion of bonus arrangements for shareholder/managers to supplementary retirement plans in its response to Question 2 at the 1998 Conference for Advanced Life Underwriting. The same principles as enunciated for shareholder/managers would also apply for executive personnel.

An SDA is defined in subsection 248(1), and basically it is an arrangement under which a taxpayer has a right to receive an amount that would otherwise be salary or wages after the year and one of the main reasons for this arrangement is to postpone taxes payable on such salary and wages. An RCA is also defined in subsection 248(1), and basically it is an arrangement by which an employer makes payments to a custodian to fund benefits to be received by the employee after retirement. If it is determined that an arrangement meets the definitions of both an RCA and an SDA, we note that, since paragraph (k) of the definition of an RCA specifically excludes an SDA from being an RCA, the arrangement would be treated as an SDA for purposes of the Act.

Where it can be established that a SERP, implemented for the benefit of the executives of a corporation, is not designed to defer the taxation of a right to employment income and the arrangement is designed primarily for the purpose of supplementing the maximum benefits that the executive is allowed to receive on or after retirement under a registered pension plan, the arrangement would be considered a retirement compensation arrangement. In general, a funded and unregistered pension plan will not meet the definition of a salary deferral arrangement but will be considered a retirement compensation arrangement for purposes of the Act.

In the general situation described above, it may be very difficult to support an argument that the arrangement is not designed or intended to postpone the taxes that would otherwise be payable in respect of an employee's salary and wages. The employer and the executives would have considered the tax benefits in deciding to replace the bonus plan with a SERP.

Generally, the determination of whether a SERP would constitute an SDA or an RCA would not depend on whether the SERP was a defined benefit or defined contribution type of pension plan or on the nature of the assets held by the trustee under the SERP.

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Question 4: RCAs and Deemed RCAs

The trustee of an RCA trust may acquire an interest in an insurance policy on the life of a plan participant in connection with the funding of the obligations under the plan. In a recent technical interpretation (file number 2000-0017065), the Agency was asked if an RCA trust that makes withdrawals from a life insurance policy would be required to pay refundable tax on the amount included in its income.

The Agency's response seemed to indicate that in circumstances such as those described above, amounts withdrawn from the policy by the trustee would be considered to have been received directly by the beneficiary and, consequently, the trust would not be liable for the payment of the refundable tax in respect thereof. The Agency also indicated that such amounts might create a refund of refundable tax previously paid by the RCA trust.

In the case of an RCA trust that holds a life insurance policy or in the case of a life insurance policy deemed to be an RCA pursuant to subsection 207.6(2), can the Agency confirm that withdrawals from a life insurance policy will not result in a liability for refundable tax within the meaning assigned by subsection 207.5(1)?

Agency's Response

In our recent technical interpretation, we provided general comments regarding the application of subsection 207.6(2) to an employer's acquisition of a life insurance policy to fund its obligation to provide certain benefits to an employee. The general comments were not intended to apply to an investment in a life insurance policy acquired by an RCA trust.

Where an employer is obliged to provide benefits that are to be received or enjoyed by any person after his or her retirement and an interest in a life insurance policy may reasonably be considered to be acquired by the employer to fund those benefits, the provisions of subsection 207.6(2) will apply to the acquisition of the life insurance policy. The life insurance policy will also be subject to the provisions of paragraphs 207.6(2)(a) to (d). The purpose of subsection 207.6(2) is to treat the employer's acquisition of the interest in the life insurance policy as a retirement compensation arrangement for the purposes of Part XI.3.

A plan or arrangement that qualifies as an RCA under the provisions of subsection 248(1) will not be subject to subsection 207.6(2). This is also the case where the custodian of an RCA acquires an interest in a life insurance policy. Consequently, the income portion of the payments made to the RCA custodian under the life insurance policy will be subject to the refundable tax described in subsection 207.5(1) and the payments to the RCA custodian under the life insurance policy will not qualify as distributions for purposes of the refundable tax.

Where an employer acquires a life insurance policy which is a deemed RCA, the amounts withdrawn under the life insurance policy will be deemed to be an amount received out of or under the RCA by the recipient and the amount will be included in the recipient's income under paragraph 56(1)(x) or 12(1)(n.3). The amounts withdrawn will not be considered as income from property of the deemed RCA, but will qualify as distributions by the deemed RCA for purposes of computing the refundable tax.

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Question 5: Investment Income Tax and RCAs

A special 15% tax under Part XII.3 is payable by life insurers on investment income earned in respect of their taxable life insurance policies. Under paragraph (e) of the definition of "taxable life insurance policy" in subsection 211(1), a life insurance policy that is at that time an RCA is excluded from being considered a taxable life insurance policy for the purposes of Part XII.3.

Will a life insurance policy owned by an RCA trust be exempted from being considered a taxable life insurance policy under paragraph (e) of the definition of "taxable life insurance policy" in subsection 211(1)?

Agency's Response

A life insurance policy owned by an RCA trust is simply property or an investment of the trust, and is not an RCA for purposes of the Act. Thus, the policy will not be excluded from the definition of "taxable life insurance policy" in subsection 211(1).

What is excluded under paragraph (e) is a life insurance policy that is a deemed RCA pursuant to subsection 207.6(2), as discussed in the previous question.

CALU Comment: The wording of the legislation that excludes "a life insurance policy that is at the time a retirement compensation arrangement" from the application of the IIT can best be described as "sloppy." There is no provision in the Income Tax Act that deems a life insurance policy to be an RCA. Pursuant to subsection 207.6(2) a corporate-owned policy may be deemed to be "the subject property of a retirement compensation arrangement" but not an RCA per se.

Although the Agency's stated position that the exclusion from the application of the IIT applies to policies referred to in subsection 207.6(2) seems reasonable, it is not entirely free from doubt. However, it does seem clear that the exclusion does not include a policy that is owned by an RCA trust.

As a practical matter, the question of whether or not the exclusion from the application of the IIT may be moot. Unless the corporate owner is prepared to acknowledge that the policy is subject to the RCA regime and provides the insurance company with adequate supporting documentation, the company will have no way of knowing whether the exclusion is applicable.

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Question 6: Corporate-Owned Insurance and Safe Income

Many private corporations own life and/or disability insurance for a key shareholder(s) to help the corporation fund the purchase or redemption of the key shareholder's shares in the event of his or her death or permanent disability. After the permanent disability or death of a key shareholder, the continuing shareholders of the corporation may wish to sell all or part of their shares in the corporation to new investors. However, to reduce the amount of the capital gain that may otherwise arise on the disposition of their shares of the corporation, the shareholders may cause the corporation to distribute its safe income on hand as a taxable dividend to its corporate shareholders.

Will the Agency outline its general position on the impact of corporate-owned insurance on the calculation of a corporation's safe income on hand, paying particular attention to the impact of the premiums paid, any increases in the policy's cash surrender value and any benefits received by the corporation under the particular insurance policy.

Agency's Response

The expression "income earned or realized by any corporation after 1971" (generally referred to as "safe income") means a corporation's net income for income tax purposes, as adjusted by paragraphs 55(5)(b), (c) or (d), as the case may be. Consequently, an amount received by a corporation will generally only be included in its safe income to the extent it has been included in the determination of its net income for tax purposes. Similarly, an amount which has been deducted in computing a corporation's net income for tax purposes will reduce the corporation's safe income. In addition, it is the Agency's view that safe income will only contribute to a capital gain on a particular share of the capital stock of a corporation where such income is on hand at that particular time (herein referred to as "safe income on hand") and is available for distribution to the particular shareholder as a dividend. Consequently, in computing the amount of safe income on hand that is attributable to a particular share during the relevant holding period it has been our long standing position that the safe income of a corporation should be reduced by the amount of any actual or potential disbursement or outlay arising in the relevant holding period that has not otherwise been deducted in the calculation of the corporation's safe income and which would reduce the gain inherent in the particular shares of the corporation.

It is also the Agency's position that when a particular shareholder's shares in a corporation are redeemed, the safe income entitlement of other shares of the corporation will not be affected provided that the redemption does not reduce the fair market value of the other shares and it is not part of a plan to avoid tax.

Based on these guidelines, our comments on the issues raised are as follows:

Any premiums paid by a corporation under a life or disability insurance policy would not generally represent amounts which are on hand and available to contribute to any unrealized gain inherent in the corporation's shares and, therefore, should be deducted in computing its safe income on hand to the extent that the premiums have not already been deducted in computing the corporation's net income for tax purposes.

Any annual increase in the cash surrender value of a corporate-owned exempt insurance policy will not be included in computing the safe income of the corporation as such amounts are not included in computing the corporation's net income for tax purposes.

Any benefit received by a corporation under the policy, whether in respect of the death or disability of the key shareholder, would not increase the amount of safe income or safe income on hand of the corporation unless the amount of such benefit is otherwise required to be included in the corporation's net income for income tax purposes. As an example, where a payment is made to a corporation that is the beneficiary and owner of an exempt life insurance policy as a consequence of the death of the person whose life was insured under the particular policy such payment would not give rise to a disposition of the corporation's interest in the policy as defined in subsection 148(9). In these circumstances, since no amount of the death benefit would be included in the corporation's net income for income tax purposes, the safe income or safe income on hand of the corporation would not be increased. The corporation may, however, be able to add the excess of the death benefit received over the adjusted cost basis of the life insurance policy, if any, to its "capital dividend account" as that term is defined in subsection 89(1). The payment of a capital dividend by the corporation would not give rise to the application of subsection 55(2).

Where a death benefit received by a corporation has been used to redeem shares held by the deceased shareholder's estate, the aggregate safe income on hand of the corporation would be reduced by the safe income on hand attributable to the shares that have been redeemed. As noted previously, the safe income entitlement of any other shares of the corporation will not generally be affected provided that the share redemption does not reduce the fair market value of those other shares. For greater certainty, where the deemed dividend arising on the share redemption is a capital dividend and it does not exceed the amount of the corporation's capital dividend account immediately before the share redemption, such capital dividend will not reduce the corporation's safe income on hand.

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Question 7: Policy Loans

Pursuant to the terms and conditions of a universal life insurance policy, the policyholder may withdraw monies from the cash surrender value of the policy. The amount of the death benefit otherwise payable under the policy and the cash surrender value of the policy are both reduced by the amount withdrawn. The withdrawal is not referred to as a policy loan in the policy.

Are such withdrawals "policy loans" as that term is defined in subsection 148(9)?

Agency's Response

Even though a withdrawal is not referred to as a "policy loan" in the terms and conditions of the policy it does not mean, in and of itself, that the withdrawal would not be a "policy loan" as that term is defined in subsection 148(9).

The definition of a "policy loan" is very broad and refers to "an amount advanced by an insurer to a policyholder in accordance with the terms and conditions of the life insurance policy". We would therefore need to look at the policy and consider its terms and conditions before we could draw any conclusions. Thus whether or not a particular withdrawal is a policy loan remains a question of fact.

CALU Comment: Whether a withdrawal from a life insurance policy is considered to be a "withdrawal" or a "policy loan" has important tax implications. For example, a withdrawal reduces the death benefit, the accumulating fund and affects the amount of premiums that may be paid into the policy in the future. A withdrawal, or partial withdrawal, is also taxed on a proportional basis, based on the ratio of the accumulating fund to the ACB. A policy loan, on the other hand, does not reduce the accumulating fund or ACB of the policy and is treated as a return of principal first, which may be repaid at any time without impairing the ability to pay future premiums. Because of the significant differences in the tax treatment of policy loans and partial withdrawals, the lack of a definitive position from the Revenue Agency is problematic. CALU will continue efforts to have the Revenue Agency clarify its position.

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Question 8: Tax treatment of commissions earned by an individual but payable to a corporation controlled by the individual

In the past, the Agency has been asked about the appropriate tax treatment of mutual fund commissions paid to a corporation where the controlling shareholder must be the registered salesperson in the particular jurisdiction. In an interpretation letter in January 2000 (document 1999-0005178) the Agency stated:

"Where the legislation of such a jurisdiction precludes a corporation from being registered as a salesperson, the assignment of commissions earned by a registered individual salesperson to that individual's corporation will not preclude the individual from being taxed on the commissions earned".

A recent Tax Court of Canada case has reached a different conclusion. In the cases of Jerome Wallsten (1999-5116(IT)I) and Lakeside Properties Ltd. (1999-5117(IT)I) vs. the Queen, the Court ruled in favour of the taxpayer. In those cases, the Appellant was a life insurance agent, licensed with Sun Life of Canada. Mr. Wallsten was a shareholder, director and employee of Lakeside. His wife and children owned the other issued and outstanding shares.

Prior to 1996, Mr. Wallsten was an employee of Sun Life. Effective Jan. 1, 1996, Mr. Wallsten entered into a written contract with Sun Life under which he agreed to sell products of that company while being free to carry on other business activities by also representing other insurance companies. Even though Sun Life would not issue a license in a limited company's name, Mr. Wallsten wished to have all insurance income in Lakeside and be paid a salary by Lakeside, like any other employee. To obtain this result Mr. Wallsten deposited all cheques payable to him from Sun Life in Lakeside's bank account.

The Agency regarded all the income and expenses as that of Mr. Wallsten and reassessed him accordingly.

In the submission of the Counsel for the Appellants, it was noted that Mr. Wallsten could have received and retained the commissions and Lakeside could have charged him a management fee for an equal amount and the result would have been the same. Perhaps the more compelling argument, however, was a reference to Her Majesty the Queen vs. Dr. H. Hoyle Campbell, 80 DTC 6239, a Supreme Court of Canada decision.

Dr. Campbell incorporated a company to operate a private hospital. He owned all the shares of the company, it employed him and paid him a salary and, in return, he paid to the company all the fees for medical services that he received from the Provincial Health Insurance Plan. While the facts indicated that fees under the provincial health plan were required to be paid to the doctor, the Court found that this was not the controlling factor when there was a valid arrangement between Dr. Campbell and the company regarding the salary to Dr. Campbell and an accounting of fees to the company as employer. It was decided that the income from the professional services provided by Dr. Campbell was the income of the company.

Consistent with the reasoning of the Supreme Court of Canada in the Campbell decision, the Tax Court found that the "fact that the agreement between them was in violation of Wallsten's contract with Sun Life does not affect tax liability". [emphasis added] The Tax Court thus decided that the appeals should be allowed.

In light of the Wallsten and Campbell decisions, will the Agency reconsider its position in circumstances where commissions in respect of the sale of insurance and mutual fund products are paid to an individual and then assigned to a corporation pursuant to a valid business arrangement between the individual and the corporation?

Agency's Response

CALU Comment:

CALU has provided the Revenue Agency with information about the formation of the MFDA and the three-year deferral in the application of MFDA rule 2.4.1, which would require commissions only to be paid in the name of the registered representative. Alberta and British Columbia have announced that they will not support this three-year transitional provision, but the other provinces (with the exception of Québec, which has its own securities regime) have accepted the transitional provision. The Revenue Agency has indicated that it will take this new information into consideration in reviewing its position. CALU will continue to monitor this issue.

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Question 9: Long-term Care Insurance

An increasing number of insurance companies are offering long-term care ("LTC") insurance in Canada. LTC insurance coverage is provided for both care in a long-term care facility (e.g., licensed convalescent, custodial, nursing or retirement homes providing continuous nursing services) and medically necessary services performed by qualified medical practitioners in the home of the person who is insured.

The specific features, terms and conditions of policies issued by different companies may vary. However, for purposes of the questions posed below we will assume that, unless otherwise noted, the policy is a stand-alone individual contract, the key provisions of which are:

  1. A per diem benefit of the amount specified in the policy (e.g., $100 per day) will be paid for each day that the person who is insured is a resident in a LTC facility, provided that the residency is medically necessary and is based on the recommendation of a physician.
  2. The cost of reasonable daily expenses incurred for home care services will be reimbursed up to a specified per diem maximum (e.g., $100 per day). The home care benefit will be paid provided that the services are:
    • medically necessary, based on the recommendation of a physician, and
    • the proper treatment of the condition would necessitate care in a hospital or LTC facility in the absence of the home care program.
  3. The benefits are payable to the insured or to such other beneficiary as is designated by the owner of the policy.
  4. The policy owner is required to pay level annual premiums for a maximum period of 20 years.
  5. In the event that an insured dies without making a claim under the policy, the insurer will pay a death benefit to the beneficiary designated by the policy owner of an amount equal to all premiums previously paid under the policy.
  6. Except as described in 5 above, the policyowner is not entitled to receive any amount upon the surrender, cancellation or other termination of the policy.
  7. Will all or any portion of the premiums paid for LTC insurance as described above qualify as medical expenses eligible for the medical expense tax credit where the person who is insured is: the owner of the policy, the spouse or other family member of the policy owner, or another individual?
  8. Where an amount is paid as a benefit pursuant to the LTC plan described above is used by the individual to pay qualified medical expenses, will the expenses still be eligible for the medical expense tax credit?

Agency's Response

A. Deductibility of Premiums Paid under LTC Plan as "medical expenses"

Two criteria must be satisfied in order for a payment for coverage under a LTC Plan to qualify as a medical expense under paragraph 118.2(2)(q).

First, the amount must be paid as a premium, contribution or other consideration to a private health services plan ("PHSP"), which is defined in subsection 248(1). Paragraph 4 of IT-339R2, Meaning of "Private Health Services Plan", explains that the coverage must be for hospital care or expense or medical care or expense which normally would otherwise have qualified as a medical expense under the Act in order for a plan to be a PHSP. Medical expenses - for the purposes of the medical expense credit - are described in subsection 118.2(2). Paragraphs 19 to 66 of IT-519R2, Medical Expense and Disability Tax Credits and Attendant Care Expense Deduction, set out the Department's general position regarding the expenses that qualify as medical expenses. For example, a plan that provides death benefits will not be a PHSP.

The second criteria is that the premiums must be paid for coverage of particular persons, namely, one or more of the individual, the individual's spouse, and any member of the individual's household with whom the individual is connected by blood relationship, marriage or adoption (except to the extent that the payment is deducted under subsection 20.01(1)). A plan would not be a PHSP where benefits may be paid to a person who is not one of the above persons. Thus, the provision of a death benefit to a designated beneficiary as described in the question would clearly disqualify the plan from being a PHSP.

B. Deductibility of Expenses where LTC Benefits Paid

Paragraph 118.2(3)(b) provides that qualifying medical expenses of an individual do not include any expense for which the individual or his or her spouse or dependant (as defined in the Act), or the legal representative of either such person has been, or is entitled to be, reimbursed except to the extent that the amount is required to be included in income and cannot be deducted in computing taxable income.

Therefore an amount paid by an individual will not be deductible as a medical expense to the extent that coverage for that expense is available under a LTC.

CALU Comment: Because LTC insurance is relatively new in the Canadian market, there is considerable uncertainty about the appropriate tax treatment of various aspects of the product and related applications. The fact that an addition of a "premium refund" provision either as an integral provision of, or a rider to, a LTC policy will exclude the premiums from qualification for the medical expense tax credit is only one example of these issues.

Other issues such as whether the annual accrual rules might apply to LTC policies when premiums are payable over a period that is shorter than the term of the coverage require clarification. CALU will continue to consult with members on these issues and request interpretations from the CCRA where necessary.

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Question 10: Critical Illness and Split-Dollar Insurance

How do we obtain the Agency's views with respect to the following arrangements:

  1. Critical illness insurance products are now widely available in the Canadian market. Insurance coverage for critical illness may be provided under individual "stand-alone" policies, as an additional benefit under a universal life insurance policy or as part of a group benefit plan offered by an employer.
  2. Under a split-dollar arrangement an employee acquires a life insurance policy and the employee enters into an agreement with his orher employer to allocate the death benefit between the employer and the estate of the employee. The premiums under the policy are to be paid by the employee and the employer will reimburse a portion of the premiums with reference to the premiums the employer would have to pay to obtain comparable coverage on the life of the employee.

Agency's Response

The Agency has not had the opportunity to review the details of a particular critical illness insurance or a specific split dollar insurance arrangement. Written confirmation of the tax implications inherent in particular situations are given by our Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request. We, therefore, welcome your industry to provide us with specific critical illness insurance and split dollar insurance arrangements such that we would be in a position to examine the specific issues or concerns which may be raised. Normally, under this process we require that a prospective individual be signed up before we can proceed with our review of an advance income tax ruling request. However, in the context of these arrangements we would also consider a request with a draft policy with expected terms and conditions before the signing up of a particular policyholder. You would be advised of our views with respect to the specific tax issues identified in the ruling request and if you determine that you wish to proceed with a ruling it would be necessary at that time to provide for a specific policyholder and the final terms and conditions of the proposed policy. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. You should submit all relevant facts and documentation to the appropriate Tax Services office for their views. We would be available to provide assistance to the particular Tax Services Office in their review.

With regard to split dollar insurance arrangements we have identified information that we would require as well as some of the specific concerns that would need to be addressed.

All of the relevant terms and conditions of the particular life insurance policy would have to be provided including the death benefit; the cash surrender value or the accumulation within the policy, if any; the premiums to be paid under the policy; the age and health condition of the individual to be insured under the policy. We also require a copy of any side agreement, which is to be entered into between the employer, the employee and/or the insurance company, and any other related documentation.

It will be necessary to establish whether each of the employer and employee have an interest in the policy. This is relevant in determining not only the nature and income tax treatment of payments made by each of the parties but the nature and income tax treatment of the payments received by each of the parties.

We would need to know how the amount of the premium, which is to be reimbursed by the employer to the employee is arrived at. We would also require evidence of the amount of the premium that the employee would be required to pay if he/she was to obtain coverage comparable to that retained by him/her.

We are assuming the reason for entering into this arrangement is a cost reduction from what would be the total premium if two separate policies were acquired. We would require evidence of how this saving will be determined and how it will be shared between the two parties.

CALU Comment: The Agency's response with respect to the critical illness and split-dollar insurance questions should not be surprising. There are a number of variations of both products in the market place and it would be very difficult for the Revenue Agency to provide some form of general guidance on the taxation of these products without a detailed review of the policy particulars.

However, the Agency has suggested an approach that would be helpful in resolving many of the unanswered questions concerning both critical illness and split-dollar applications. CALU will seek cooperation from companies that offer these products and other industry groups in formulating requests for comprehensive technical interpretations in a format that will be acceptable to the Agency.

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