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At the CALU Annual Meeting on May 4, 2004, Mickey Sarazin, Acting Director of the Financial Industries Division of the Income Tax Rulings Directorate of the Canada Revenue Agency (CRA), responded to various questions and technical issues of current concern. The following are the questions and the Agency's position on such issues as transfer of a life insurance policy, gift of a life insurance policy to charity, corporate-owned life insurance, and borrowing to acquire common shares. For some questions, CALU has provided a note of clarification or comment concerning the official responses. CALU thanks William R. Holmes, Partner, Thorsteinssons, CALU's Tax Advisor, for his participation in the CRA Roundtable. All statutory references are to the Income Tax Act (Canada) unless otherwise specified.
Table of Contents
If a life insurance policy is denominated in a currency other than the Canadian dollar, there are two different views as to how the exempt policy test is to be applied to the policy. One view is that the rules (in sections 306 and 307 of the Income Tax Regulations) for determining if a policy is an exempt policy should be applied using the currency of the policy. The alternative view is that all amounts should be determined in Canadian dollars for the purposes of these rules, based on exchange rates at the relevant time. For example, the face amount of the first exempt test policy would be determined in Canadian dollars using the exchange rate at the time the policy is issued. In applying the rule that deems further exempt test policies to be issued if the face amount of the policy increases by more than 8% between policy anniversaries, the face amount of the policy would be translated to Canadian dollars using the exchange rate on each policy anniversary.
The use of the foreign currency seems more consistent with the policy of the rules, which is to compare the magnitude of the savings component of a life insurance policy to the protection on death that it provides. If the Canadian dollar is used, a policy could cease to be an exempt policy because of fluctuations in the exchange rate, a factor which has nothing to do with the relative magnitude of the savings and death protection components of the policy.
(a) In the Agency's view, which currency is to be used in determining if a life insurance policy is an exempt policy - the Canadian dollar or the currency in which the policy is denominated?
(b) If the Canadian dollar is to be used, is a current exchange rate to be used on each policy anniversary in determining amounts (death benefit, accumulating fund) in respect of the policy?
(a) In the Agency's view, the Canadian dollar is to be used in determining whether an insurance policy is an exempt policy. As was stated by the Federal Court of Appeal in the case of Gaynor v. The Queen (91 DTC 5288), in determining the value of amounts denominated in a foreign currency, the amounts "must be valued in Canadian currency which is the only monetary standard of value known to Canadian law."
(b) Based on the principles set out in Gaynor v. The Queen, it is our view the components of the computations in sections 306 and 307 of the Regulations, which are denominated in a foreign currency, should be converted to Canadian dollars using the exchange rate at the relevant times. For example, the death benefit at the date the policy is issued should be converted to Canadian dollars using the exchange rate at the date the policy is issued and the death benefit at the first policy anniversary date should be converted to Canadian dollars using the exchange rate on the first policy anniversary date. The result is that foreign currency fluctuations are factored into the computations which determine whether a policy is an exempt policy at any particular time.
A recent section 173 referral to the Tax Court of Canada, in the case of Imperial Oil Ltd v. The Queen (2004 TCC 207), dealt with the issue of computing amounts for purposes of the Income Tax Act in circumstances where the components of the computation are denominated in a foreign currency. Both the taxpayer and The Queen made arguments which were based on the principles in Gaynor v. The Queen, which were rejected by the court. The decision of the Tax Court is under appeal to the Federal Court of Appeal. Once this case had made its way through the courts, we will consider whether a change in our responses above is warranted.
The purpose of the exempt test policy rules is to place limitations on the investment growth in a policy and thereby restrict tax deferral to policies considered to have insurance protection as their main purpose. In our opinion, foreign currency gains and losses should be factored into that growth.
CALU Comment: There may be practical difficulties in establishing that a foreign-issued life insurance policy with a savings component is an exempt policy. In many cases, the policyholder will not have sufficient information for this purpose. The CRA noted this difficulty in a letter dated June 28, 1999 (Document No. 9917195), which expressed the view that generally policyholders will not be able to demonstrate that policies issued outside Canada are exempt policies. A policyholder who cannot do this will also not have sufficient information to determine income under the accrual rules, with the result that the proposed mark-to-market rules may apply.
CALU Report June 2004
The legislative proposals for the taxation of non-resident trusts and foreign investment entities that were tabled in the House of Commons on Oct. 30, 2003, as a Notice of Ways and Means Motion include rules specifically applicable to foreign-issued insurance policies. If a policy is subject to these rules, the holder is required to apply the mark-to-market regime in determining income from the policy.
Certain insurance policies are excluded from these rules. By virtue of subparagraph 94.2(11)(c)(iii) of the proposed legislation, a life insurance policy is excluded for a particular taxation year if the holder can establish to the CRA's satisfaction that the holder has included the amount, if any, required by section 12.2 in computing the taxpayer's income for the year. Where a taxpayer holds an interest in a foreign-issued annuity contract that is a prescribed annuity contract, the accrual rules in section 12.2 do not apply to the annuity contract. Thus, no amount is required by section 12.2 to be included in the taxpayer's income.
If a taxpayer can establish that a foreign-issued annuity contract is a prescribed annuity contract, and hence that the amount required by section 12.2 to be included in the taxpayer's income in respect of the contract is nil, does the Agency agree that the contract is excluded from the mark-to-market rules?
We do not agree. There is no basis to argue that an amount equal to nil is included in the taxpayer's income under section 12.2 of the Act since this section does not apply with respect to prescribed annuity contracts. A foreign issued annuity contract, that is not a prescribed annuity contract, may be excluded from the mark-to-market rules under subparagraph 94.2(11)(c)(iii) of the proposed legislation, if the taxpayer can establish to the satisfaction of the Minister, that an amount has been included in the taxpayer's income under section 12.2 of the Act.
CALU Comment: The market value of a foreign currency annuity contract, determined in Canadian dollars, could vary substantially from one year to the next because of changes in interest and exchange rates. Thus, there could be large fluctuations from year to year in the amount required to be included in the holder's income under the mark-to-market rules, and in some years the holder could have a deductible loss.
One of the conditions for an annuity contract to be a prescribed annuity contract is that generally the annuity payments must be equal periodic payments. Given the CRA's answer to question 1, they may interpret this condition to apply to the Canadian dollar equivalent of the payments, in which case no foreign currency annuity could qualify as a prescribed annuity contract.
CALU Report, June 2004
Subsection 148(8) provides rollover treatment when a policyholder transfers a life insurance policy to a child of the policyholder for no consideration if a child of the policy or of the transferee is the life insured.
Consider the following scenario: A father owns a life insurance policy under which both his son and daughter-in-law (who is considered a child under the extended definition of child in subsection 252(1)) are the lives insured. The son's son is named as beneficiary. The father transfers ownership of the policy to his son for no consideration.
It is unclear whether subsection 148(8) applies to the transfer. Paragraph 148(8)(b) requires that "a child of the policyholder or a child of the transferee is the person whose life is insured under the policy." (emphasis added) This can be interpreted to limit the rollover to situations where only one life is insured under the policy. On the other hand, the position can be taken based on the Interpretation Act that there can be more than one life insured, as long as each life is a child of the policyholder or the transferee. Subsection 33(2) of the Interpretation Act provides that in construing every enactment "[w]ords in the singular include the plural, and words in the plural include the singular."
Does the Agency agree that subsection 148(8) applies to the transfer in this example?
It is the Agency's view that subsection 148(8) would not apply to the transfer in this example. As is noted in the question, subsection 33(2) of the Interpretation Act provides that in construing every enactment "[w]ords in the singular include the plural, and words in the plural include the singular." Subsection 3(1) of the Interpretation Act, however, provides that the provisions of the Interpretation Act apply to all other federal enactments "unless a contrary intention appears".
Subsection 148(7) of the Income Tax Act provides that as a general rule, transfers of life insurance policies to non-arm's length persons are taxable dispositions at the value of the policy (as defined in subsection 148(9)). Subsections 148(8) to (8.2), provide for transfers at the adjusted cost basis of a life insurance policy in specific non-arm's length circumstances. Since subsection 148(8) is, in our view, intended to provide an exception to the general rule, it would be contrary to the intention of the provision to apply subsection 33(2) of the Interpretation Act, in order to expand the exception to the general rule.
This position is consistent with our response to Question 1 at the 2000 CALU Conference Roundtable. That question dealt with the interpretation of the phrase "the person whose life was insured" in subsection 70(5.3) of the Income Tax Act in the context of a multiple-life policy. Our response was that the wording in subsection 70(5.3) contemplates that there can only be one life insured under the policy.
The Department of Finance confirmed that at the time subsections 70(5.3) and 148(8) were enacted there was no tax policy intention to have the provisions apply to life insurance policies under which more than one life is insured. It is our view that a legislative amendment would be required to provide for the application of subsection 148(8) to multiple life policies. A request for such amendment would need to be made to the Department of Finance.
CALU Report, June 2004
Subsection 118.1(5.2) applies where a registered charity is named as a beneficiary of a life insurance policy and the requirements in subsection 118.1(5.1) are met. It deems the death benefit paid to the charity to be a gift made by the life insured immediately before death. One of the requirements in subsection 118.1(5.1) is that, immediately before the individual's death, the individual's consent would have been required to change the recipient of the death benefit. At the 2003 CALU Annual Meeting, in response to Question 8: Charitable Donations of Life Insurance Policies, the CRA stated that this requirement is not met when a charity is named as an irrevocable beneficiary under a life insurance policy. Consequently, subsection 118(5.2) will not apply to deem the death benefit in this case to be a gift to the charity.
Has the CRA reconsidered its position regarding gifts of life insurance proceeds where a charity is named as an irrevocable beneficiary?
Yes -- the CRA has reconsidered its position regarding gifts of life insurance proceeds where a charity is named as an irrevocable beneficiary. The revised position is based upon our understanding, which has been confirmed by you, that insurance legislation in Canada is generally consistent in its application to irrevocable beneficiary designations, that such designations cannot be changed unless the policyholder and the beneficiary both consent to the change.
Where the applicable insurance legislation requires policyholder consent to change an irrevocable beneficiary designation, our view is that proceeds of a life insurance policy paid to a registered charity pursuant to the irrevocable beneficiary designation would be deemed to be the policyholder's gift to the charity pursuant to subsection 118.1(5.2)l provided that the provisions of subsection 118.1(5.1) are otherwise satisfied.
CALU Comment: In August of last year CALU wrote a letter to the CRA setting out why we disagreed with their response to Question 8 at the 2003 Annual Meeting and asking them to reconsider their position. The CRA's willingness to do so is appreciated.
CALU Report, June 2004
In a technical interpretation letter dated Dec. 15, 1998 (E9824645), the Agency considered the situation where Parentco is the beneficiary of an insurance policy on the life of its controlling shareholder, and Subco, a wholly-owned subsidiary of Parentco, is the owner of the policy and pays the premiums under policy. The Agency expressed the view that "generally subsection 15(1) of the Act would not apply to include a benefit in a beneficiary's income as a consequence of the policyholder paying the premiums due under the policy or upon receipt by the beneficiary of the proceeds of the life insurance policy as a consequence of the death of the life insured". The Agency's response also noted that unless there was a bona fide reason for this structure, other than to obtain a tax benefit, the GAAR could be applied to reduce the amount of the life insurance proceeds to be included in the capital dividend account of Parentco by the adjusted cost basis of the policy to Subco.
Will the Agency confirm that the views expressed in this technical interpretation letter still reflect the Agency's position?
It remains the Agency's position that generally subsection 15(1) of the Act will not apply with respect to the situation described in our technical interpretation (E9824645). Concerns regarding the potential application of subsection 15(1) of the Act in other situations involving corporate-owned life insurance policies should be submitted to this Directorate for consideration by way of an advance income tax ruling request in the case of proposed transactions or to the local tax services office in the case of completed transactions.
With regard to the GAAR, it is currently the Agency's practice to comment on the application of subsection 245(2) of the Act only after reviewing all the facts and circumstances of a transaction in connection with a request for an advance ruling.
CALU Comment: When this question was submitted to the CRA, it included other scenarios. It also asked the CRA to confirm that, based on recent GAAR jurisprudence, the GAAR would never be applied to adjust the capital dividend account of the parent corporation. As the CRA's answer indicates, it will only consider these other scenarios and the potential application of the GAAR in connection with a request for an advance income tax ruling.
CALU Report, June 2004
The parent of a minor or infirm child wants the amount in the parent's RRSP to be used on his or her death to purchase an annuity for the benefit of the child. This could be achieved by designating the child as the beneficiary of the RRSP. On the parent's death, the child would use the RRSP proceeds to acquire the annuity, which would be payable to the child. In this case, assuming that the conditions are met for the RRSP payment to be a refund of premiums and that the annuity qualifies for the paragraph 60(l) of the Income Tax Act (the "Act") deduction, there would be a rollover for the RRSP proceeds.
Alternatively, the child could use the RRSP proceeds to purchase an annuity that is payable to a trust for the sole benefit of the child. Paragraph 60(l) of the Act permits this for a minor child, and the technical amendments that were released on Feb. 27, 2004, would extend this option so that it is available for a mentally infirm child.
The parent may prefer, however, that the RRSP proceeds be paid directly to a trust for the benefit of the child, and that the trust use the proceeds to acquire the annuity. It appears that if a trust is named as a beneficiary of the RRSP, and the trust uses the proceeds to acquire the annuity, there will be no rollover for the RRSP proceeds. One reason is that the payment to the trust will not qualify as a refund of premiums. Another is that paragraph 60(l) of the Act does not provide a deduction for trusts.
One way in which the parent can achieve the objective on a rollover basis without designating the child as beneficiary of the RRSP is to name the parent's estate as beneficiary, and to provide for the estate to purchase the annuity and have it designate a trust for the sole benefit of the child as the recipient of the annuity payments. In this case, if the parent's legal representative and the child file a prescribed form pursuant to subsection 146(8.1) of the Act, the RRSP proceeds will be deemed to have been received by the child as refund of premiums. Furthermore, the payment by the legal representative to the annuity issuer will be considered the payment of an amount on behalf of the child for purposes of paragraph 60(l) of the Act.
Does the Agency agree with all the statements made above?
Paragraph 60(l) of the Act allows a deduction where a refund of premiums received by a child is used to buy an annuity described under clause 60(l)(ii)(A) or (B) of the Act.
A refund of premiums is defined in subsection 146(1) of the Act to be any amount paid out of or under an RRSP as a consequence of the death of the annuitant under the plan, to the spouse of the annuitant or to a child or grandchild of the annuitant who was, at the time of the death, financially dependent on the annuitant for support. It is a question of fact whether a child or grandchild was financially dependent on a deceased annuitant immediately before the annuitant's death. For this purpose, there is a rebuttable presumption that a child or grandchild is not considered to be financially dependent on the annuitant if the child or grandchild's income for the year preceding the taxation year in which the annuitant died exceeded the amount determined under subsection 146(1.1) of the Act.
In the circumstances described in the first and second scenarios, the conditions are met for the RRSP payment to be a refund of premiums if the child is financially dependent on the annuitant for support at the time of the death. When an amount is paid out of an RRSP to another person other than the spouse, a child or grandchild of the annuitant, like in the third scenario described above, this amount does not qualify as a refund of premiums.
However, when an amount is paid out of an RRSP to the legal representative of the deceased annuitant of the RRSP, and a portion of the amount would have been a "refund of premiums", as defined in subsection 146(1) of the Act, if it had been paid to a beneficiary of the deceased's estate, the legal representative and the beneficiary may make a joint designation in accordance with subsection 146(8.1) of the Act in respect of all or a part of the portion of the payment that would have been a refund of premiums. The amount so designated is thereby deemed to be an amount received by the beneficiary (and not by the legal representative) at the time it was so paid as a benefit that is a refund of premiums. In our view, subsection 146(8.1) of the Act is not applicable in the third scenario, as the RRSP proceeds are not paid to the legal representative of the deceased annuitant, which is the case in the fourth scenario.
The refund of premiums may be used to acquire an eligible annuity. Paragraph 60(l) of the Act requires that the annuity be an annuity, acquired by the child or on his behalf, under which the child, or a trust under which the child is, before his or her death, the sole person beneficially interested in a amount payable under the annuity. We are of the view that paragraph 60(l) of the Act will apply where there is an acquisition of an annuity on behalf of the child as this is the case in the fourth scenario.
CALU Report, June 2004
Will the CRA confirm that, if interest on borrowed money used to acquire common shares is otherwise deductible, the Oct. 31, 2003 Release by the Department of Finance regarding the draft proposals dealing with "reasonable expectation of profit" would not apply to deny the recognition of any loss that results from the deduction of the interest?
On March 23, 2004 the Department of Finance in its Budget Plan extended the period for written submissions in respect of the legislative proposals, contained in the Release, until the end of August 2004. As such, until the public consultation process is completed and the final proposed amendments become law, the CRA is not in a position to comment. In the interim, the CRA will continue to administer paragraph 20(1)(c) of the Income Tax Act in accordance with the current comments contained in paragraph 31 of Interpretation Bulletin IT-533 dated Oct. 31, 2003.
CALU Report, June 2004