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At the CALU Annual Meeting on April 29, 2008, Mickey Sarazin, Director of the Financial Sector and Exempt Entities Division of the Income Tax Rulings Directorate of the Canada Revenue Agency (CRA), responded to various questions and technical issues of current concern. Our summary of his answers to the general questions as well as the CRA's official responses to the technical questions are provided in this Report. For some questions, CALU has provided a note of clarification or comment concerning the official responses. CALU would also like to thank Ted Ballantyne, CALU's Director, Advanced Tax Policy and Jillian Welch, Partner, Wilson and Partners LLP, CALU's Tax Advisor, for their participation in the Roundtable. All statutory references are to the Income Tax Act (Canada) unless otherwise specified.
Paul McKay, CAE
At the 2007 CLHIA Tax Officers Section Meeting, the CRA talked about the establishment of a group in the North York Tax Services office relating to a policyholder audit project.
At the CALU meeting, the CRA confirmed that such a group has been established, but in their Kitchener-Waterloo Tax Services Office and that the project has commenced. The audits are focused on reviewing life company tax reporting and accounting systems for insurance policies to ensure that policyholders are properly reporting their income in accordance with income tax legislation and regulations.
At the 2008 CLHIA Tax Officers Section Meeting, held in May, Equitable Life confirmed during a panel discussion that it was the subject of the first CRA policyholder audit. Equitable Life commented that the CRA has reviewed their tax reporting on group retention cases and found no problems. The CRA subsequently requested a list of Universal Life policies and indicated that it would be requesting specific policies to test for exempt test compliance, such as ACB calculations, fund values and appropriate tax reporting. As at that time, Equitable had not been notified as to which policies the CRA wished to review.
This project is currently in its infancy and the CRA indicated at both meetings that it would be willing to provide updates at future conferences.
Over the past several months the CRA has indicated that it will be reviewing all tax-shelter gifting arrangements. The CRA has indicated that up until August 2007 that it had audited 26,000 individuals and about $1.5 billion in charitable donations had been disallowed. In addition, about another 50,000 individuals would be audited in respect of these arrangements. In early 2008, the CRA published Registered Charities Newsletter No. 29, which provided examples of three common arrangements:
The CRA confirmed that all tax-shelter gifting arrangements will be reviewed and that indeed thousands of reassessments denying claims for donations have already been issued and thousands more are on the way.
The CRA indicated that even though these arrangements are accompanied by legal opinions, many of those opinions contained so many caveats that investors and their advisors should question the actual amount of comfort being provided. As a general comment, where an arrangement looks to good to be true, it probably is.
CALU Comment: Given that the CRA is actively reviewing all ta- shelter gifting arrangements, CALU members should demonstrate good judgement in advising clients. Members may also wish to refer to INFOexchange 2007, Vol 3, "Tax-Shelter Gifting Arrangements" as well as Registered Charities Newsletter No. 29, available in PDF format on the web at http://www.cra-arc.gc.ca/E/pub/tg/charitiesnews-29/charitiesnews29-e.pdf
Another "scheme" that seems to come up regularly are arrangements which purport to allow taxpayers to withdraw funds tax-free from their RRSPs or RRIFs. Typically, promoters of these questionable schemes direct the owner of a self-directed RRSP or RRIF to purchase a particular investment through a specific trustee. The particular investment could be shares in a company, units of participation in a co-operative, a mortgage or other types of investments.
The CRA confirmed that these arrangements were being targeted. In its view the promoter's fees are generally greater than the taxes that would otherwise be paid had the amounts been withdrawn from the registered plan over an extended period of time. In addition, it was not uncommon for the promoter to "vanish into the night" with all the annuitant's funds and the annuitant has no protection.
As a result, the participants pay the promoter's fees as well as any required income taxes and penalties when the arrangement or scheme is reassessed. Lawsuits often result, and if the promoter has disappeared, as is more than likely the case, it will be the financial advisor who may bear the brunt of a client's legal action.
In addition, the CRA confirmed it would consider applying the civil penalty provisions of the Act to RRSP
CALU Comment: For clarification, RRSP strips should not be confused with RRSP or RRIF "melt-down" strategies. Under a "melt-down" strategy, the RRSP or RRIF owner borrows to establish a non-registered investment portfolio and then withdraws funds from the RRSP or RRIF that match the tax-deductible interest payments on the investment loan. This type of strategy should be acceptable. A copy of a CRA warning with respect to RRSP strip schemes is available on the web at http://news.gc.ca/web/view/en/index.jsp?articleid=364489.
The Supreme Court of Canada heard the Lipson Appeal on April 23, 2008, and reserved judgment. It is hoped that the Court will release its decision by the end of this year. (A discussion of the Lipson case and possible planning implications may be found in INFOexchange, 2007, Vol. 4, "When Does Tax Planning Become Abusive Tax Avoidance" and INFOexchange, 2007, Vol. 2, "Lipson: GAAR Overrides Deduction of Interest") The questions were how soon following the release of the Supreme Court's decision can taxpayers expect guidance from the CRA on the deductibility of interest expenses and what should taxpayers do in the interim.
In response, the CRA confirmed that its position, as described in IT-533, Interest Deductibility and Related Issues, still applied until such time as the Court released its decision. Paragraphs 13 and 18 of that IT still reflect its position. If the Court finds against Lipson, the CRA would issue a technical news providing its updated position. Depending on the Court's decision and reasoning, the CRA may need to work with Finance in order to have them consider legislative amendments to provide for interest deductibility for investment purposes (relating to Singleton type of situations).
CALU Comment: For a historical perspective on interest deductibility and a discussion of the Singleton and other relevant decisions, please see CALU Reports November 2003, June 2002 and December 2001.
The CRA currently handles approximately 275 rulings and 2,500 interpretation requests per year (about 800 internal and 1,700 external). In its last fiscal year, the Charitable and Financial Institutions Section completed 16 rulings, 80 internal enquires and 74 external enquiries. Less than a quarter of those would relate to the insurance industry and a good proportion of those come from roundtables, such as those held at CALU.
Conference for Advanced Life Underwriting, June 2008
The Canada Revenue Agency (CRA) now archives interpretation bulletins that are used infrequently. The result is that these archived ITs are no longer updated and no longer appear to be available on the CRA's website. Although the interpretations and positions reflected in ITs do not bind the CRA, in our experience taxpayers and advisors do take guidance from and place some reliance on ITs when analyzing and interpreting the law.
Archived ITs are still an important resource for taxpayers and their advisors. For example, IT-355R2, which dealt with deductibility of policy loan interest, amongst other things, has been archived. In other cases, ITs are cancelled.
a) Can you provide any update as to whether the CRA is reconsidering its position with respect to updating ITs?
b) What, in your view, is the status of an archived IT? How is this different from a cancelled IT?
c) What guidance can you provide our members as to steps they or their clients should take in confirming whether a position in an archived bulletin still reflects the CRA's current position?
a) The Income Tax Rulings Directorate is responsible for maintaining ITs. We are currently in the process of recruiting tax professionals to fill the many vacant positions within the Directorate. Until we staff up, we do not have the resources to maintain all of the ITs that require attention. I currently have five revised ITs circulating for approval. It is apparent that the other areas of the CRA, the Department of Finance and the Department of Justice are understaffed and prioritizing workloads because the circulation process is taking years.
b) An IT is archived when it hasn't been updated for some time and only some of the positions expressed therein continue to be relevant. A cancelled IT no longer reflects the CRA's views and they should not be relied on.
c) Members that want to rely on positions expressed in archived ITs are urged to contact us to determine if the specific positions still reflect CRA's views.
CALU Comment: We believe this is the first time that the CRA has confirmed that it is impractical for the CRA to continue to update ITs, given staffing issues and the time it takes to obtain approval. Members are urged to keep this in mind when looking at ITs and determining whether they or their clients should rely on the positions stated and seek tax or legal advice, as appropriate.
At the 1993 CALU conference, the CRA stated that, notwithstanding the position stated in paragraph 3 of IT-244R3, Gifts by individuals of life insurance policies as charitable donations, it "Éis an administrative position taken by the Department based on a legal opinion that the gift [of a life insurance policy] should be valued at the FMV of the policy to the donor and not the donee." (Document No. 9310135.) This position appears to have been reversed in May 2006 (Document No. 2006-016859) when the CRA confirmed its position as stated in IT-244R3. However, at the 2007 APFF conference, in its answer to Question 1, it appears that the CRA has further modified its position, based on proposed subsection 248(31) of the Income Tax Act ("the Act"), contained in Bill C-10 (previously Bill C-33).
Given the CRA's response to question 1 at the 2007 APFF conference it would now appear that a charitable organization can issue a receipt for the fair market value of the life insurance policy at the time it is gifted to the charity. The factors to be considered in determining the fair market value of the policy are those listed in paragraph 40 of Information Circular 89-3 Policy Statement on Business Valuation. These are factors taken into account in valuing a corporate owned life insurance policy for the purpose of valuing the surviving shareholder's shares.
Paragraph 40 states that the value of the life insurance policy should reflect the following factors:
a) cash surrender value;
b) the policy's loan value;
c) face value;
d) the state of health of the insured and his/her life expectancy;
e) conversion privileges;
f) other policy terms, such as term riders, double indemnity provisions; and
g) replacement value.
In its response, the CRA stated that:
Paragraphs 40 and 41 of Information Circular 89-3 Policy Statement on Business Equity Valuations list the factors to be considered in valuing a life insurance policy. The CRA is
of the opinion that these paragraphs must be taken into account in establishing the fair
market value of a life insurance policy gifted to a qualified donee. Paragraph 3 of Interpretation Bulletin IT-244R3 Gifts by Individuals of Life Insurance Policies as Charitable Donation must be read taking into account the CRA's new position. In the scenario described above, the charitable organization will be required to indicate
on the receipt the fair market value of the life insurance policy at the time of the gift. As a result, the amount of the charitable gift could be different than the donor's proceeds of disposition. The donor would receive a tax receipt in an amount equal to the fair market value of the policy while he or she would include in income an amount equal to the cash surrender
value of the policy, less its adjusted cost basis.
a) Can the CRA please confirm that our understanding of its answer to Question 1 at the 2007 APFF conference is correct?
b) Does the CRA intend to revise its position stated in paragraph 3 of IT-244R3 to
reflect its new position?
Firstly, it should be noted that at the 1993 CALU conference, the CRA was only explaining the reason for the position stated in paragraph 3 of IT‑244R3.
In 2007, we revisited our long-standing position and as stated at the 2007 APFF conference we are now of the opinion that the factors listed in paragraphs 40 and 41 of Information Circular 89-3 Policy Statement on Business Equity Valuations must be taken into account in establishing the fair market value of a life insurance policy gifted to a qualified donee.
Consequently, paragraph 3 of Interpretation Bulletin IT-244R3 Gifts by Individuals of Life Insurance Policies as Charitable Donation must be read taking into account this new position of the CRA.
In the situation described above, the charity will be required to enter on the receipt the fair market value of the life insurance policy at the time of the gift.
CRA will publicly state it new position in a future Income Tax Technical News.
When an individual ceases to be a resident of Canada and owns certain reportable properties with a total fair market value in excess of $25,000, an information return must be filed in accordance with subsection 128.1(9) of the Act. A life insurance policy is included in the definition of "reportable property" under subsection 128.1(10) of the Act.
In the CRA's view, in valuing the life insurance policy for the purposes of subsection 128.1(9) of the Act should the policyholder use cash surrender value or fair market value of the policy using the guidelines found in paragraphs 40 and 41 of Information Circular 89-3, Policy statement on business equity valuations?
For the purposes of subsection 128.1(9) of the Act, it is our view that an interest in a life insurance policy owned by an individual and that is a "reportable property" as defined under subsection 128.1(10) of the Act must be valued at its fair market value taking into account the factors listed in paragraphs 40 and 41 of Information Circular 89-3 Policy Statement on Business Equity Valuations.
CALU Comment: This answer is consistent with the CRA's response to Question 1 in its approach to determining fair market value when valuing a life insurance policy for purposes other than subsection 148(7).
Some universal life insurance policies have an explicit surrender charge in the early years that results in very low cash surrender values during those years. Over a period of time those surrender charges are reduced and eventually disappear. The effect is similar to deferred sales charges or back-end load fees on a mutual fund unit. However, the accumulating fund, which equates with the account value in the plan, continues to grow. The account value would approximate the cash surrender value before surrender charges.
If the ownership of a policy is transferred in a non-arm's-length transaction (such as to or from a controlled private corporation) the transfer occurs at the cash surrender value of the policy in accordance with the provisions of subsections 148(7) and (9) of the Act.
If, at the time of transfer, surrender charges are still in effect, these would reduce the cash surrender value for purposes of determining the proceeds of disposition of the policy.
Does the CRA agree that the value of the policy in a non-arm's-length transfer, or in an arm's-length transfer as described in subsection 148(7) of the Act, is the amount the holder is entitled to receive net of surrender charges?
Other than by virtue of a deemed disposition under paragraph 148(2)(b) of the Act, subsection 148(7) of the Act applies when an interest of a policyholder in a life insurance policy is disposed of at arm's length by way of a gift, by operation of law only or by distribution from a corporation. It also applies to any such dispositions at non-arm's length. For purposes of subsection 148(7) of the Act, we are of the opinion that the value of a life insurance policy corresponds to the amount determined according to the definition of that term under subsection 148(9) of the Act. Consequently, the same definition applies whether it is an arm's-length or non-arm's-length disposition.
The question of whether or not an amount constitutes the "value" as defined in subsection 148(9) of the Act depends upon all the terms and conditions of a particular policy and the law applicable to the policy.
We are of the view that such an examination could be done in the context of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, "Advance Income Tax Rulings," dated May 17, 2002, where all the relevant facts and documentation are submitted.
A continuing issue for employers is fashioning post-retirement plans for lateral and mid-life hires when such plans cannot be funded out of an existing registered pension plan (RPP). A continuing tax issue resulting from this dilemma is determining whether the proposed plan could be considered to be a salary deferral arrangement rather than a supplementary pension plan.
The CRA has indicated that factors suggesting that a particular plan is a supplementary executive pension plan and not a salary deferral arrangement include whether the plan is a "top-up" to the employer's pension plan, providing benefits that would arise under the RPP but for the limits imposed by the provision of the Act and the regulations. Another factor is whether the plan terms "mirror" the RPP terms.
In designing a "top-up" arrangement for an executive, employers might look at developing a plan that has a pension formula that takes into account multiples of years of service or salary, or uses delayed vesting beyond the usual two year limit to fashion a plan for a particular executive's situation. These would be points on which the top-up arrangement would not "mirror" the underlying RPP terms. What are the CRA's views on whether such plans could be considered salary deferral arrangements (SDAs)?
The CRA has previously stated that a plan will not be treated as an SDA where the plan has the characteristics of an unregistered or supplementary pension plan and the amounts that may be paid out of, or under, the plan can be considered to be reasonable superannuation or pension benefits. Where a plan provides benefits that are not reasonable superannuation or pension benefits, the CRA is of the view that a salary deferral arrangement will exist.
The CRA generally takes the position that supplementary pension benefits will be considered reasonable if the terms of an arrangement are substantially the same as those of the RPP that applies to the same beneficiaries to whom the arrangement applies and the benefits that can be paid under the arrangement are the same as the benefits that would have been paid under the RPP but for the defined benefit or money purchase limit. Where a specific arrangement provides benefits that are not the same as those provided under the registered plan, or are greater than those that could be provided under the registered plan (but for the defined benefit or money purchase limit), then the terms of the arrangement and any other relevant information must be considered to determine if the benefits are reasonable in order to ensure that the plan or arrangement will not be considered an SDA.
When CRA is asked to express its views on whether a particular plan or arrangement is a SDA it must review all the terms of the plan and the factors related to its use in a particular situation in order to determine whether the plan is an SDA.
The CRA cannot provide any definitive answers with respect to any one factor as we would have to look at the arrangement as a whole. However, we would not view the use of multiple years of service or multiple years of salary rather than actual years of service or actual salary as appropriate. In addition, any vesting schedule that is less than the vesting schedule under the pension plan may also not be appropriate.
CALU Comment While a more restrictive vesting schedule may not cause the CRA to consider a plan to be an SDA, it appears the CRA has developed an administrative position, a self-described "line in the sand," that in CALU's view is not supported by the definitions of these plans in the Act. As an example, it is the CRA's position that an RCA that has a "richer" benefit formula than the maximum 2% times of years of service for a defined benefit registered pension plan would cause the plan to be considered an SDA as opposed to an RCA. This is presumably because the funding in excess of the 2% maximum for a pension plan would be considered by the CRA to be deferred salary. Members should ensure clients considering establishing an RCA, and their professional advisors, are aware of this administrative position in order to appropriately assess risk.
Life insurance policies have many uses in estate and financial planning. One use of life insurance proceeds is to settle a trust for the benefit of children or grandchildren. The CRA has confirmed in the past (Document No. 9605575) that a trust settled with life insurance proceeds can qualify as a testamentary trust.
The question has arisen as to how a joint last-to-die policy would be treated where the policy is jointly owned by a husband and wife (or common-law partners). Where a policy is jointly owned, it must be dealt with jointly meaning that two signatures are required in respect of policy transactions, including beneficiary designations.
However, after one spouse dies and the other spouse becomes the sole owner of the policy (that is, the policy passed to the surviving spouse by right of survivorship), that spouse could change the beneficiary designation.
In the CRA's view, would a trust settled with the proceeds of a jointly owned last-to-die life insurance policy qualify as a "testamentary trust", as defined in subsection 108(1) of the Act, if the trust was designated by the spouses jointly and the surviving spouse makes no change to the designation? Assume the trust is settled in the same manner as that set out in the above noted technical interpretation.
A testamentary trust is a trust that arises on and as a consequence of the death of an individual with certain exceptions. One of these exceptions is a trust created after Nov. 12, 1981, if, before the end of the taxation year, property has been contributed to the trust otherwise than by an individual on or after the individual's death and as a consequence thereof.
As previously stated by the CRA at this conference and in other technical interpretations issued by the CRA, a trust created pursuant to the individual's will or other testamentary instrument will not lose its testamentary trust status solely by reason of the receipt of the proceeds of an insurance policy on the life of that individual (who was the policyholder), where the trust is the designated beneficiary under the policy and the trust was not created or settled before the death of the individual.
In the case of a joint last-to-die life insurance policy where the only amount that is payable to the trust under the policy is paid on the death of the last of the two persons insured under the policy, our position would be the same - that is, a trust created from the receipt of the proceeds of such a policy will not lose its testamentary trust status solely by reason of the receipt of the proceeds of that insurance policy provided that the life insurance policy is owned by the individual who survives the other immediately before his or her death and the policy qualifies as a testamentary instrument of that person at that time.
In accordance with subsection 148(8) of the Act, where a policyholder transfers his or her interest in a life insurance policy to a child or grandchild of the policyholder and the child or grandchild is the life insured under the policy, the transfer is deemed to have occurred at the adjusted cost basis (ACB) of the policy.
The CRA has previously stated (Document No. 9826715) that where the policy is transferred to a trust of which the child is the beneficiary, the transfer would not be considered a transfer to the child. Therefore the rollover under subsection 148(8) would not be available. The result would be that the transfer would be considered to be a disposition of the policy at its value at the time of transfer and the difference between the proceeds of disposition and the ACB of the policy would be taxable to the transferor if the transfer is subject to subsection 148(7).
At the death of the parent or grandparent, there are circumstances where transfers of policy ownership must be made to a person other than the child or grandchild who is the life insured. Such a transfer to a third party could occur where the life insured is a minor child or is a person who is mentally challenged and incapable of managing property, regardless of age. In such a case, another person may be appointed as a "guardian of property" for the child.
A guardian of property is someone who is appointed to manage the financial affairs of a minor or a person who is a mentally incapable of doing so for himself or herself. People are considered to be mentally incapable of managing property if they cannot understand the relevant information or appreciate what may happen as a result of decisions they make, or do not make, about their finances.
Will the CRA confirm that the provisions of subsection 148(8) will apply where an individual is appointed as a guardian of property, in accordance with the relevant provincial legislation?
Subsection 148(8) of the Act stipulates that if the interest of a policyholder in a life insurance policy, other than an annuity contract, is transferred to the policyholder's child for no consideration and a child of the policyholder or a child of the transferee is the person whose life is insured under the policy, the interest is deemed to have been disposed of by the policyholder for proceeds of disposition equal to the ACB to the policyholder of the interest immediately before the transfer, and to have been acquired by the person who acquired the interest for a cost equal to those proceeds.
The ownership of an interest in a life insurance policy is a question of law. In order to determine if the interest in the life insurance policy is transferred to a child of the policyholder, we have to rely on the relevant law applicable in to the policy. We are, however, prepared to offer the following comments.
For the purpose of subsection 148(8), CRA will generally consider that an interest of a policyholder has been transferred to the policyholder's child if the child becomes the owner of the life insurance interest. Based on our understanding of the relevant law applicable in Ontario, the fact that a guardian of property is appointed to manage the financial affairs of a minor or a person who is a mentally incapable of doing so for himself or herself will not affect the ownership of the interest since the guardian of property only acts on the incapable person's behalf. The property (the interest in the life insurance policy) is still belonging to the minor or the incapable person. In such a case, the interest in the policy would be deemed to have been disposed of by the policyholder for proceeds of disposition equal to the ACB.
CALU Comment: The CRA's position is good news where the insured is a minor or a person who is mentally incapable of managing their financial affairs. While the question deals specifically with Ontario law, other provinces may have similar legislation and members may wish to check to ensure equivalent legislation is in place. Advisors may wish to confirm the status of any such transfer in their jurisdiction with the CRA by reference to this opinion, when formally published.
For life insurance policies issued prior to Dec. 2, 1982, there is no requirement to calculate the net cost of pure insurance (NCPI) for the policy or to deduct the NCPI from the premiums paid in determining the adjusted cost basis (ACB) for the policy. However, it is possible that policies issued prior to Dec. 2, 1982, may be assigned as collateral for a loan. While the policyholder/borrower could simply apply for a new policy, there may be any number of reasons why this is not desirable. The insured policyholder could be required to pay increased premiums due to increased age or ratings due to health considerations or the life insured is no longer insurable.
Prior to 1990, IT-309R described the limited circumstances under which (and prior to the application of paragraph 20(1)(e.2) of the Act) all or part of an insurance premium in respect of term insurance was deductible as a cost of borrowing money under subparagraph 20(1)(e)(ii) of the Act. Subsequently, the current provisions of paragraph 20(1)(e.2) became effective for premiums payable after 1989 restricting the amount of the deduction to the lesser of the NCPI and the premiums paid in the year.
Where a life insurance policy issued prior to Dec. 2, 1982, is assigned as collateral for a loan in the circumstances required by paragraph 20(1)(e.2) of the Act, would the CRA consider allowing the policyholder to calculate an equivalent NCPI for the purposes of determining if the deduction is available?
Provided that all the conditions are met, the amount eligible for deduction under paragraph 20(1)(e.2) is the portion of the lesser of the premiums payable by the taxpayer under a life insurance policy (other than an annuity contract) in respect of the year, and b) the net cost of pure insurance in respect of the year, as determined in accordance with the regulations, in respect of the interest in the policy referred to in (a) above.
The CRA is of the opinion that this calculation applies to all life insurance policies used as collateral including the ones issued prior to Dec. 2, 1982.
The net cost of pure insurance under a life insurance policy is to be determined in accordance with section 308 of the Income Tax Regulations. The CRA is of the opinion that this provision a, pplies to all life insurance policies notwithstanding the date , of their issuance.
CALU Comment: This has been a troubling issue for some time, although perhaps not a widespread concern. The fact that the NCPI can be determined for any policy should enable those who have assigned policies issued prior to Dec. 2, 1982, as collateral for loans to be able to deduct the NCPI in relation to the amount at risk under those policies, regardless of the fact that the NCPI does not reduce the ACB for those policies.
The CRA has stated (Document No. 9904155) that where a Private Health Services Plan (PHSP) is established for a sole proprietor, and there is an administrator that adjudicates the health claims for an administration fee and then reimburses the proprietor, the plan would not qualify as a PHSP as the plan does not contain the necessary elements of insurance. In particular, the plan would not satisfy the criteria found in paragraph 3 of IT-339R2, Meaning of "private health services plan", which reads as follows:
A private health services plan qualifying under paragraphs (a) or (b) of the definition in subsection 248(1) is a plan in the nature of insurance. In this respect the plan must contain the following basic elements:
a) an undertaking by one person,
b) to indemnify another person,
c) for an agreed consideration,
d) from a loss or liability in respect of an event,
e) the happening of which is uncertain.
The CRA has also indicated (Document No. 0014245) that if the plan provides coverage for other employees in addition to the sole proprietor, the plan would constitute a plan of insurance and therefore may qualify as a PHSP. This is because the plan would contain an undertaking by one person (the proprietor) to indemnify another person (an employee). The CRA has taken the view that the status of the plan is not affected if the proprietor is also covered under the plan. The full-time employee may also be non-arm's length to the proprietor, subject to the deduction limitations contained in paragraphs 20.01(2)(c) and (d) of the Act.
Where a partnership, which has no employees, enters into such a cost-plus arrangement, it may be argued that the basic elements of an insurance plan are in place. There is an undertaking by one person (the First Partner) to indemnify another person (the Other Partner(s)) for an agreed consideration (the insurance amount plus administration fee) from the loss or liability in respect of an event, the happening of which is uncertain.
Does the CRA agree that the plan would qualify as a PSHP?
In our view, a cost-plus PHSP for a partnership would be subject to the same rules and constraints as outlined by us for such plans established by sole proprietorships. That is, unless there are employees who are insured under the same cost-plus arrangement, the plan does not have the necessary elements of insurance to qualify as a PHSP. In this regard, since each member of a partnership carries on business as both principal and agent of the other member(s), it is our view that a cost-plus arrangement consisting of partners only results in each partner covering his or her own risks with respect to contingent medical expenses.
In 2006 the Income Tax Act was amended so that the capital gain on a listed security that is donated to a charity is deemed to be nil. The result is that the charity receives the security and issues a charitable donation receipt for the fair market value of the security and the donor has no capital gain inclusion on the donation, resulting in a net tax benefit to the donor. An interest in a related segregated trust is a listed security, and therefore the capital gain on the donation of an interest in the segregated fund trust should be nil.
But, there are some unique problems with segregated funds because of the nature of the tax reporting the issuer is required to do. Gains resulting from trading within the fund are allocated to the policyholder and reported on a T3 slip. In addition, when a policyholder withdraws or surrenders an interest in the segregated fund, any gain resulting from dispositions or deemed disposition of the trust property as a result of the surrender of the interest are also reported on the T3. As a result, the policyholder includes in income the amount the total capital gain reported on the T3.
The assignment of ownership of the segregated fund policy to a charity would be a disposition of the policyholder's interest, but would not necessarily mean that the policyholder had withdrawn or surrendered their interest in the segregated fund. In addition, the determination of the adjusted cost base of the policyholder's interest is complex and normally determined by the insurer, and in fact as the insurer reports both trading and disposition gains on the T3, there is really no need for the policyholder to know their ACB.
Does the CRA have any suggestions as to how the insurer, policyholder and/or charity determine the capital gain that is excludable from income?
T3 information slips prepared by the insurer for segregated fund units include both capital gains and losses realized throughout the year by the segregated fund in accordance with subsection 138.1(3) and deemed capital gains and losses resulting from an election by the insurer under subsection 138.1(4). This election is only available to the insurer when the policyholder withdraws all or part of his interest from the segregated fund. The donation to a charity of an interest in a segregated fund is not a withdrawal of an interest but a change of ownership. Therefore, no election is available under subsection 138.1(4). The T3 will only include capital gains and losses resulting from trading within the segregated fund that have been allocated to the donor based on the terms and conditions of the segregated fund policy.
The transfer of ownership to the charity is considered to be the disposition of a capital property under subsection 39(1). The insurer does not report this disposition on the T3. Any resulting taxable capital gain is deemed to be zero by paragraph 38(a.1)(i). However, the donor must still complete form T1170 - Capital Gains on Gifts of Certain Capital Property to determine the amount of taxable capital gain, if any, to report on Schedule 3 of his T1. The donor will need to contact the insurer for a determination of the ACB of the segregated fund units donated. The amount of the donation for tax purposes is the fair market value of the units at the time of the ownership transfer. The onus is on the charity and the donor to determine the fair market value. Donors should refer to P113 - Gifts and Income Tax for more information.
CALU Comment: While the CRA's answer confirms that a transfer to a charity of an interest in a segregated fund (e.g., a segregated fund policy) should be accorded the same treatment as the transfer of any other capital property, there may be a practical issue as to whether the insurer, from an administrative standpoint, can accommodate such a transfer. Policyholders making such a gift should confirm with their insurer that the transfer of ownership to the charity will not be documented as a redemption of the holder's interest.
Under proposed subsections 94.2(10) and (11) of the Act, contained in Bill C-10, foreign-issued life insurance policies will be subject to the mark-to-market income inclusion rules, subject to certain exclusions contained in proposed subsection 94.2(11).
What we are particularly interested in is the exclusion that applies if any of the conditions of subparagraph 94.2(11)(c)(ii) are met. These criteria are as follows:
the taxpayer can establish to the satisfaction of the Minister that
(A) the interest in the policy was, on the anniversary day of the policy that occurs in the particular taxation year,
(I) an exempt policy, or
(II) a prescribed annuity contract, or
(B) the taxpayer has included in computing the taxpayer's income for the particular taxation year the amount, if any, required under section 12.2 to be included in computing the taxpayer's income for the particular taxation year in respect of the interest;
Where a non-resident acquires a life insurance policy from a life insurer not resident in Canada, it is unlikely that the individual will be able to determine if the policy satisfies any of the required conditions listed above. However, not being able to determine if, or how, these complex rules apply to their insurance policies may leave immigrants or others owning foreign issued life insurance policies open to reassessment and potential penalties.
Does the CRA intend to publish any guidance as to what will satisfy the Minister that the conditions necessary to qualify for exclusion have been met?
Since CRA depends on a self-assessing taxation regime, the onus is on the taxpayer to establish that the conditions for exclusion under subparagraph 94.2(11)(c)(ii) have been met. The CRA does not plan on publishing any guidelines at this time. Our intention is to evaluate the merits of documentation provided to support exclusion on a case-by-case basis. It may be possible to develop an administrative policy in the future after a thorough review of taxpayer submissions.
Where an annuity contract is intended to qualify as a prescribed annuity contract it must comply with the requirements of Regulation 304(1). Clause 304(1)(c )(iv)(D) of the Regulations requires that the holder's rights under the contract not be disposed of otherwise than on the holder's death.
Does this requirement preclude the collateral assignment of a prescribed annuity contract as security for a loan?
Provided that the assignee is unable to force any disposition of the policy by the holder, but has only a right to the annuity payments that continue to be constructively received by the holder, in our view, the collateral assignment of an annuity contract does not affect the requirement under clause 304(1)(c )(iv)(D) of the Regulations that the holder's rights under the contract not be disposed of otherwise than on the holder's death.
Copyright the Conference for Advanced Life Underwriting, June 2008
 Substitute Decision Act S.O. 1992, Chapter 30, section 31; 32; 33.2