Menu
455 Avenue Road, Suite 100, Toronto, Ontario, M4V 2J2
Tel: (416) 966-9675 Fax: (416) 966-9677
At the CALU Annual Meeting on May 4, 2010, Mark Symes, Director of the Financial Sector and Exempt Entities Division of the Income Tax Rulings Directorate, Canada Revenue Agency (CRA), responded to various questions of current concern to CALU members. The CRA's official responses to the questions are provided in this Report, along with our summary of Mark Symes' verbal responses to three additional questions. For some questions, CALU has provided a note of clarification or comment concerning the CRA responses. CALU would like to thank Ted Ballantyne, CALU's former 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.
Table Of Contents
On February 4, the CRA apparently notified tax professionals that it will be starting a campaign "to provide Canadians with the information they need to understand their tax obligations." The initiative will take the form of letters sent to taxpayers and will be the responsibility of the Audit Divisions in each Tax Services Office.
To quote from the letter to professionals:
Two types of letters will be sent to thousands of Canadians. Some will receive a letter providing information about eligibility criteria for certain deductions they have claimed in their recent income tax returns. Other taxpayers will receive a similar type of letter, and will be advised of the possibility that their income tax returns may be selected for audit.
The goal of the campaign is to educate taxpayers as well as promote compliance with the Income Tax Act. We are asking individuals to self-review their claims related to rental income and expenses, employment expenses, and business or commission income and expenses.We also wish to provide taxpayers the opportunity to amend their income tax returns by completing an adjustment request and/or by making a voluntary disclosure in cases where the taxpayer may have claimed deductions in error or provided inaccurate information. Requests for adjustments can be made online by accessing "My Account" using the "Change my Return" option or by mail with form T1-ADJ, T1 Adjustment Request, available from our Web site at www.cra-arc.gc.ca/forms.
According to an article in the April 2010 issue of the Investment Executive, these letters have been sent to some 37,000 individuals.
Question
Can the CRA provide our members some background on this initiative? If a taxpayer gets this letter and then chooses to voluntarily disclose something to the CRA, will this count as a proper voluntary disclosure or does the letter mean that the taxpayer is already under review?
CRA's Response
It is felt that not all non-compliance requires the intervention of audit to influence taxpayer behaviour. In light of this, the CRA has undertaken this letter-writing campaign as part of its commitment to address areas of possible non-compliance. Each year, the CRA conducts a number of review activities aimed at promoting compliance with the laws we administer in order to sustain and enhance the integrity of the Canadian tax system, which would in turn increase Canadians' confidence in the fairness of the system.
The CRA relies on risk assessment systems to allocate its compliance resources. This includes research to identify current and emerging risks to the tax base. Risks are prioritized based on their potential effect on the revenue base and on compliance in general. We also use different systems and programs to identify and deal with different types of non-compliance. These systems and programs use complex algorithms that determine the potential level of risk. For example, our sophisticated matching programs compare income and other information reported by taxpayers with information provided to the CRA by parties, such as employers, banks, mutual fund companies and others. Another example is the review of various deductions and credits claimed, sometimes before tax returns are assessed and sometimes after the "Notice of Assessment" has been issued. These risks were considered in selecting which sectors would be addressed as part of this campaign.
This campaign includes two types of letters: one which will provide information about eligibility criteria for certain deductions that taxpayers may have claimed in their most recent income tax and benefit returns, and the other that will provide, in addition to the same information, a statement advising them of the possibility of audit actions by the CRA of their industry. A total of 18,500 letters of each kind were mailed during the months of January and February 2010.
Individuals and businesses who have not filed returns for previous years, or who have not reported all their income, can still voluntarily correct their tax affairs, prior to a compliance action being initiated. If a taxpayer is not otherwise under review the letter itself will not be considered to constitute the commencement of compliance action by the CRA. Under the Voluntary Disclosures Program, they will not be penalized or prosecuted if they make a valid disclosure before the CRA commences a compliance action against them. More information on the Voluntary Disclosures Program can be found on the CRA's Web site at www.cra.gc.ca/voluntarydisclosures.
A valid disclosure must meet four conditions. These conditions require that the disclosure be voluntary, complete, include amounts that are potentially subject to penalty, and generally include information that is more than one year overdue. If the CRA accepts the disclosure, the taxpayer will have to pay the taxes owing, plus interest. However, the taxpayer will not be subject to penalty or prosecution for those amounts accepted as a valid disclosure.
Copyright the Conference for Advanced Life Underwriting, July 2010
Situation A
At both the 2009 L'Association de planification fiscale et financière (APFF) and Canadian Tax Foundation CRA Roundtables (question #15 at the APFF Roundtable and question #3 at the Foundation's Roundtable), the CRA announced a change in its policy regarding shareholder benefits arising from corporate-owned life insurance policies. Specifically, the CRA considered the situation where the life insurance policy was owned by a wholly owned subsidiary ("Subco") with the beneficiary of the policy being the shareholder of Subco ("Parentco"). The CRA is now of the view that the payment of premiums by Subco results in a benefit under subsection 15(1) ITA to Parentco. To quote from CRA Views #2009-0347291C6 (which provides both the English and French versions of question #3 from the Foundation's Roundtable), "whether a corporation has conferred a benefit on a shareholder for subsection 15(1) ITA purposes is generally one of fact. The situation described gives rise to an impoverishment of the subsidiary corporation and an enrichment of the parent corporation, and therefore a benefit to the parent corporation."
It is often industry practice to have a structure that is different from the one described above. Under this arrangement, the life insurance policy is owned and paid for by Parentco, with Subco as the revocable beneficiary of the policy. This arrangement is implemented to provide creditor protection for the insurance policy while the life insured is alive, and avoid disposition issues should Subco be sold and Parentco wants to retain ownership of the policy.
Question
Can the CRA confirm that Parentco will not be subject to subsection 15(1) ITA in the above situation?
Situation B
Assume a similar structure to the one described in Situation A but Subco is designated as the irrevocable beneficiary under the policy owned by Parentco and reimburses Parentco for the insurance premiums paid by Parentco. It should also be assumed that the amount of premiums paid does, in fact, represent the charge or amount that should be paid by Subco as the ultimate beneficiary of the life insurance proceeds.
It is our view that Subco would not be impoverished by such payment or reimbursement as Subco is only paying an amount that allows the policy to remain in force and ultimately result in the company receiving the insurance proceeds. Similarly, Parentco would not be receiving a benefit as it is not the beneficiary of that part of the life insurance policy for which it is receiving reimbursement from Subco.
Questions
a) Can the CRA confirm that Parentco would not be subject to subsection 15(1) ITA in the above situation?
b) Can the CRA also comment on whether the adjusted cost basis (ACB) of the life insurance policy owned by Parentco would be reduced by the amount of any insurance costs reimbursement made by Subco?
Situation C
Instead of a Parentco-Subco relationship, assume there are two companies ("Sisterco 1" and "Sisterco 2") that are wholly owned by the same shareholder ("Individual A"). Sisterco 1 is the owner of the policy with Sisterco 2 as the beneficiary. Sisterco 2 would reimburse Sisterco 1 the premiums paid (as Subco reimbursed Parentco in Situation B). In addition to the reasoning described above for the Parentco-Subco situation, subsection 15(1) ITA would not apply to Sisterco 1 as it is not a shareholder of Sisterco 2. It is also our view that subsection 15(1) ITA should not apply to Individual A as there has not been an impoverishment to either company as reviewed above for the Parentco-Subco situation, and Individual A has not been enriched by the premium payments and reimbursements as Individual A is the 100% shareholder of both companies.
Questions
a) Can the CRA confirm that Sisterco 1 and Individual A would not be subject to subsection 15(1) ITA in the above situation?
b) Would the CRA's opinion be different if Individual A had less than a 100% ownership interest in either company?
c) Can the CRA also comment on whether the ACB of the policy owned by Sisterco 1 would be reduced by the amount of any insurance costs reimbursement by Sisterco 2?
CRA's Responses
The question of whether or not a corporation has conferred a benefit on a shareholder for the purpose of subsection 15(1) ITA is generally one of fact. Generally, the CRA considers that subsection 15(1) ITA would be applicable where a transaction or a series of transactions gives rise to an impoverishment of the corporation and an enrichment of the shareholder. In Del Grande v. The Queen, 93 DTC 133 (TCC), the Court stated:
Paragraph 15(1)(c) contemplates the conferral of a genuine economic benefit upon the shareholder. The word "confer" implies the bestowal of bounty or largesse, to the economic benefit of the conferee and a corresponding economic detriment of the corporation.
In our view, Parentco (in Situation A) and Sisterco 1 (in Situation C) would not be subject to subsection 15(1) ITA. However, the provisions of subsection 246(1) ITA could apply to Subco in Situation A.In Situations B and C, it would be necessary to determine in an actual situation with all the relevant documentation, whether the reimbursement should be included in the income of Parentco (in Situation B) or Sisterco 1 (in Situation C) under section 9 or paragraph 12(1)(x) ITA. Subsection 15(1) ITA would not generally be applicable in Situation B to Parentco where the reimbursement is included in its income. Concerning the application of subsection 15(1) ITA to Individual A in Situation C, we cannot make a final determination with the facts submitted.
In Situations B and C, the policyholder's adjusted cost basis would not be reduced by the reimbursement of premium received because that reimbursement is not described in the adjusted cost basis definition under subsection 148(9) ITA.
As stated at the CTF-CRA roundtable - 61st Annual Tax conference Ð 2009, and at the APFF-Round Table on the Taxation of Fiscal Strategies and Instruments Ð 2009, subsection 245(2) ITA could, depending on the circumstances, apply to adjust the calculation of the amount to be included in the capital dividend account (CDA) of the corporate beneficiary upon receipt of the proceeds of the life insurance policy.
CALU Comment: Situation A The CRA indicated it would not assess a shareholder benefit in this situation, which is to be expected given that Parentco has not received any benefit from Subco under the arrangement. However, the CRA noted that subsection 246(1) could apply to assess a benefit to Subco. This subsection is a little used assessing section which can be paraphrased as follows:
Where a person (i.e., Parentco) confers a benefit (directly or indirectly by any means whatever) on a taxpayer (i.e., Subco), the amount of the benefit shall, to the extent it is not otherwise included in the taxpayer's income, and would be included in the taxpayer's income if the amount of the benefit were a payment made directly by the person to the taxpayer, be included in computing the taxpayer's income for the year.
It could be argued that Parentco has indirectly conferred a benefit on Subco by paying the insurance premium for a policy under which Subco is the beneficiary. But for there to be an income inclusion under subsection 246(1), the direct payment by Parentco of an amount equal to the premium to Subco would have to be otherwise taxable to Subco. It is not clear that Subco would be required to include such a hypothetical payment from Parentco in its income.
Situation B - The CRA indicated there will be no shareholder benefit issue under subsection 15(1) to the extent Subco's reimbursement of premium is included in Parentco's income under section 9 or paragraph 12(1)(x). Section 9 states that "a taxpayer's income for a taxation year from a business or property is the taxpayer's profit from that business or property in the year." The CRA has always maintained and most recently has expressed the view that life insurance is "property" for purposes of the Act, and that it is possible to earn income from a life insurance policy.[1] If the arrangement is maintained until the death of the life insured, it would appear unlikely that Parentco would derive any "profit" from the arrangement. However, Parentco might earn a "profit" should Subco consent to the surrender of the policy at a point where the policy has a cash surrender value, which becomes payable to Parentco as owner of the policy.
Paragraph 12(1)(x) generally includes in a taxpayer's income any amount received by the taxpayer in the year in the course of earning income from a business or property, from a person who pays the amount in the course of earning income from a business or property and where the amount can be considered a refund, reimbursement, contribution or allowance in respect of an amount included in or deducted as the cost of property, or an outlay or expense, to the extent the amount is not otherwise included in the taxpayer's income.
Paragraph 12(1)(x) appears to be a broadly drafted provision, with its focus on commercially based transactions. To the extent that Parentco is deducting the premiums under the policy (which would be permitted if the policy is collaterally assigned and the requirements of paragraph 20(1)(e.2) are otherwise met), arguably this provision could be used to tax the reimbursement. As well, since Parentco's ACB is not reduced by the amount of the reimbursement, it might be argued that an income inclusion under paragraph 12(1)(x) could be justified.
If the CRA was successful this could result in a form of double taxation where Subco could not deduct the premium, while this amount will be included in Parentco's income.
Assuming the CRA was not successful in assessing a taxable amount under section 9 or paragraph 12(1)(x) for the reimbursed premium, the CRA left open the possibility of assessing a benefit under subsection 15(1). The CRA may have success where the reimbursement made by Subco exceeds the true cost of the coverage. Also, as discussed above, if Subco releases its beneficial interest in the policy prior to the death of the life insured, the policy may have a transfer value that could result in a shareholder benefit to Parentco.
Situation C - The CRA indicated that subsection 15(1) would not apply, presumably because there is no shareholder relationship between Sisterco 1 and Sisterco 2. It declined to comment on the issue with respect to Individual A, stating that it could not make a final determination based on the facts submitted. The discussion under Situation B relating to the possible application of section 9 or paragraph 12(1)(x) to the reimbursement of the premium would appear to apply equally to Situation C.
Other Comments
Generally, the CRA is concerned with the ability of a corporation to avoid having the ACB of a policy "grind"[2] the CDA credit by having the death benefit paid to a different corporate entity. The CRA has indicated that it may try to apply the general anti-avoidance rule (GAAR) to negate this type of planning. It is therefore very important to be able to demonstrate a bona fide business reason for separating the ownership and beneficiary designation between two corporate entities.[3] More recently the CRA has also indicated it may apply subsection 15(1) or 246(1) to assess a taxable amount where the beneficiary is different than the owner and premium payer.[4] Again, this demonstrates the CRA's concerns with these types of arrangements.
It should also be noted that the potential for an enhanced CDA credit is in some respects just a "timing issue." If the policy is held for a sufficiently long period of time, its ACB will eventually be reduced to nil as a result of the net cost of pure insurance adjustment, with the result that the full amount of the insurance proceeds would be credited to the recipient corporation's CDA in any event.
In Summary
As a starting point, it is important for advisors and their business clients to review the current structuring of corporate-owned life insurance to make sure that it does not get caught by the CRA's new assessing position (in 2010 for new structures or 2011 for existing structures).
In terms of the three corporate-owned situations posed to the CRA, the scenario with Parentco as the owner and Subco as the beneficiary, without any reimbursement of the premium costs, appears to be the least problematic from a tax perspective. As discussed, there is the chance that the CRA could challenge the full CDA credit to the Subco, and it is therefore important to have bona fide reasons for this arrangement outside of maximizing the CDA credit.The two other scenarios raise additional tax issues relating to the reimbursement of the premium. It is possible depending on the facts that the CRA may attempt to use section 9 or paragraph 12(1)(x) to try to assess an income inclusion equal to part or all of the amount of the reimbursement. Whether they would be successful is open to debate, but this tax risk needs to be factored into the planning exercise.
Copyright the Conference for Advanced Life Underwriting, July 2010
This question relates to the 2009 CRA announcement related to a change in its assessing practices related to corporate-owned life insurance (see Question 2 for further background). The issue being addressed in this question relates to the impact, if any, on the change in CRA assessing practice to grandfathered life insurance policies acquired to fund stock redemption agreements entered into before April 27, 1995.The stop-loss rules in subsections 112(3) to (3.32) generally apply to share dispositions that occur after April 26, 1995. Pursuant to subsection 131(1) of S.C. 1998, c.19, they do not apply, however, to share dispositions taking place after that date where:
Questions
a) Can the CRA please confirm that where a policy was acquired for the purpose described in paragraph 131(1)(b) of S.C. 1998, c.19, that a change in ownership of the policy from Subco to Parentco or a change in beneficiary designation from Parentco to Subco, due to the CRA's new assessing practice, will not result in the loss of grandfathered status for the purposes of subsections 112(3) to (3.32)?b) Can the CRA also confirm that if a policy that qualifies for grandfathering in 2010 is renewed, converted or replaced that the grandfathering will apply to the new policy?
CRA's Response
Grandfathering for the purposes of the stop-loss rules is fact dependent and will be determined on a case-by-case basis. Accordingly, whether or not the conditions of paragraph 131(1)(b) of S.C. 1998, c.19 would continue to be met in the situations described above may only be determined after a review of all relevant circumstances. However, where a change in ownership of the policy, or a change in beneficiary designation, even in circumstances similar to the ones described above, would result in one corporation being the beneficiary of the policy without also being the policyholder of the policy, the result would, in our view, be contrary to the intent of paragraph (d) of the definition of "capital dividend account" in subsection 89(1) which is that the amount of the proceeds of a life insurance policy to be included in the CDA be reduced by the adjusted cost basis, within the meaning assigned by subsection 148(9), of the policy. Accordingly, as we have previously stated, there may be a reasonable argument for applying subsection 245(2) to reduce the amount to be included by the beneficiary corporation in its CDA in respect of the life insurance policy by the adjusted cost basis of the policy.
CALU Comment: In its verbal comments relating to Question a), the CRA expressed the general view that if the beneficiary or ownership of the policy was changed in order to ensure that the new position of the CRA did not give rise to a shareholder benefit, the CRA would not challenge the grandfathered status of the arrangement.
The CRA did not respond to Question b) relating to what changes could be made to an existing policy in 2010 while continuing to be grandfathered from the CRA's new assessing position until the end of this year. As a result, members should caution clients that significant changes made to existing corporate-owned policies may result in the loss of grandfathering, and the possible assessment of a shareholder benefit under subsection 15(1) in 2010.
Copyright the Conference for Advanced Life Underwriting, July 2010
Since 1993 Ontario has had a corporate minimum tax (CMT) which applies if the corporation, together with any associated corporations, has annual gross revenues in excess of $10 million or total assets in excess of $5 million.In determining if Ontario CMT applies, financial statements must be prepared in accordance with Generally Accepted Accounting Principles (GAAP) (and after the end of 2010, in accordance with International Financial Reporting Standards, should those apply to the particular corporation). Under GAAP, non-taxable amounts that are received by the corporation, such as the non-taxable portion of a capital gain, are included in income for accounting purposes.
If Ontario CMT applies, the amount of the minimum tax paid may be carried forward and used to offset Ontario corporate tax payable in future years.
Questions
a) Can the CRA provide its views as to whether the Ontario CMT would apply to a life insurance death benefit received by a corporation?
b) If yes, would the CRA please confirm that a corporation could minimize its potential exposure to Ontario CMT by paying either a taxable or a capital dividend in the taxation year the death benefit is received?
CRA's Response
a) Subsection 54(2) of the Ontario Taxation Act, 2007 (the "TA"), determines a corporation's net income or loss for CMT purposes. The net income for CMT purposes of a corporation, other than a life insurance corporation or a bank, is generally equal to the corporation's net income, before income taxes, determined in accordance with GAAP, except that the consolidation and equity methods of accounting are not used. For life insurance corporations, the net income for CMT purposes is generally based on the corporation's net income, before income tax and the special additional tax on life insurance corporations, reported in its annual report to the relevant authority. Therefore, if a life insurance death benefit received by a corporation, that is subject to CMT in the year, is included in net income under GAAP or in net income reported to the relevant authority, it will be subject to CMT since the TA does not provide a deduction from net income for CMT purposes for the life insurance death benefits received.
b) Pursuant to subsection 57(2) of the TA, no deduction is permitted from net income for CMT purposes for a taxable dividend or a capital dividend paid or payable by the corporation.
CALU Comment: The potential increase in a corporation's net income for Ontario corporate minimum tax purposes due to the receipt of life insurance proceeds can be problematic. However, it should be noted that such tax can be recaptured in subsequent taxation years to the extent the corporation's regular tax liability exceeds its minimum tax payable for the year. It is not clear that this result is intended and CALU plans to review this further with the Ontario tax authorities.
Copyright the Conference for Advanced Life Underwriting, July 2010
Paragraph 27 of Interpretation Bulletin IT-470R, Employees' Fringe Benefits (Consolidated), contains the following statement:
"...where a life insurance salesperson acquires a life insurance policy, a commission received by that salesperson on that policy is not taxable provided the salesperson owns that policy and is obligated to make the required premium payments thereon."
Since the publication of IT-470R, the CRA has modified the above-described administrative position through various technical interpretations and other public statements so that it now applies to both self-employed salespersons as well as those who are employed by a life insurer where the particular salesperson has purchased the particular life insurance policy for personal use rather than investment or business purposes.We understand that the reason for this administrative position is that the commission income in such circumstances is analogous to an employee product discount (i.e., the amount of the commission received by the salesperson is effectively netted against the premium that is payable by the salesperson).
However, recently the Tax Court of Canada (TCC) in Bilodeau v. The Queen, 2009 D.T.C. 1757 addressed the issue of whether commission income received by a life insurance agent on a life insurance policy was taxable. The TCC found that the commission income was fully taxable as business income in the hands of the agent, who was an independent agent and that the CRA's administrative position was misleading.
Question
Can the CRA provide further guidance as to the situations or fact patterns where it may seek to apply the Bilodeau decision rather than following its administrative position as described above?
CRA's Response
As noted in various technical interpretations, including 2009-032451 (F), 2006-019716 (F) and 2001-007065 (F), the CRA had indicated that the administrative position described in paragraph 27 of IT-470R would not apply where the amount of commission income was significant. This position is also consistent with the following comment that appears in paragraph 2 of IT-470R:
"In the second group there may well be a point beyond which the Ôprivilege' concept is no longer valid, i.e., the advantage to the employee is, in fact, a form of remuneration."
Furthermore, the CRA has opined that the administrative position is not intended to apply where the insurance was obtained for investment or business purposes. Accordingly, where based on the facts, circumstances and any other relevant factors, the CRA is of the view that the amount of commission income is significant and/or the particular life insurance policy has an investment component or a business use, the above-described administrative policy will not apply.In respect of the particular situation addressed by the TCC in Bilodeau, the amount of commission income received by the taxpayer ($43,115) was not only significant, the particular life insurance policies acquired by the taxpayer, in our view, appeared to have an investment component (i.e., a cash surrender value). Thus, even though the taxpayer in Bilodeau maintained that the acquisition of the two universal life insurance policies was purely for personal protection, since the commission income on these two policies was clearly substantial and such policies did appear to have an investment component, whether intended by the taxpayer or not, the administrative policy should not have applied.
Given the comments of the TCC in Bilodeau, we have commenced a review of the administrative position in IT-470R. If CALU would like to submit representations in this regard, we will consider them in the course of our review. Any changes to the position will first be published in an Income Tax Technical News with a prospective effective date.
CALU Comment: CALU will be making a submission to the CRA on the tax treatment of commissions earned on personally owned life insurance policies. Further information will be provided to members once this submission has been completed. Fortunately the CRA has indicated that any change in assessing practice will only be prospective in effect. Members should also be aware that the CRA's administrative practice does not apply to commissions earned on personally owned segregated fund contacts as they are considered to be for investment purposes.
Copyright the Conference for Advanced Life Underwriting, July 2010
Proposed subsections 248(35) to (37) of the Act set out special rules for determining the fair market value (FMV) of a property that is subject to a charitable gift for purposes of determining the eligible amount of a gift under subsection 248(31). Proposed paragraph 248(35)(b) provides that the FMV of the gifted property is deemed to be the lesser of its FMV otherwise determined and its cost, or in the case of capital property its ACB immediately before the gift is made, if one of two conditions are met:
(i) The taxpayer acquired the property that is the subject of the gift less than three years before the day that the gift is made (except if the gift is made as a consequence of death), or(ii) The taxpayer acquired the property that is the subject of the gift less than ten years before the day that the gift is made (except if the gift is made as a consequence of death) and it is reasonable to conclude that, at the time the taxpayer acquired the gifted property, one of the main reasons for its acquisition was to make the gift.
Proposed subsection 248(37) excludes several types of gifts from the application of subsection 248(35). However, gifts of interests in life insurance policies are not excluded from the proposed application of subsection 248(35). During the CLHIA Roundtable in May 2009, the CRA confirmed that proposed subsection 248(35) could apply to the gift of an interest in a life insurance policy such that the amount that can be receipted would be the lesser of the policy's "cost" and "fair market value."
In the commentary provided by the CRA it was stated:
The cost of a life insurance policy is a factual determination. While premiums paid to acquire and maintain a life insurance policy may reflect the cost, this may not always be the case. We recognize that the Act does not specifically define the cost of a life insurance policy and we have brought this to the attention of the Department of Finance for consideration."
Where proposed subsection 248(35) is applicable, the draft legislation indicates the FMV of a property in certain situations is deemed to be the lesser of the FMV of the property otherwise determined and the cost. However, in the case of capital property, the FMV is deemed to be the lesser of the FMV otherwise determined and the ACB of the property immediately before the gift is made. Similarly, it would appear that the "adjusted cost basis" of an interest in an insurance policy is a much better proxy for the "cost" of an interest in an insurance policy as it reflects a number of transactions with respect to the policy including the payment of premiums. While this legislation has yet to be enacted it is stated to be effective in respect of gifts made after 6:00 p.m. (EST), Dec. 5, 2003, and most donors and charities have been operating as if this draft legislation is in effect. Therefore, it is important to have greater certainty in determining the "cost" of an interest in a insurance policy for purposes of subsection 248(35).
Question
Could the CRA provide further guidance as to what factors it would consider in determining the "cost" of an interest in an insurance policy for purposes of proposed subsection 248(35)?
CRA's Response
The fair market value of an interest in a life insurance policy otherwise determined and the cost of the interest in the policy must be considered in applying proposed subsection 248(35) to a gift of an interest in a life insurance policy to a qualified donee. As stated by the CRA at the CLHIA Roundtable in May 2009, we recognize that the Act does not specifically define the cost of an interest in a life insurance policy and we have brought this to the attention of the Department of Finance for their consideration.
The ACB to a policyholder of an interest in a life insurance policy is determined by a formula under subsection 148(9). In general terms, the ACB to the original policyholder will be the amount by which the cash premiums paid by the policyholder (excluding premiums for accidental death benefits), and any income in respect of the policy that has previously been reported for tax purposes, exceeds the "net cost of pure insurance" (NCPI) under the policy.
It is our view that the ACB of an interest in a life insurance policy as defined in subsection 148(9) would generally be a reasonable proxy for the "cost" of an interest in a life insurance policy for purposes of the deemed FMV of an interest in a policy under proposed subsection 248(35).
CALU Comment: The CRA's response provides some welcome certainty in terms of determining the "cost" of an insurance policy for purposes of subsections 248(35) to (37). There was a somewhat related question posed at the CRA Roundtable held at the STEP National Meeting on June 8, 2010. The CRA was asked to comment on the following fact pattern:
Assume that an individual shareholder transfers an interest in a life insurance policy to a wholly owned corporation, where the policy has a FMV of $300,000, and no cash surrender value (CSV). The deeming rule in subsection 148(7) provides that such a transfer between non-arm's-length parties is deemed to occur at CSV or zero in this case. Therefore, where the deemed cost of the policy to the corporation is zero, but its FMV is $300,000 and subsection 248(35) applies, would the CRA allow the gift which occurs immediately after the transfer to take place at $300,000?
The CRA expressed the position that in these circumstances the "cost" of the policy would be nil, and assuming subsection 248(35) applied, the charity could not issue a receipt for the gift made by the wholly owned corporation.
Copyright the Conference for Advanced Life Underwriting, July 2010
Charitable remainder trusts (CRTs) have been used in Canada for many years, despite the fact there are no specific rules in the Income Tax Act dealing with such trusts. As written by the CRA in its Registered Charities Newsletter #27:
"A charitable remainder trust involves transferring property to a trust whereby the donor or beneficiary retains a life or income interest in the trust but an irrevocable gift of the residual interest is made to a registered charity. A registered charity can issue an official donation receipt for the fair market value of the residual interest at the time that the residual interest vests in the charity."
In that Charities Newsletter and in Interpretation Bulletin IT-226R, the CRA provides a number of requirements that must be satisfied for there to be a gift of a residual interest. These requirements include an irrevocable transfer of the property, vesting of the property in the charity at the time of transfer, and no ability to encroach on capital for the life tenant. It is also the CRA's view that the gift to a CRT results in a taxable disposition of the entire property. However, the CRA takes the additional view that the donor can elect under subsection 118.1(6) for the proceeds of disposition to be not greater than the FMV of the property and not less than the ACB of the property. In other words, the donor does not have to recognize a gain on the transfer if he or she elects at the ACB of the property. The donation receipt would also be equal to the elected amount. If the FMV of the residual interest of the property is less than the elected amount, the donation receipt, in the CRA's view, cannot be greater than the value of the residual interest.
With the above as background, the provisions in the Income Tax Act for alter ego trusts and joint partner trusts could effectively allow for a CRT if the alter ego beneficiary or the joint partner beneficiaries (as the case may be) do not have any capital encroachment rights and the other requirements for a CRT have been satisfied. As the rules in the Income Tax Act provide for an automatic rollover of certain properties to these trusts (unless the transferor elects out of the rollover rules), the rule in subsection 118.1(6) would not be needed to avoid any gain on the transfer.
Question
If an individual transferred property to an alter ego trust as described in the above paragraph, can the CRA confirm that there would be no recognition of a gain on the transfer of the property and a donation receipt could be issued by the registered charity beneficiary equal to the value of the charity's residual interest?
CRA's Response
Unless an election is made to the contrary, an individual may transfer property to an alter ego trust on a tax-deferred basis under subsection 73(1) provided the transfer is made in the circumstances described in subsections 73(1.01) and 73(1.02). Consequently, where an individual transfers property to an alter ego trust there would generally be no recognition of a capital gain. Consistent with IT-226R, where a gift is made to a registered charity of a residual interest in an alter ego trust, and there is no right to encroach on the trust's capital for the benefit of the settlor, an official donation receipt could be issued by the registered charity beneficiary in an amount equal to the value of the charity's residual interest at the time the particular interest vests, provided the FMV of that interest can otherwise reasonably be established at that time. It should be noted, however, that any accrued capital gains with respect to the trust's capital property as at the end of the day in which the settlor of the trust dies, would be taxed in the trust, pursuant to subsection 104(4) for that year. This factor would be relevant in establishing a reasonable estimate of the value of the residual interest in the trust to the charity at the time the trust is created.
CALU Comment: The CRA's response appears to confirm that an individual may transfer property into an alter ego or joint partner trust on a rollover basis, and obtain a charitable tax receipt equal to the "fair market value" of the gift made to a registered charity as the residual beneficiary of the trust.
However, subsequent to the CALU Roundtable it was brought to our attention that at the 2009 APFF conference the CRA and Finance were asked to deal with a question relating to charitable remainder trusts and the definition of "non- qualifying securities" in section subsection 118.1(8). Paragraph 118.1(18)(b.1) defines a non-qualifying security to be a beneficial interest of the individual in a trust that is affiliated with the individual, or a beneficial interest of the individual in a trust that holds non-qualifying securities. The definition of "excepted gift" would not appear to apply to this type of property even where the underlying assets in the trust would not otherwise be "non-qualifying securities." These rules would therefore prevent the taxpayer from claiming the gift unless it was no longer affiliated with the trust within a five-year period of time after making the gift. This result does not appear to be appropriate where the trust assets would not otherwise be "non-qualifying securities."CALU will be preparing a technical interpretation on this issue and liaising with other interested organizations in the event an amendment is required to the Act to correct this situation.
Copyright the Conference for Advanced Life Underwriting, July 2010
In certain provinces, a licensed insurance advisor is permitted and may agree to pay a portion of the commission he or she has earned as a "rebate" to a client purchasing an insurance policy. The "rebate" effectively reduces the advisor's commission income as well as the amount of the initial premium that is paid by the purchaser for the policy coverage.
Question
Can the CRA confirm the tax treatment of the rebate to the policy purchaser and to the paying advisor? Can the purchaser reduce what would otherwise be his or her ACB for the policy by the amount of the rebate?
CRA's Response
We can confirm that the position taken in Technical Interpretation Letter 2008 Ð 0271381E5 continues to reflect our view of the tax treatment of the rebate to the insurance advisor and the policy purchaser. The insurance advisor will include the full amount of the sales commission in business income pursuant to subsection 9(1) and, except as otherwise limited by the Act (e.g., sections 18 and 67), can deduct the rebate that is paid to the policy purchaser. The policy purchaser will include the rebate in income pursuant to paragraph 12(1)(x). With regard to the second question, we are of the view that there is no basis that would permit the policy purchaser to reduce the ACB of the life insurance policy by the amount of the rebate.
Subsection 148(9) defines the ACB of a life insurance policy and includes in variable A "the total of all amounts each of which is the cost of an interest in the policyÉ". This would include the initial premium paid for the policy. It is our understanding that any rebate paid by the insurance advisor to the policy purchaser would be made independent of the insurance company and would not, in fact, reduce the initial premium paid for the policy. Consequently, the cost of the policy for the purpose of variable A would not be reduced. Variables H through L of the definition of ACB reduce the ACB in a number of situations; however, none of those situations are applicable to the type of rebate in question.
The treatment you have asked for is similar to that provided by the election pursuant to subsection 53(2.1) for an amount that a taxpayer has received in respect of a capital property. This election generally allows the taxpayer to elect to reduce an amount that would otherwise be included in income pursuant to paragraph 12(1)(x), by reducing the ACB of the property in question by the amount so elected pursuant to paragraph 53(2)(s). However, as you indicated, the election does not allow the same treatment to be accorded to the ACB of a life insurance policy.
Absent an election similar to subsection 53(2.1), it is our view that the policy purchaser does not have the option of reducing the ACB of the policy in lieu of including the rebate in income.
CALU Comment: It may come as a surprise to many CALU members that a rebate of commissions will be viewed by the CRA as taxable to the recipient client. It would be wise in these situations to alert clients to the CRA's point of view.
Copyright the Conference for Advanced Life Underwriting, July 2010
In accordance with paragraph 128.1(4)(b), a taxpayer is deemed to dispose of "each property owned by the taxpayer" at the property's FMV when departing Canada. The deemed disposition does not apply to certain specified exceptions. One such exception is for property that is an "excluded right or interest." A life insurance policy, other than a segregated fund policy is defined to be an excluded right or interest under s. 128.1(10)(l). However, where an insurance policy is not a life insurance policy, it appears that there is no similar exclusion and therefore the deemed disposition rules appear to apply. For example, a personally owned disability insurance policy, which provides for specified benefits to be paid in the event of the disability of the insured, would appear to be caught.
As there is no situation where a Canadian resident holder of a disability insurance policy would be required to dispose of their policy and have a realization of "income" for tax purposes, it is arguable that this section should not apply to bring about this result simply because the individual departs from Canada.
Questions
a) Can the CRA please confirm that a disability insurance policy is not subject to the deemed disposition rules in s. 128.1 where an individual ceases to be a resident of Canada?
b) If a disability insurance policy is subject to the deemed disposition rules, can the CRA confirm that the proceeds of disposition would be NIL for the purposes of this provision?
CRA's Response
Paragraph (l) of the definition of "excluded right or interest" in subsection 128.1(10) refers to a "life insurance policy in Canada." Pursuant to subsection 138(12) a "life insurance policy in Canada":
means a life insurance policy issued or effected by an insurer on the life of a person resident in Canada at the time the policy was issued or effected;
Where a disability policy is not an excluded policy because it is not a life insurance policy, it will be deemed to be disposed of for proceeds of disposition equal to the FMV of the policy. Such FMV is a question of fact to be determined in the circumstances. However, paragraph 128.1(4)(b) only requires an amount to be included in income to the extent that there would have been an inclusion had the policy actually been disposed of.
CALU Comment: While a disability policy would appear to be caught by the deemed disposition rules when a taxpayer departs Canada, in most situations there should be no adverse tax consequences under paragraph 128.1(4)(b). This is due to the fact that paragraph 128.1(4)(b) only requires an amount to be included in income to the extent that there would have been an inclusion had the policy actually been disposed of, and it is unlikely there would be any tax payable on the disposition of the policy while the taxpayer resided in Canada.
Copyright the Conference for Advanced Life Underwriting, July 2010
CALU's last three questions were meant for discussion with the CRA and there are no formal written responses to these questions. Please note that the following summary of CRA's responses have not been reviewed or approved by the CRA.
Question 1: Review of Interpretation Bulletins
On several occasions the CRA has announced that it does not intend to keep its interpretation bulletins revised and up to date. Rather, bulletins may be archived or cancelled. However, in our experience and certainly among CALU's members, interpretation bulletins continue to represent a frequently used resource and are viewed as authoritative as to the CRA's administrative and assessing position on a wide number of topics.
While relatively newer resources for determining CRA's administrative and assessing policy such as technical interpretations and the Technical News publication are available, the bulletins continue to provide comprehensive guidance on particular subject matters.
Question
Would the CRA consider an approach that would favour the "survival" of the interpretation bulletin as a primary source for CRA's administrative and assessing policy Ð either through updating and revising some if not all of the bulletins from time to time, or by cataloguing on an updated basis which particular positions in a bulletin are no longer indicative of the CRA's policy? This latter approach would at least preserve parts of an IT, if not all, rather than lead to the cancellation or archiving of a bulletin in its entirety.
Verbal Response
The CRA is having difficulty keeping the various Interpretation Bulletins up to date due to other resource requirements. Much of this information is available through other sources such as advance tax rulings, technical interpretations, technical bulletins and phone services. However, a number of professional groups including the Canadian Institute of Chartered Accountants (CICA) and the Canadian Bar Association (CBA) would prefer that the Interpretation Bulletins be kept updated. The CRA is looking at its resources to see how this might be accomplished.
Note: Subsequent to the CALU Tax Roundtable, the Association provided the CRA with an itemized list of Interpretation Bulletins that it would like to see kept current as they are relied upon by CALU members.
Question 2: Status of CRA Review of 10/8 Insurance Arrangements
At the Canadian Tax Foundation Meeting in November 2009, Wayne Adams, Director General of the Income Tax Rulings Directorate of the Canada Revenue Agency (CRA), indicated that the CRA would confirm its position with respect to 10/8 insurance arrangements by mid-2010.
Question
Can you please provide our members with an update with respect to the CRA's position?
Verbal Response
The CRA is now in the process of reviewing several client situations where a 10/8 insurance arrangement has been implemented. The CRA expects to release its findings and views on these arrangements in the next two to three months.
Question 3: Status of Health and Welfare Trusts
On Feb. 26, 2010, the Department of Finance released new tax proposals to accommodate Employee Life and Health Trusts (ELHT). The proposals (which, if passed, will apply for 2010 forward) create a new type of taxable inter vivos trust that will enable funds to be accumulated within the ELHT from employer contributions for the benefit of employees' health benefits. It would appear that these proposals will replace the administrative material in IT-85R2.
Question
Does the CRA plan to withdraw IT-85R2 if the ELHT proposed legislation is passed?
Verbal Response
The CRA is still considering the potential impact of the new rules to its current administrative practices as set out in IT-85R2. There have been a number of submissions relating to the proposed ELHT rules that also comment on IT-85R2, and these are also being reviewed by the CRA.
Note: At the CRA Update session held at the Canadian Tax Foundation Prairie Province Tax Conference (June 1 - 2, 2010) the CRA noted that the draft ELHT rule only applies to trusts created after 2009, and therefore it would appear that there is still a need for the administrative guidance set out in IT-85R2. At the STEP National Conference CRA Roundtable (June 8, 2010) the CRA reinforced this message by indicating it had no "immediate plans" to withdraw IT-85R2, and would only take this step after taxpayer consultation.
Copyright the Conference for Advanced Life Underwriting, July 2010
[1] CRA Technical Interpretation 2008-0271381E5 dated Feb. 11, 2009.
[2] The ACB of a policy is essentially made up of premiums paid into the policy less the net cost of pure insurance, which is a notional cost of insurance charge specified under the Act. See the definition of "adjusted cost basis" in subsection 148(9) of the Act. Where the death benefit is received by a corporation that did not pay the premium, it has no ACB in the policy and CDA credit would equal the full death benefit.
[3] In establishing the "bona fides" of the arrangement, it is likely equally important to demonstrate the need for the other corporate entity to be the beneficiary of the policy (i.e., to satisfy the terms of a buy-sell agreement).
[4] Wayne Adams, Director General of the Income Tax Rulings Directorate of the Canada Revenue Agency, speaking at the CTF Prairie Province Tax Conference held on June 1 and 2, 2010.
Copyright the Conference for Advanced Life Underwriting, July 2010
First York Insurance Agency Limited, 455 Avenue Road, Suite 100, Toronto, Ontario, M4V 2J2
Tel: (416) 966-9675 Fax: (416) 966-9677
First York is a trade mark of First York Insurance Agency Limited. Web site contents Copyright © 2024. All rights reserved.