Section 148

Regarding the taxation of prescribed and non-prescribed annuity contracts on the death of the holder and annuitant (the "Annuitant"), the Directorate referred to ss. 148(2)(b) and (c), and then stated:

[O]n the death of a prescribed annuity contract holder, the deemed disposition rule in paragraph 148(2)(b) does not apply. …

If the annuity contract provides that on the death of the Annuitant, the Estate continues to receive the annuity amounts but also has the option to terminate the annuity contract and receive a lump sum, there will be a disposition of the prescribed annuity contract by the Estate when it makes the election.

The will of Mr. Donor provided for a gift of his life insurance policy on the life of his daughter to a private foundation. On his death, the policy had a cash surrender value (CSV), adjusted cost basis (ACB) and fair market value (FMV) of $200,000, $50,000 and $500,000, respectively. This gift was made by his graduated rate estate within three years of his death. Does this gift generate a gain under s. 148(7) of $150,000 (being the CSV excess over ACB)? CRA responded:

To the extent that the $200,000 CSV represents the "value" of the interest within the meaning of subsection 148(9), Mr. Donor will be deemed to have become entitled to receive proceeds of disposition equal to $200,000 (the greatest of (i) the value of the interest to Mr. Donor ($200,000), (ii) the FMV of the consideration given for the interest ($0) and (iii) the ACB of the interest to Mr. Donor ($50,000)). …[A] gain of $150,000 … in respect of the disposition of … the policy should be included in computing his income for the taxation year of his death … .

Mr. X holds the preferred shares of Opco with a redemption value of $1 million, and adjusted cost base and paid-up capital of $1, and a family trust holds the common shares. Opco owns a $1 million life insurance policy on the life of Mr. X with a cash surrender value of $500, adjusted cost basis (ACB) of $50,000 and fair market value $450,000. If the Policy is transferred to Mr. X as a dividend in kind on his preferred shares, what would be the proceeds of the disposition of the Policy to Opco, the income inclusion to Mr. X and the ACB of the Policy to Mr. X? CRA responded:

[P]aragraph 148(7)(a) would apply to deem the proceeds of the disposition to Opco to equal $50,000 (the greatest of CSV ($500), consideration (nil) and ACB ($50,000)), resulting in a policy gain of nil. Mr. X would be deemed to acquire the interest in the Policy at $50,000 pursuant to paragraph 148(7)(b). At the same time, subsection 82(1) would result in an income inclusion to Mr. X…[of] $450,000 plus a gross up… .

In cases where the FMV of the interest in the life insurance policy is greater than the ACB of that interest, subsection 148(7) provides for a transfer of the interest on a rollover basis (assuming that the consideration given for that interest and the CSV are equal to or less than the ACB). Notwithstanding that the shareholder will have an ACB in the policy that is less than FMV, it is not clear that this result is intended in terms of tax policy. We have brought this situation to the attention of the Department of Finance for their consideration.

Holdco, which was the holder and beneficiary of a life insurance policy on the life of its sole shareholder, transferred the policy to him as a dividend in kind. The adjusted cost basis (“ACB”), cash surrender value and fair market value (“FMV”) of the policy were $200,000, $240,000 and $450,000, respectively. Would the proceeds of disposition of the policy be determined on the basis that no consideration was given for the transferred policy? CRA responded that s. 148(7)(a) applied to deem Holdco:

to have become entitled to receive proceeds of disposition equal to $240,000 (the greater of (i) the cash surrender value of the interest ($240,000), (ii) the FMV of any consideration for the interest (N/A), and (iii) the ACB of the interest to Holdco ($200,000).) The result would be a gain to Holdco of $40,000… . Mr. X… would be deemed to acquire his interest in the policy for $240,000. In addition, pursuant to… subsection 82(1), Mr. X should include in his income an amount equal to the FMV of the interest in the policy ($450,000), but as increased in accordance with paragraph 82(1)(b).

…[T]he gain on the disposition of the interest in the policy that Holdco must include in computing its income is less than that which it would have been required to include had it instead sold its interest to Mr. X at its FMV. … We have brought this situation to the attention of the Department of Finance.

(a) Mr. X, who has for a number of years been the policy holder of a term life insurance policy (for 100 years) without a cash surrender value and an adjusted cost basis of $10,000, transfers the policy to his wholly-owned corporation (ABC Inc.) for no consideration, so that it becomes the policyholder and beneficiary and assumes the premium-payment obligations. Would Mr. X’s proceeds of disposition under proposed s. 148(7)(a) be $10,000 given that there is no “consideration…given” and that s. 69(1)(b) only deems proceeds to have been “received”?

(b) At the 2005 CALU Roundtable, CRA indicated that s. 69(5) (respecting a s. 88(2) wind-up) prevailed over s. 148(7). However, in 920437, CRA indicated that s. 148(7) prevailed over the more general rule in s. 52(2). Is CRA prepared to recognize the primacy of s. 148(7) given its specific nature?

CRA responded:

Since the preamble to subsection 69(1) provides that it is applicable "except as expressly otherwise provided in this Act," it follows that proposed paragraph 148(7)(a) prevails over paragraph 69(1)( b).

Given the above, Mr. X is deemed to have become entitled to receive proceeds of disposition equal to $10,000 under proposed paragraph 148(7)(a).

Respecting (b), CRA stated:

Given the…limited scope of the proposed amendments with respect to the disposition of an interest in a life insurance policy, the CRA is of the view that the comments made at the two Roundtables are still valid.

As a result of employee B no longer being considered to be a key employee, her employer (Corporation A) transfers its “key person” permanent life insurance policy on her life to her for nominal consideration. At the transfer time, the death benefit, cash surrender value and ACB are $1 million, $50,000 and $20,000, respectively. The policy FMV equals its CSV.

Does the transfer engage s. 6 or 148(7) or in Corporation A having to report a gain on disposition of the policy? After finding that s. 6(1)(a) applied to the employee and that s. 148(7) applied to the transfer, CRA stated:

Under paragraph 56(1)(j) and subsection 148(1), Corporation A would report a policy gain of $30,000. This policy gain is computed as the greatest of the three amounts described in paragraph 148(7)(a), which would be the CSV of $50,000, less the ACB of the policy of $20,000. …

Under paragraph 148(7)(b), Employee B will be deemed to have acquired the policy at a cost of $50,000 (which is the amount determined under paragraph 148(7)(a)).

[T]he net cost of pure insurance (the "NCPI")… represents the cost the policyholder paid to be covered by insurance during the time he or she held the policy. The reduction of ACB by NCPI applies to life insurance policies acquired after December 1, 1982.

…In the case of a pre-December 2, 1982 life insurance policy, the full amount of the premiums paid is included in the calculation of the ACB and there is no reduction in respect of the NCPI. However, certain changes made to a pre-December 2, 1982 policy may cause it to lose this favourable treatment (e.g., where after December 1, 1982, a premium is paid under the policy which was not fixed on or before that date, and either (a) the policy is not an exempt policy, or (b) there has been a prescribed increase in any benefit on death under the policy).

A corporate policyholder and beneficiary of an exempt universal life policy on the life of one of its key shareholder pays the premiums on the policy and then receives a cash withdrawal from the policy, which the insurer advises is a policy loan. CRA provided a general discussion, including the following:

The ACB of a policyholder's interest in a life insurance policy is determined at any particular time by a formula under subsection 148(9) of the Act. In very general terms, the ACB will be the amount by which the cash premiums paid by the policyholder, and any income in respect of the policy that has previously been reported for tax purposes exceeds the net cost of pure insurance under the policy.

Furthermore, proceeds of the disposition in respect of a policy loan will reduce the ACB and a gain resulting from a policy loan will increase the ACB. Note that policy loan repayments that were not deductible under paragraph 60(s) of the Act (as described below) will be added to the ACB, to a maximum of the proceeds of the disposition in respect of the loan.

In the course of a general response to a question as to which insufficient facts were provided, CRA stated:

Subsection 148(9) defines the "adjusted cost basis" to a policyholder at a particular of the policyholder’s interest in a life insurance policy. The description of D in the definition provides, inter alia, for the addition of the total of all amounts each of which is an amount in respect of the policyholder’s interest in the policy that was, pursuant to section 12.2, included in computing the policyholder’s income for any taxation year ending before that time.

In a situation where there is a disposition of an interest in a policy immediately after the anniversary day of the same taxation year, we are of the view that the adjusted cost basis immediately before the time of disposition would not include the amount included in income pursuant to subsection 12.2(1) for the year.

A corporation held a life insurance policy on an individual who was a senior executive and shareholder. The death benefit of $1,000,000 was payable to the policyholder (the corporation). The policy had a cash surrender value of $125,000, an adjusted cost basis of $50,000 and a fair market value of $125,000.

CCRA confirmed the following consequences of the transfer of the policy by the corporation to the individual for no consideration:

• Pursuant to s. 148(1), the corporation was required to include $75,000 in income, being the excess of the deemed proceeds of disposition under s. 148(7) over the policy ACB ($125,000 - $50,000).
• The individual was required to include the policy FMV of $125,000 in income pursuant to s. 6(1)(a) or 15(1).
• If the policy was transferred to the individual qua employee rather than shareholder, the $125,000 value could be deducted by the corporation in computing its income.
• Pursuant to s. 148(7), the individual was deemed to have acquired the policy at a cost equal to its FMV of $125,000.

In rejecting a suggestion that the ACB was further increased by the full amount included in the individual’s income under s. 6(1)(a) or 15(1), CCRA stated:

• Where the FMV and CSV of a policy are identical, no amount is to be added to the ACB of the policy under variable C of the definition of ACB in subsection 148(9).
• Where:

(a) subsection 148(7) applies to the transaction,
(b) the FMV of the policy exceeds its CSV, and
(c) the transferee is required pursuant to subsection 15(1) or paragraph 6(1)(a) to include an amount in respect of the transfer in computing the transferee’s income,

the CCRA would allow the excess of the FMV of the policy over its CSV to be added in computing the ACB to the transferee.

A private corporation acquires (and becomes the policyholder of) a permanent life insurance policy on the life of one of its shareholders, pays the premiums on the policy for 12 years, then transfers the policy without consideration to the shareholder who, two years later, after having taken over the premium payments, cancels the policy.

CCRA indicated that on the transfer, the corporation was required by s. 148(7) to include an amount pursuant to s. 148(1) if the cash surrender value exceeded the ACB at the time of transfer and that the amount of the benefit to be included in computing the shareholder's income pursuant to s. 15 (1) equaled the excess of the policy’s FMV over any consideration paid.

Regarding the shareholder's ACB under s. 148(9), the amount of the cash surrender value, deemed to be the cost of the interest in the life insurance policy pursuant to s. 148(7), was included in Variable A of the ACB calculation. In addition, the amount by which the FMV of the policy included pursuant to s. 15(1) exceeded the cash surrender value was to be included in the ACB calculation – so that the policy’s ACB consequent on the transfer would be equal to the FMV of the policy.

Where one private company is the beneficiary of a life insurance policy taken out by a second holding company on the life of that second company's sole shareholder, the ACB of the policy to the first company would be nil because it was not the policy holder. Accordingly, the full amount of the insurance proceeds would be added to its capital dividend account.

Where an individual owns a life insurance policy and pays the premiums, there will be no addition to the corporation's adjusted cost basis of the policy because that paragraph creates a cost base only for the policyholder.

Regarding whether an endorsement to provide a new benefit under an in-force exempt life insurance policy for no cost and without any underwriting requirement, to a defined set of policyholders, would constitute a disposition, CRA stated:

[I]t is necessary to determine whether the changes that are made to the terms of the policy, including but not limited to endorsements providing additional benefits, are so fundamental as to go to the root of the policy. If this were the result, there would be a disposition of the policy and the acquisition of a new policy.

Where a policy is silent with respect to a particular type of change, the amending of the policy, if a material change, could result in a disposition of the existing policy and the acquisition of a new policy at law. [This] is a mixed question of fact and law … .

An individual owning a policy on that individual’s life with coverage of $1 million, a cash surrender value (“CSV”) of $250,000 and an adjusted cost basis ("ACB") of $150,000, donates ½ of the individual’s interest in the policy to a registered charity or, alternatively, only donates ½ of the entitlement to the CSV. How is the gain under s. 148(7) computed? CRA responded:

[T]he donor will wish to ensure that a new policy is not created and that the portion of the policy the individual wishes to donate has been fully assigned in order to qualify for a donation tax credit. …

… [I]t would be necessary to determine, inter alia, whether the gift of a portion of the policy can be made without resulting, for the purposes of the applicable private law, in a disposition of the entire interest in the policy rather than just a portion of it. On the other hand, where a gift to a person of a portion of an interest in a policy is intended to establish a type of arrangement commonly referred to as a life insurance interest sharing strategy (and assuming that such a sharing is possible without resulting in a disposition of the entire interest in the policy), in addition, it would be necessary to determine whether it is possible to determine what fraction of the whole represents the portion assigned to the donee and also whether, as a result of the assignment, the donor and donee would be joint policyholders or, rather, each would own a separate policy.

Respecting the exercise by a policyholder of a contractual right to split a universal life insurance policy covering two lives into two policies, CRA indicated that whether there was a disposition on general principles (before looking at s. 148(10)(d)) turned on whether “the changes that are made to the terms of the policy…are so fundamental as to go to the root of the policy.”

While not legally obligated to provide funding to terminally ill policyholders with a life expectancy of less than 24 months, life insurers are considering providing loans to such policyholders out of their general funds and receiving an assignment of the life insurance policy as security for the loan. The payment of the loan proceeds would not result in a disposition of the life insurance policy. (However, where such a loan is provided for under the terms and conditions of the life insurance policy, the loan would be a "policy loan" and would result in a disposition.)

Re: whether the conversion of a deferred annuity contract into a prescribed annuity contract would constitute a disposition of the deferred annuity contract.

A rider to a term life insurance policy amended the policy (in a manner not contemplated in the original policy) to provide that the premiums would no longer escalate over the balance of the first six years of the term and that there would be a resulting reduction in the amount insured by the policy. After the taxpayer’s death, and in connection with a capital dividend account computation, the taxpayer’s representatives took the view that this amendment resulted in the policy’s disposition, so that the adjusted cost basis of the “new” policy only reflected the premiums that had been paid subsequently to the amendment. In finding that there had been no disposition, the Directorate stated:

For the purposes of civil law, each individual has the right to modify the effects of the obligation and to extinguish it, in agreement with the individual’s co-contractor. Furthermore, the right to modify a contract without that possibility being expressly provided for in advance is a universally recognized principle of civil law.

[W]e cannot conclude from the sections of the CCLC dealing with obligations that the effect of the amendments to the life insurance policy would be to cancel the policy and create a second one. …

[I]t seems difficult to argue that the parties intended to create a new contract. Rather, the intention of the parties appears to have been to make a simple modification to the existing contract.

An amendment to a group insurance policy to pay special disability benefits either as an advance or as a claim in itself would not result in a disposition of the policy provided the death benefit is reduced by the amount of the special benefit but is not otherwise altered, and there is no additional cost to the policyholder/employer or the insured.

The furnishing of outstanding instructions or the making of an election by a policyholder with respect to future withdrawals would not normally constitute a disposition.

A payment received by a policyholder under a mortgage life insurance policy equal to 10 years of premiums paid under the policy will be considered to be proceeds of disposition of a part interest in the policy.

Under the terms of a universal life insurance policy, the policyholder may withdraw an amount, which reduces the amount of the benefit payable at death and the policy cash surrender value - but the withdrawal is not referred to as a "policy loan" in the policy.

Can the withdrawal be considered a "policy loan"? CCRA responded:

Even if the withdrawal is not referred to as a "policy loan" under the terms and conditions of the policy, this does not mean that the withdrawal is not a "policy loan" … .

The definition of "policy loan" is broad enough to allow for this interpretation, as it defines "policy loan" as "an amount advanced by an insurer to a policyholder in accordance with the terms and conditions of the life insurance policy.

Regarding a life insurance policy pledged by the taxpayer’s corporation to borrow from a bank a series of amounts to be repaid only after the taxpayer’s death from the proceeds of the policy, CCRA indicated that it could be argued that s. 245(2) applied “where financial products are backed by interdependent loans (for example, a life insurance policy and a loan) and more particularly where there is no obligation to repay the loan in question and the related interest before death.”

A loan made by an insurance company to a policy holder under a formal agreement similar to that used by a bank or trust company nonetheless would be considered to be a policy loan if the loan need not be repaid until the death of the insured, or where the loan agreement and the policy appear to be so interdependent as to constitute a single agreement.

A corporate policyholder and beneficiary of an exempt universal life policy on the life of one of its key shareholder pays the premiums on the policy and then receives a cash withdrawal from the policy, which the insurer advises is a policy loan. CRA provided a general discussion, including the following:

The "proceeds of the disposition" of an interest in a life insurance policy is defined in subsection 148(9) of the Act as the amount of the proceeds that the policyholder is entitled to receive on the disposition. Where the disposition is the result of a policy loan, the proceeds of the disposition is the lesser of the following amounts:

• a) the amount of the loan, other than the portion of the loan used to pay a premium under the policy, as provided for under the terms and conditions of the policy, and
• b) the amount, if any, by which the cash surrender value of the policy before the loan was made exceeds the total of the balances outstanding at that time of any policy loans in respect of the policy.

Does a taxpayer have to include an amount in computing income when settling the taxpayer's life insurance policy at age 65 (before death)? In responding affirmatively, CRA stated:

[T]he disposition of an interest in a life insurance policy includes the dissolution of that interest by virtue of the maturity of the policy. …

In general, the proceeds of disposition of an interest in a life insurance policy correspond to the amount of the proceeds that the policyholder is entitled to receive on a disposition of an interest in the policy. …

The amount of the proceeds of disposition of an interest due to maturity and the adjusted cost basis are amounts that only the insurer can establish because it has all the necessary elements for that purpose.

In the course of a general discussion, CRA stated:

An insurance policyholder who disposes of an interest in a life insurance policy must include in computing income under subsection 148(1) and paragraph 56(1)(j) ... the amount by which the proceeds of disposition of the policyholder's interest in the policy that the policyholder is entitled to receive in the year exceed the policyholder's adjusted cost basis in that interest immediately before the disposition. This income inclusion applies whether or not the policy is an exempt policy, as defined in section 306 of the Regulations.

In general terms, the proceeds of disposition of an interest in a life insurance policy are the amount of proceeds that the policyholder, beneficiary or assignee is entitled to receive on the disposition of the interest in the policy. The disposition of an interest in a life insurance policy includes the termination of that interest due to the maturity of the policy.

The taxpayer is the policyholder of a universal life insurance policy providing life insurance coverage on the lives of the taxpayer and the taxpayer’s child (“additional insured”). Both coverages have cost of insurance charges that apply for 10 years and coverage as long as the life insured is alive, and guaranteed cash values. The policy gives the policyholder the contractual right to split the coverage by setting up a separate policy respecting the child that has the same death benefit, same cost of insurance charges and same guaranteed cash values. In exercising this right, the policyholder opts to be the owner of the separate policy rather than the child. Does the exercise of this contractual right result in a disposition under s. 148(1)?

After noting the definition of disposition in s. 148(9) and before declining to answer the question in the absence of a review of the policy, CRA stated:

In order to give meaning to the word "only" [in s. 148(10)(d)], it… is necessary to determine whether the changes that are made to the terms of the policy, including but not limited to the premium structure, are so fundamental as to go to the root of the policy. If this were the result, there would be a disposition of the policy… .

…The Act does not contemplate the splitting of a multiple life insurance policy into separate policies. Accordingly, …the objective of introducing paragraph 148(10)(d)… was not to provide for a non-disposition of the policy in these circumstances.

If a corporation which is the owner and beneficiary of a life insurance policy changes the beneficiary to its subsidiary, does this change result in the disposition of the policy? CRA responded:

[A] disposition by operation of law alone can occur if a change to the existing contract results in the creation of a new contract under the Civil Code of Québec. … According to paragraph 148(10)(d), a policyholder is deemed not to have disposed of or acquired an interest in a life insurance policy as a result only of the exercise of any provision of the policy. Generally, the … CRA … considers that the change of beneficiary, in and of itself, does not constitute an amendment that results in a disposition of the life insurance policy.