1 May 2009 Roundtable, 2009-0316671C6 - Criss-Cross Buy Sell Life Insurance Arrangement

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: A series of questions regarding the tax implications of a series of transactions involving policy loans, transfers of policies and repayments of policy loans.

Position: The "value" of a policy at any particular time will depend upon the facts of the particular situation. Generally, the taking of a policy loan will result in a taxable gain to the extent the amount of the loan exceeds the adjusted cost basis of the policy; the transfer of a policy in circumstances to which subsection 148(7) applies will result in the transferor being considered to have received proceeds of disposition on the transfer equal to the "value" of the policy at that time and the transferee will be considered to have acquired the policy for an amount equal to that "value"; the repayment of a policy loan where the amount of the repayment has been included in the taxpayer's income for the current or a previous taxation year will be deductible to the extent it had been so included. Application of GAAR should be considered.

Reasons: The legislation

CLHIA ROUNDTABLE - MAY 2009

Question #5

Criss-Cross Buy Sell Arrangement and Policyholder Tax

Facts

Two shareholders (A and B) of a corporation enter into a buy-sell agreement where the criss-cross purchase method is used. Under this method, A is the policyholder, premium payer and beneficiary of a policy on the life of B, and B is the owner, premium payer and beneficiary of a policy on the life of A. The company A and B own is sold. Consequently, there is no longer a need for life insurance on their lives for buy-sell purposes. However, both A and B personally have a need for life insurance on their own lives and they decide to transfer ownership of the policies to the life insured on each respective policy. Both policies are in a policy gain position under section 148 of the Act as shown by the cash surrender values ("CSV") and adjusted cost basis ("ACB") of the policies below.

Life Insured 	CSV	ACB	Policy Gain
A	$76,000	$22,000	$54,000
B	$84,000	$33,000	$51,000

Step A: In 2009, A takes out a policy loan of $84,000 on the policy on B's life. Under section 148 of the Act, the policy gain of $51,000 would have to be declared as income on A's income tax return. After the policy loan, the amount that would be payable on surrender of the policy would be zero. As a result, the "value" (as that term is defined in subsection. 148(9) of the Act) would be zero and the ACB would be zero.

Question A: Would the CRA agree that the tax results stated above are correct?

CRA Response A: It is our view that the policy loan of $84,000 would be a "disposition" of an interest in the policy pursuant to paragraph (b) of the definition of "disposition" in subsection 148(9) of the Act. If the ACB of the policy owned by A was $33,000 immediately before the policy loan was taken, we would agree that under section 148 of the Act, a policy gain of $51,000 would have to be declared as income on A's income tax return, and that the ACB of the policy immediately after the policy loan would be zero. The "value" (as that term is defined in ss. 148(9) of the Act) of a policy at any particular time is a question of fact. "Value" is defined in subsection 148(9) of the Act, for the purposes of section 148 of the Act, to generally be the amount that the holder of the interest in the policy would be entitled to receive on the surrender of the policy if the interest disposed of includes an interest in the CSV of the policy, and in any other case to be nil. If A would not be entitled to receive any amount on the surrender of the policy, we would agree that the "value" of the policy at that time would be zero.

Step B: A absolutely assigns the policy to B for no consideration. A would not incur any additional policy gain because the proceeds of disposition would be deemed to be zero under subsection 148(7). B would own the policy on his own life with a value of zero and an ACB of zero.

Question B: Would the CRA agree that the tax results stated above are correct?

CRA Response B: Where A assigns the policy to B for no consideration such that subsection 148(7) of the Act applies to the transfer, the legislation provides that A will be considered to have received proceeds of disposition on the transfer in an amount equal to the "value" of A's interest in the policy at the time of the transfer. Subsection 148(7) of the Act further provides that B will be considered to have acquired the policy for an amount equal to that same "value". As noted above, the "value" of a policy at any particular time is a question of fact. If the "value" of the policy (as defined in subsection 148(7) of the Act) at the time of the transfer is zero we agree that A would not incur an additional policy gain and that the ACB of the policy to B, immediately after the transfer, would be zero.

Step C: At the same time as the above transaction, B takes out a policy loan of $76,000, with a resulting policy gain of $54,000. B absolutely assigns the policy to A for no consideration. After the policy loan, the amount that would be payable on surrender of the policy would be zero. B would not have any further policy gain from the transfer of ownership and A would own the policy on his own life with a value of zero and an ACB of zero.

Question C: Would the CRA agree that the tax results stated above are correct?

CRA Response C: The comments made in Responses A and B would equally apply to Question C.

Step D: Later in 2009, A uses $51,000 of the cash received from the loan on the policy on B's life and repays that policy loan (the policy on B's life is now owned by B). Paragraph 60(s) of the Act states:

Repayment of policy loan - the total of all repayments made by the taxpayer in the year in respect of a policy loan (within the meaning assigned by subsection 148(9)) made under a life insurance policy, not exceeding the amount, if any, by which
(i) the total of all amounts required by subsection 148(1) to be included in computing the taxpayer's income for the year or a preceding taxation year from a disposition described in paragraph (b) of the definition "disposition" in subsection 148(9) in respect of that policy
exceeds
(ii) the total of all repayments made by the taxpayer in respect of the policy loan that were deductible in computing the taxpayer's income for a preceding taxation year;

The above paragraph requires that the taxpayer who makes the repayment of the policy loan be the same taxpayer who had to include the policy gain that arose by taking the policy loan in his income. In this example, A was the taxpayer who had to include the $51,000 in his income and he is the one who made the repayment; therefore, he is entitled to the deduction under paragraph 60(s) of the Act.

B continues to own the policy and it has a value of $51,000 and an ACB of zero.

Question D: Would the CRA agree that the tax results stated above are correct?

CRA Response D: Where A is required to include the $51,000 policy gain in computing income as a consequence of having received an $84,000 policy loan, and A repays $51,000 of that policy loan, assuming no other policy loan repayments made by A, we agree that A would be entitled to claim a deduction for the $51,000 policy loan repayment pursuant to paragraph 60(s) of the Act. It is also our view that the fact that A has made the partial repayment of an outstanding policy loan under a policy owned by B at the time of the repayment, will not factor into the ACB of the interest in the policy now owned by B. Again, the "value" of a life insurance policy at any particular time is a question of fact.

Step E: At the same time as Scenario D is completed, B uses $54,000 of the cash received from the loan on the policy on A's life and repays that policy loan (the policy on A's life is now owned by A). B is entitled to deduction of $54,000 under paragraph 60(s) of the Act. A owns the policy with a value of $54,000 and an ACB of zero.

Question E: Would the CRA agree that the tax results stated above are correct?

CRA Response E: The comments made under Response D equally apply to Question E.

CRA General Comments

The transactions described above are intended to provide for the transfer of insurance policies in circumstances to which subsection 148(7) of the Act applies, without tax arising on tax deferred surpluses that have accumulated within the policies. We have discussed this situation with the Department of Finance which is reviewing the policy implications of this and other tax-motivated or tax-planned transactions involving life insurance policies. The possible application of section 245 of the Act should also be considered.

2009-031667
Alison Campbell
May 1, 2009