28 September 2023 CLHIA Roundtable Q. 3, 2023-0971721C6 - CLHIA 2023 - Shares owned by life interest trust

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: Does subsection 70(5.3) influence the determination of whether a corporate held life insurance policy taints a spousal trust when the shares of a corporation are transferred to the spousal trust for purposes of subsection 70(6)?

Position: Subsection 70(5.3) does not influence the determination of whether a testamentary spousal trust meets the requirements set out in subsection 70(6) of the Act.

Reasons: Subsection 70(5.3) is a valuation provision that only assigns a life insurance policy a fair market value (FMV) equal to the policy's cash surrender value when determining the FMV of any property that is deemed to have been disposed of as a consequence of a particular individual's death or as a consequence of the particular individual becoming or ceasing to be resident in Canada for purposes of subsections 70(5) and 104(4) and section 128.1 of the Act.

CLHIA Roundtable – September 28, 2023

Question 3 - Ownership of Life insurance by a Corporation – Shares owned by a Life Interest Trust

Background

In CRA technical interpretation 2012-0435681C6 dated May 8, 2012, the CRA was asked to comment on several different situations involving the ownership of a life insurance policy to fund tax liabilities arising in a spousal testamentary trust on the death of a spousal beneficiary.

In Question 2.3 the CRA was presented with following hypothetical situation:

Assume Mr. B owns all the shares in a private corporation (Opco B) and that these shares have a significant capital gain. Under Mr. B’s will, on his death the shares are to be transferred to a testamentary spousal trust (the “Trust”), and upon the death of Mrs. B, the Trust is to hold and/or distribute the shares to the surviving children who are active in Opco B.

Opco B has acquired a life insurance policy on the lives of Mr. and Mrs. B under which it is the beneficiary and premium payor. The purpose of the insurance is to create liquidity in the corporation on the death of the survivor of them, which may be accessed by the trustees of the Trust to fund taxes arising on the deemed disposition of the Trust’s assets including the shares of Opco B. The directors of Opco B have signed a resolution requiring Opco B to maintain the insurance policy until the death of the survivor, and to pay out the insurance proceeds to the Trust as a capital and/or taxable dividend. Thus, upon the second death of Mr. and Mrs. B, Opco B would pay a dividend to the Trust funded by the life insurance proceeds, providing the trustees of the Trust with liquidity to fund taxes arising on the deemed disposition of the Trust’s assets, including the shares of Opco B.

The CRA was asked to confirm whether, in this hypothetical situation, the life insurance policy held by Opco B would not taint the testamentary trust for purposes of the rollover of property under subparagraph 70(6)(b)(ii) of the Act. The CRA responded that it was unable to confirm that such a structure would not taint the status of a testamentary trust and also impact the rollover of property under subparagraph 70(6)(b)(ii) of the Act. The CRA stated that this determination was a question of fact and would require a review of all relevant factors.

We would note that in the question posed to the CRA, as well as the CRA’s response, consideration was not given to subsection 70(5.3) of the Act in determining whether Opco B’s ownership of life insurance would taint the testamentary spousal trust.

Subsection 70(5.3) of the Act is a special valuation rule that applies to life insurance policies in circumstances where property is deemed to be disposed of by virtue of subsections 70(5) and 104(4) and section 128.1 of the Act. Generally, under subsection 70(5.3) of the Act where certain deemed dispositions of property occur as a result of the death, immigration or emigration of an individual, in determining the fair market value (FMV) of any property, the FMV of any life insurance policy is deemed to be equal to the policy’s cash surrender value (CSV) as defined in subsection 148(9) of the Act.

A common example of the application of subsection 70(5.3) of the Act is where an individual dies holding all of the shares of a private corporation. In determining the FMV of the deceased’s shares for purposes of subsection 70(5) of the Act, the FMV of any life insurance policy owned by the corporation on the life of the shareholder (or on any other individual not dealing at arm’s length with the particular individual at that time or when the policy was issued) will be deemed to be the CSV of the policy.

Similarly, where a testamentary spousal trust has been established, and the spouse dies, paragraph 104(4)(a) of the Act will deem the trust to have disposed of certain property for proceeds equal to FMV (determined with reference to subsection 70(5.3) of the Act) at the end of that day, and to have reacquired the property immediately after that day for an amount equal to the same FMV. For example, where a testamentary spousal trust owned capital property that are shares of a private corporation, upon the deemed disposition, by the testamentary spousal trust, of such shares arising on the death of the trust’s spousal beneficiary, the FMV of any life insurance policy that the corporation owns on the life of that deceased beneficiary is deemed to be its CSV immediately before death when determining the FMV of the shares of the corporation.

It therefore appears from the interaction between subsections 70(5.3) and 104(4) of the Act that a spousal trust can own shares in a private corporation, which in turn can own life insurance on the life of the surviving spouse, and that such trust would not be tainted by the ownership of those shares.

Question

Given the above analysis, can the CRA confirm that based on the hypothetical situation described in CRA technical interpretation 2012-0435681C6 (and reproduced in the Background), assuming that Opco B is the sole owner, beneficiary and funder of the life insurance policy, that the life insurance policy held by Opco B would not taint the testamentary spousal trust for purposes of the rollover of property under subparagraph 70(6)(b)(ii) of the Act?

CRA Response

Subsection 70(5) of the Act generally provides for a deemed disposition at FMV of each capital property of a taxpayer immediately before the death of the taxpayer, resulting in a realization of any accrued capital gains and/or recapture of capital cost allowance. However, subsection 70(6) of the Act provides for tax-deferred rollover of such property in certain circumstances.

One of the circumstances where the rollover applies is where a capital property of a deceased taxpayer, who was resident in Canada immediately before death, has been transferred or distributed, as a consequence of the death, to a trust for the benefit of the spouse or common-law partner (“spouse or common-law partner trust”), provided certain conditions are met. When subsection 70(6) of the Act applies in the context of a transfer to a spouse or common-law partner trust, the deceased is deemed to have disposed of the property immediately before death and received proceeds equal to its adjusted cost base at that time, and the trust is deemed to have acquired the property at the time of the death at a cost equal to such proceeds, in accordance with paragraph 70(6)(d) of the Act. For subsection 70(6) of the Act to apply in the case of a transfer to a trust, the trust must, among other things, be created by the will of the deceased and be a trust under which the spouse or common-law partner beneficiary (“spousal beneficiary”) is entitled to receive all of the income of the trust that arises during the spousal beneficiary’s lifetime, and no other person may receive or have the use of any income or capital of the trust during the spousal beneficiary’s lifetime. For further information regarding the application of subsection 70(6) of the Act, see Income Tax Folio S6-F4-C1 – Testamentary Spouse or Common-law Partner Trusts.

Generally, paragraph 104(4)(a) of the Act provides for a deemed disposition of all non-depreciable capital property and land inventory of certain trusts for FMV (determined with reference to subsection 70(5.3) of the Act, where applicable) and for a deemed reacquisition of such property for the same value, at the specified times referred to in the provision, where certain conditions are met. Where the trust is a spouse or common law partner trust described in subparagraph 104(4)(a)(i) or (i.1) of the Act, the trust must be one under which the spousal beneficiary was entitled to receive all of the income of the trust that arose before the spousal beneficiary’s death and no person except the spousal beneficiary could, before the spousal beneficiary’s death, receive or otherwise obtain the use of any of the income or capital of the trust, in accordance with subparagraph 104(4)(a)(iii) of the Act. For such trusts, a deemed disposition occurs on the day on which the spousal beneficiary dies.

Subsection 70(5.3) of the Act is a valuation provision that applies where a life insurance policy is relevant to determining the FMV of a property deemed disposed of under subsections 70(5) and 104(4) and section 128.1 of the Act. In this regard, the FMV of such property is determined under subsection 70(5.3) of the Act as if the FMV of the policy were the policy’s CSV immediately before the taxpayer’s death or change in residence, as the case may be.

In other words, subsection 70(5.3) of the Act assigns a life insurance policy a FMV equal to the policy’s CSV to determine the FMV of any property that is deemed to have been disposed of as a consequence of a particular individual’s death or as a consequence of the particular individual becoming or ceasing to be resident in Canada for purposes of subsections 70(5) and 104(4) and section 128.1 of the Act.

In our view, subsection 70(5.3) does not influence the determination of whether a testamentary spousal trust meets the requirements set out in subsection 70(6) of the Act. Consequently, our response to the hypothetical situation described in Question 2.3 of document 2012-0435681C6 remains unchanged. The determination of whether a testamentary spouse or common-law partner trust is tainted remains a question of fact.

Steven Szilagyi
2023-097172
September 28, 2023