30 September 1994 Internal T.I. 9414527 - BORROWINGS & EXCESS INSURANCE COLLATERAL

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

RULINGS DIRECTORATE
CORRESPONDENCE SUMMARY

Principal Issues:

WHETHER COLLATERAL IN EXCESS OF THE LOAN AMOUNT IS RELEVANT IN DETERMINING A DEDUCTION UNDER PARAGRAPH 20(1)(e.2) OF THE INCOME TAX ACT.

Position TAKEN:

EXCESS COLLATERAL IS NOT DIRECTLY RELEVANT TO THE DETERMINATION OF A DEDUCTION UNDER PARAGRAPH 20(1)(e.2). HOWEVER THE PRESENCE OF OTHER COLLATERAL SECURITY MAY BRING INTO QUESTION THE ISSUE OF WHETHER AN ASSIGNMENT OF INSURANCE REPRESENTS A "GENUINE REQUIREMENT" OF THE BORROWING AND THEREFORE MEETS THE CONDITION OF CLAUSE 20(1)(e.2)(i)(C).

Reasons FOR POSITION TAKEN:

LEGISLATION - PARAGRAPH 20(1)(e.2)

			September 30, 1994

	VANCOUVER DISTRICT OFFICE	HEAD OFFICE
	Audit 442-23	Rulings Directorate
G. Donell
	Attention:  Tom Markota	(613) 957-8953

			941452

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This is in reply to your memorandum of May 27, 1994 concerning the application of paragraph 20(1)(e.2) of the Income Tax Act (the "Act") to the above-mentioned corporate taxpayer in a case where a restricted financial institution ("RFI") as defined in subsection 248(1) of the Act, before granting a loan, requires the provision of assets and an assignment of life insurance as collateral security against a specific borrowing such that the face value of insurance coverage plus the total realizable value of all other collateral exceeds the loan balance ("excess collateral"). Specifically you have asked for our opinion on whether the issue of excess collateral is relevant to a determination of a deduction under paragraph 20(1)(e.2). In addition you have asked for our view of the word "required" as used in the context of clause 20(1)(e.2)(i)(C) of the Act.

You propose to disallow the deduction of life insurance premiums payable on a policy assigned to a "RFI". The total realizable value of other collateral is more than sufficient for the RFI to fully realize upon the debt. It is your view, when determining a deduction under paragraph 20(1)(e.2) of the Act, the existence of a clause in a loan agreement or letter of understanding issued by the RFI that requires the assignment of a life insurance policy as additional collateral should not be determinative. Furthermore in your view the life insurance premiums payable by XXXXXXXXXX are excessive and therefore no deduction should be allowed under paragraph 20(1)(e.2) of the Act with respect to these amounts.

In their letter of May 12, 1994, XXXXXXXXXX representatives, acknowledge that the introduction of paragraph 20(1)(e.2) of the Act does codify, with modification, the previous departmental position contained in IT-309R ("Expense of borrowing money - Life insurance premiums", January 10, 1979). However, in their view, unlike the IT position, the legislation does not provide for the reduction or denial of insurance premiums on the basis that other collateral is present. Furthermore they question whether the postamble to paragraph 20(1)(e.2) of the Act, specifically the words "...as can reasonably be considered to relate to the amount owing from time to time during the year...", are broad enough to support an interpretation that otherwise deductible insurance premiums be proportionately reduced to the extent that the face value of the policy exceeds the average loan balance outstanding at a given point in time.

Paragraph 20(1)(e.2) of the Act, is applicable with respect to premiums payable, after 1989, by a taxpayer on a life insurance policy where:

(1) An interest in the life insurance policy is assigned to a RFI in the course of a borrowing from that RFI,

(2) the interest payable in respect of the borrowing is or would, but for subsections 18(2) and (3.1) and sections 21 and 28, be deductible in computing the taxpayer's income for the year, and

(3) the assignment referred to in (1) is required by the RFI as collateral for the borrowing.

Where the above conditions are satisfied, the amount eligible for deduction under paragraph 20(1)(e.2) of the Act is the lesser of:

(a) the premiums payable under the policy in respect of the year, and

(b) the net cost of pure insurance ("NCPI") under the policy for the year, as determined in accordance with section 308 of the Income Tax Regulations,

as may reasonably be considered to relate to the amount owing from time to time during the year by the taxpayer to the RFI under the borrowing.

The words of paragraph 20(1)(e.2) of the Act do not directly allow for the consideration of other collateral, regardless of amount, in the determination of deductible life insurance premiums. The only direct limitation, assuming that all of the conditions of subparagraph 20(1)(e.2)(i) of the Act, are satisfied, that will reduce or deny a deduction are contained in the words of the postamble ("...as can reasonably be considered to relate to the amount owing from time to time during the year..."). These words provide an overriding legislative constraint that serves to limit the deductible amount to the portion of the premium that logically, rationally or plausibly may be regarded as bearing a relationship to the amount of the borrowing. For example, where the life insurance coverage under the assigned policy is $500,000 and the average balance owing under the borrowing is $200,000, the amount deductible under paragraph 20(1)(e.2) of the Act is limited to 40% of the lesser of the premiums payable and the NCPI under the policy for the year. That is since the average loan amount for the year is only $200,000 the deductible amount is limited to $200,000 of insurance coverage or, in this case, 40% of the policy premiums. Technically this result would not change if the borrowing was covered by the pledging of other collateral.

As indicated paragraph 20(1)(e.2) of the Act permits a deduction where the three conditions enumerated in clauses 20(1)(e.2)(i)(A) to (C) are met. Clauses 20(1)(e.2)(i)(A) and (C) are inextricably linked and together ensure that an assignment of insurance is a requirement of the borrowing. The Shorter Oxford English Dictionary defines "require/required" as "...implying a demand on the part of one person and the performance of some action by the recipient of the demand. It is also defined as "an imperative without which something would fail". In other words, there must be a genuine requirement to provide the specified amount of collateral insurance. It is our opinion that the requirement referred to in clause 20(1)(e.2)(i)(C) of the Act should be genuine and critical to the granting such that, without the assignment, the borrower would be unable to obtain the borrowing.

It is not enough that the lender simply accept an assignment of insurance where none has been requested; that the borrower offers the insurance without a formal demand; or that the terms and conditions of the borrowing remain intact and unaltered when the lender has formally requested an assignment without the actual assignment being effected or any other similar circumstance. The assignment must represent a "genuine requirement" of the borrowing. This would not be the case where the facts support a finding that the insurance assignment represents an accommodation by the lender. Where excess collateral is present it remains a question of fact as to whether an assignment of insurance would be considered a genuine requirement of the borrowing.

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We trust that the above comments are of assistance to you.

for Director
Financial Industries Division
Rulings Directorate
Policy and Legislation Branch