Principal Issues: See below
Position: See Below
Reasons: See below
XXXXXXXXXX 2011-039178 Dominic Tiu 416-973-8002
January 18, 2012
Dear XXXXXXXXXX :
Re: Trust Distribution of a Life Insurance Policy
This is in reply to your letter dated December 31st, 2010 requesting our comments as to the tax implications in a hypothetical distribution of a life insurance policy held by an inter vivos trust into a joint-ownership between two resident capital beneficiaries and alternatively, between two non-resident capital beneficiaries. The hypothetical fact situation described in your letter was clarified/amended during the XXXXXXXXXX /Tiu telephone conversations of January 20th and March 16th and 17th, 2011. You wanted to know the following:
1. With regard to the distribution of the life insurance policy into a joint-ownership between two resident capital beneficiaries under the trust
- Whether the rollover provisions in subsection 107(2) of the Income Tax Act (the "Act") would apply.
- What reporting is required of the life insurance company if any?
- What reporting is required of the inter vivos trust?
2. With regard to the distribution of the life insurance policy into a joint-ownership between two non-resident capital beneficiaries under the trust
- What relevant sections of the Act would apply?
- What reporting is required of the life insurance company if any?
- What reporting is required of the inter vivos trust?
- Whether withholding tax would apply and what tax slips and forms are required?
The Hypothetical Fact Situations
- The trust is an inter vivos trust resident in Canada and it has two beneficiaries (both income and capital) and the settlor of the trust is the father of the two beneficiaries
- The trust is the holder and beneficiary of a life insurance policy that is a "life insurance policy in Canada" as defined in subsection 138(12) of the Act and the settlor is the person whose life is insured under the policy and who will remain a resident in Canada
- The trust is a personal trust as defined in subsection 248(1) of the Act
- The trust will be replaced as policyholder of the life insurance policy by the two capital beneficiaries of the trust
- The distribution of the life insurance policy by the trust into a joint ownership by the two capital beneficiaries will be in satisfaction of the beneficiaries' capital interests in the trust
- The trust will then be wound up under the terms of the trust document
Our Comments:
Pursuant to subsection 148(7) of the Act, the proceeds from a non-arm's length disposition or gift of a life insurance policy is generally equal to the cash surrender value of the policy at the time of disposition and the person acquiring the policy is deemed to have acquired it for an equal amount.
In response to question 9 during the May 1999 Conference for Advance Life Underwriting, the Canada Revenue Agency ("CRA") opined that where a life insurance policy owned by a trust is distributed to a beneficiary resident in Canada in satisfaction of all or a portion of the beneficiary's capital interest in the trust and the trust is a "personal trust" as defined in subsection 248(1) and subsection 107(4.1) does not apply to the distribution of property from the trust, subsection 107(2) takes precedence over subsection 148(7) such that there would be a tax-deferred rollover.
With regard to the distribution of the life insurance policy into a joint-ownership between two resident capital beneficiaries under the trust, as described above, it is our opinion that the rollover provisions in subsection 107(2) of the Act would apply if subsection 107(4.1) does not apply, the trust does not elect pursuant to subsection 107(2.001), and provided that the distribution is in satisfaction of all or part of the beneficiaries' capital interest in the trust.
Generally, if the distribution by a personal trust resident in Canada of a trust property is to a non-resident beneficiary under the trust and is in satisfaction of all or part of the non-resident beneficiary's capital interest in the trust, the trust property passes to the said non-resident beneficiary at fair market value pursuant to subsections 107(5) and 107(2.1).
On July 16th, 2010, the Department of Finance released proposed amendments to the Act that included many changes formerly proposed in Bill C-10 (2007), including the previously proposed changes to subsection 107(5) of the Act. As amended, subsection 107(5) will provide that subsection 107(2.1) will apply (and subsection 107(2) will not) to a distribution of property (other than a share of the capital stock of a non-resident-owned investment corporation or a property described in any of subparagraphs 128.1(4)(b)(i) to (iii) of the Act) by any trust to a non-resident beneficiary in satisfaction of all or part of the non-resident beneficiary's capital interest in the trust. The proposed amendments will apply to distributions made after February 27th, 2004.
A property described in subparagraph 128.1(4)(b)(iii) refers to an excluded right or interest of a taxpayer and paragraph 128.1(10)(l) states that an excluded right or interest of a taxpayer who is an individual means an interest of the individual in a life insurance policy in Canada, except for that part of the policy in respect of which the individual is deemed by paragraph 138.1(1)(e) to have an interest in a related segregated fund trust.
With regard therefore to the distribution of the life insurance policy into a joint-ownership between two non-resident capital beneficiaries under the trust, based on the foregoing and to the extent the interest in the relevant life insurance policy is considered to be a property that is an excluded right or interest of the non-resident beneficiaries as described in paragraph 128.1(10)(l), it is our opinion that the rollover provisions in subsection 107(2) of the Act would apply provided that the distribution is in satisfaction of all or a portion of the beneficiaries' capital interest in the trust, subsection 107(4.1) does not apply, and no election is made pursuant to subsection 107(2.001).
In the year that the trust is wound up, a final T3 return would have to be filed. In particular, we would note that question 9 on page 2 of the return would be applicable.
It is our understanding that when a life insurance policy is to be transferred into the joint ownership of the two resident or non-resident capital beneficiaries, any consent that is required by provincial regulations to be signed to change a beneficiary of the life insurance policy must be signed before there is a valid transfer of the policy.
Yours truly,
Phil Kohnen
for Director
Business and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch