Principal Issues: On a transfer of an interest in a life insurance policy by way of a dividend in kind after March 21, 2016, what will be the proceeds of the disposition to the transferor; the income inclusion to the transferee; and the adjusted cost basis (ACB) of the policy to the transferee?
Position: The proceeds of the disposition to the transferor and the ACB to the transferee would be the greatest of the cash surrender value, the consideration given for the interest and the ACB of the interest in the policy. The income inclusion to the transferee would be based on the FMV of the interest in the policy received.
Reasons: Subsections 148(7) and 82(1)
CLHIA CRA Roundtable – May 2017
Question 2 – Dividend in kind transfer of life insurance policy to shareholder
Scenario
- Mr. X owns 100% of the preferred shares of Opco with a redemption value of $1 million, adjusted cost base and paid-up capital (PUC) of $1.
- The Opco common shares are owned by a family trust.
- Opco owns a $1 million life insurance policy on the life of Mr. X (Policy). The Policy has the following attributes: cash surrender value (CSV) $500; adjusted cost basis (ACB) $50,000; and fair market value (FMV) $450,000.
- Mr. X would like to personally own the Policy at a time that is after March 21, 2016. That is, they would like to transfer the Policy from Opco to Mr. X.
- Mr. X does not deal at arm’s length with Opco.
Question
Assuming the Policy is transferred to Mr. X as a dividend in kind on his preferred shares in Opco, 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 Response
Subsection 148(7) of the Income Tax Act applies to a non-arm's length transfer of an interest in a life insurance policy and also to an arm's length transfer made by way of gift, by operation of law only or by distribution from a corporation. For dispositions after March 21, 2016, where subsection 148(7) applies, the policyholder is deemed to become entitled to receive proceeds of the disposition equal to the greatest of the value of the interest at the time of disposition, the FMV of the consideration given for the interest and the ACB of the interest in the policy immediately before the disposition. The person acquiring the interest in the policy is deemed to acquire it at a cost equal to the same amount. Value is defined in subsection 148(9) to generally mean the CSV of the policy.
In general terms, the recipient of a taxable dividend paid by a corporation resident in Canada must include the amount received in income, as provided under subsection 82(1). The value to be placed on a dividend, other than a stock dividend, paid by a corporation in assets other than cash (a dividend in kind) is the FMV of such assets at the date of payment or transfer to the shareholders. Where the shareholder is an individual, a gross up will apply pursuant to paragraph 82(1)(b) to a dividend included in computing the income of the shareholder. The shareholder will be entitled to a dividend tax credit in respect thereof in determining his or her tax payable.
In the scenario described above, the transfer of Opco’s interest in the Policy by way of a dividend in kind is a disposition to which subsection 148(1) will apply. The policy gain to Opco under subsection 148(1) is the amount, if any, by which the proceeds of the disposition of Opco’s interest in the Policy exceed the ACB to Opco of that interest. For this purpose, paragraph 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 for the FMV of the interest in the Policy ($450,000 plus a gross up as applicable pursuant to paragraph 82(1)(b)).
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.
Sylvie Danis
2017-069033
May 18, 2017