Mr. A acquired a life insurance policy on his life with a $1 million death benefit and then transferred it to his wholly-owned corporation (ACo) for no proceeds at a time that it had a nil adjusted cost basis (ACB) and cash surrender value (CSV). Thereafter, while the policy has a fair market value (FMV), ACB and CSV of $100,000, $50,000 and nil, respectively, ACo will donate this policy to a registered charity.
On the original transfer from Mr. A to ACo, s. 148(7) deemed him to dispose of the policy, and ACo to have acquired it, for nil proceeds, i.e., the greatest of the FMV of the consideration given, the ACB of the policy and the CSV of the policy at the time of transfer. On the subsequent gift, the greatest of these three amounts was the policy’s $50,000 ACB (i.e., no taxable gain). Under s. 248(35)(b)(i), the FMV of the policy for gift receipting purposes was the lesser of its FMV ($100,000) and its ACB ($50,000) – except that under s. 248(36), for s. 248(35) purposes, the cost or adjusted cost base, of the property to ACo immediately before the gift could be deemed to equal the lower of its cost and adjusted cost base to Mr. A. How would s. 248(36) apply to the gift?
CRA responded:
[A]s originally proposed, neither subsections 248(35) nor (36) included a specific reference to the ACB of a life insurance policy. However, proposed subsection 248(35) was later amended to include such a reference before it was enacted.
Notwithstanding that proposed subsection 248(36) was not similarly amended, it remains our view that the ACB of an interest in a life insurance policy, as defined in subsection 148(9), is generally a reasonable proxy for the "cost" of an interest in a life insurance policy for purposes of subsection 248(36). …
[S]ince ACo acquired the life insurance policy less than three years before it intends to donate the policy, the proposed gift would meet the condition in subparagraph 248(35)(b)(i) and be subject to the deemed FMV rule in subsection 248(35). In applying subsection 248(35), subsection 248(36) would need to be taken into account as ACo acquired the life insurance policy from a non-arm’s length person within a three-year period of the gift. In our view, the cost of the gifted property to ACo under subsection 248(36) would be nil (the lowest amount that is the ACB of the policy to ACo or Mr. A). Then, in applying subsection 248(35), the deemed FMV of the policy would also be nil (the lesser of the FMV of the policy at the time of the gift and the deemed ACB as determined under subsection 248(36)).