Principal Issues: How are the exempt test policy rules in section 307 of the Income Tax Regulations to be applied to a life insurance policy issued in a currency other than the Canadian dollar?
Position: The exempt test policy rules are to be applied using Canadian dollar amounts. The amounts used in the computations should be converted to Canadian dollars using the currency exchange rate at the relevant time, such that any foreign currency fluctuations would be factored into the determination of whether a life insurance policy is an exempt policy at any particular time.
Reasons: Pursuant to the FCA decision in Gaynor v. The Queen (91 DTC 5288), in determining the value of amounts denominated in a foreign currency, the amounts "must be value in Canadian currency which is the only monetary standard of value known to Canadian law".
CALU - Conference for Advanced Life Underwriting (2004)
Question 1
Foreign Currency Life Insurance Policies
If a life insurance policy is denominated in a currency other than the Canadian dollar, there are two different views as to how the exempt policy test is to be applied to the policy. One view is that the rules (in sections 306 and 307 of the Income Tax Regulations) for determining if a policy is an exempt policy should be applied using the currency of the policy. The alternative view is that all amounts should be determined in Canadian dollars for the purposes of these rules, based on exchange rates at the relevant time. For example, the face amount of the first exempt test policy would be determined in Canadian dollars using the exchange rate at the time the policy is issued. In applying the rule that deems further exempt test policies to be issued if the face amount of the policy increases by more than 8% between policy anniversaries, the face amount of the policy would be translated to Canadian dollars using the exchange rate on each policy anniversary.
The use of the foreign currency seems more consistent with the policy of the rules, which is to compare the magnitude of the savings component of a life insurance policy to the protection on death that it provides. If the Canadian dollar is used, a policy could cease to be an exempt policy because of fluctuations in the exchange rate, a factor which has nothing to do with the relative magnitude of the savings and death protection components of the policy.
Questions:
(a) In the Agency's view, which currency is to be used in determining if a life insurance policy is an exempt policy -the Canadian dollar or the currency in which the policy is denominated?
(b) If the Canadian dollar is to be used, is a current exchange rate to be used on each policy anniversary in determining amounts (death benefit, accumulating fund) in respect of the policy?
Agency's Response
(a) In the Agency's view, the Canadian dollar is to be used in determining whether an insurance policy is an exempt policy. As was stated by the Federal Court of Appeal in the case of Gaynor v. The Queen (91 DTC 5288), in determining the value of amounts denominated in a foreign currency, the amounts "must be valued in Canadian currency which is the only monetary standard of value known to Canadian law."
(b) Based on the principles set out in Gaynor v. The Queen, it is our view the components of the computations in sections 306 and 307 of the Regulations, which are denominated in a foreign currency, should be converted to Canadian dollars using the exchange rate at the relevant times. For example, the death benefit at the date the policy is issued should be converted to Canadian dollars using the exchange rate at the date the policy is issued and the death benefit at the first policy anniversary date should be converted to Canadian dollars using the exchange rate on the first policy anniversary date. The result is that foreign currency fluctuations are factored into the computations which determine whether a policy is an exempt policy at any particular time.
Additional Comment
A recent section 173 referral to the Tax Court of Canada, in the case of Imperial Oil Ltd v. The Queen (2004 TCC 207), dealt with the issue of computing amounts for purposes of the Income Tax Act in circumstances where the components of the computation are denominated in a foreign currency. Both the taxpayer and The Queen made arguments which were based on the principles in Gaynor v. The Queen, which were rejected by the court. The decision of the Tax Court is under appeal to the Federal Court of Appeal. Once this case had made its way through the courts, we will consider whether a change in our responses above is warranted.
The purpose of the exempt test policy rules is to place limitations on the investment growth in a policy and thereby restrict tax deferral to policies considered to have insurance protection as their main purpose. In our opinion, foreign currency gains and losses should be factored into that growth.