Principal Issues: Mrs. X is divorced from Mr. Z and receives $50,000 of spousal support payments each year. Mr. Z dies and his children (which are not Mrs. X's children) must continue to make the support payments until Mrs. X's death. It is decided that an annuity contract will be acquired to guarantee the amounts to which Mrs. X is entitled. More specifically, Mrs. X would first incorporate "NEWCO." A corporation ("CHILDCO") owned by the children would then subscribe to non-voting and non-participating preferred shares of NEWCO for a consideration of $1 million. NEWCO would use this amount to acquire an annuity contract and a $1 million life insurance policy on the life of Mrs. X. NEWCO would receive the amounts under the annuity contract, pay the cost of insurance coverage and pay taxable dividends to Mrs. X. At Mrs. X's death, NEWCO would use the proceeds of the insurance policy to redeem its preferred shares held by CHILDCO. Whether subsection 15(1) would apply in such a situation.
Position: The result of the proposed transactions is to remove the children's obligations towards Mrs. X. In that sense, there is a benefit for the children resulting from the proposed transactions. Among other things, subsection 15(1) could apply in the given situation if it is established that CHILDCO is impoverished as a result of the transactions. The amount or value of the benefit could equal the amount that the children would have to pay, in similar circumstances, to get the same benefit from a non-arm's-length person.
Reasons: Wording of the Act and previous positions.
FINANCIAL SERVICES ROUND TABLE
2004 APFF CONFERENCE
Question 8
Subsection 15(1) I.T.A.
Background:
Mrs. X was divorced from Mr. Z and received $50,000 per year in support. Mr. Z died and his children (who are not Mrs. X's children) must continue to pay Mrs. X the same amount for the rest of her life.
The best way for the children to fulfill their obligation and support Mrs. X is to purchase a life annuity that will guarantee Mrs. X the necessary income.
The children's cash is within a corporation ("Childco") and therefore, if the children use this cash to purchase a life annuity for Mrs. X, subsection 15(1) will apply.
The following planning is therefore proposed:
Mrs. X will create a corporation ("Newco") and will hold all the issued and outstanding common shares of its capital stock. Childco will subscribe for non-voting and non-participating preferred shares in the amount of $1,000,000.
Newco will use the $1,000,000 proceeds to purchase a non-prescribed life annuity, combined with a life insurance policy on the life of Mrs. X. Newco will receive the annuity and pay taxes on the taxable portion thereof. Newco will also pay the cost of insurance and pay a taxable dividend to Mrs. X.
An agreement will be signed to the effect that upon the death of Mrs. X, the proceeds of the policy on Mrs. X's life will be used by Newco to redeem the preferred shares of its capital stock held by Childco.
Question:
Does the CRA agree with our interpretation that subsection 15(1) would not apply to the proposed planning?
CRA response
It should be noted at the outset that the statement in this question only briefly describes a particular situation (the "Particular Situation"). Accordingly, we will limit ourselves to making general comments on the potential application of subsection 15(1) with respect to the children in the Particular Situation.
The proposed transactions described in the statement of this question permit providing for the obligations of the children. In this sense, there is a benefit to the children from these proposed transactions.
Thus, subsection 15(1) could apply in the Particular Situation to require the children to include in their income the value of a benefit conferred on them by Childco, if Childco were found to be impoverished by the transactions.
Because the statement in this question only briefly describes the Particular Situation, it is difficult to establish definitively the value of the benefit that would come within subsection 15(1). However, the value of the benefit could be the amount that the children would have to pay, in similar circumstances, to obtain the same benefit from a person dealing at arm's length with them that results from the particular situation.
Stéphane Prud'Homme
(613) 957-8975
October 8, 2004
2004-009080