CALU ANNUAL MEETING - May 11, 1992
DRAFT/EBAUCHE
Question 8
RETIREMENT COMPENSATION ARRANGEMENTS
The acquisition of an interest in a life insurance policy by an employer will constitute an RCA where "it may reasonably be considered" that such interest was acquired to fund, in whole or part, retirement benefits which the employer is obliged to provide. Assuming that an employer has established a non-registered supplementary employee retirement plan (SERP) for selected employees and that the employer also owns insurance policies on the lives of some or all of such employees, what factors would the Department consider in determining whether or not the insurance policies will constitute an RCA?
Department's Position
Some of the factors the Department would consider are:
1) the identity of the employees whose lives are insured as compared to those to be provided benefits under the SERP;
2) the timing of the acquisition of the insurance and the setting up of the SERP;
3) the extent of the monetary coverage under the insurance as contrasted with the value of the benefits under the SERP;
4) reasons (other than the existance of the SERP) for the employers purchase of insurance such as;
(i) "key man" insurance acquired as coverage for losses or damages the employer might suffer on the death of the employee; and
(ii) life insurance policies acquired solely to pay benefits in the event of the death of an employee.
Author: Patricia Spice
(The following is the original response to the original questions submitted by the Association and to which we eventually decided not to respond.)
CALU Annual Meeting
Questions for Revenue Canada
RETIREMENT COMPENSATION ARRANGEMENTS
10. The acquisition of an interest in a life insurance policy by an employer will constitute an RCA where "it may reasonably be considered" that such interest was acquired to fund, in whole or part, retirement (and certain other) benefits which the employer is obliged to provide. Assume that an employer has established a non-registered supplementary employee retirement plan (SERP) for selected employees. The employer also owns insurance policies on the lives of some or all of such employees.
In each of the following situations, will the Department consider that the insurance policies constitute an RCA? What are the tax consequences for both the employer and the employees?
Q. (a) The policies represent "key man" insurance acquired for the purpose of indemnifying the employer against potential losses or additional costs that might be suffered as a consequence of the death of the employee. There is no linkage between the coverage under the policy and any amounts that are payable to the employee under the SERP. The employer is the sole owner and beneficiary under the policy. The employee has no ownership or security interest in the policy.
A. (a) In these circumstances, the "key man" insurance might be considered to have been acquired to fund the SERP benefits and, therefore, each life insurance interest might be deemed to be a retirement compensation arrangement ("RCA") pursuant to subsection 207.6(2) of the Income Tax Act (the "Act").
Some of the factors the Department would look at would be: 1) the identity of the employees whose lives are insured as compared to those to be provided benefits under the SERP - the greater the congruity between the two, the more likely the insurance interests will be considered RCA's; 2) the timing of the acquisition of the insurance and the setting up of the SERP - if the insurance is acquired just before or any time after the SERP is established, it is more likely to be regarded as having been acquired to fund the SERP; 3) the extent of the monetary coverage under the insurance - if it is less than or close to the value of the benefits to be offered the particular employee under the SERP, each insurance interest may be regarded as an RCA; 4) establishment of a real loss or damages which the employer may suffer as a result of the death of the employee which are not related to the employer's liability under the SERP - if established, the interests in the policies would be less likely to be considered to be RCA's. The Department would weigh these factors and any other evidence of the purpose for obtaining the "key man" insurance before a final determination was made. We cannot offer a definitive answer to this question given the number of variables that can affect the outcome.
Q. (b) The policies provide death benefits equal to amounts due to the estate (or heirs) upon the death of the employees under the terms of the SERP. The employer is the sole owner of the policies.
A. (b) In our view, subsection 207.6(2) of the Act does not apply where the life insurance policy used to fund a "death benefit" provides solely for a payment of benefits in the event of the death of an employee.
In these circumstances, the tax consequences are as follows:
- no deduction for the annual premiums will be permitted the employer in accordance with paragraph 18(1)(h) and the definition of "personal and living expenses" in subsection 248(1) of the Act,
- the employer is subject to an annual inclusion in income under subsection 12.2(1) because it holds an interest as the beneficiary, unless the policy is an exempt policy,
- the employer's proceeds of disposition in excess of the adjusted cost base of the policy interest is brought into the employer's income under paragraph 56(1)(j) and subsection 148(1), unless it is excluded by reason of subparagraph 148(9)(c)(ix) of the Act,
- the amount paid by the employer to the estate will be deductible to the employer to the extent it is reasonable,
- the amount paid by the employer to the estate will be a death benefit if the employee dies during his employment, and will be a retiring allowance if the employee dies after he has left the employment,
- there is a $10,000 exemption on the death benefit in accordance with the subsection 248(1) definition for the spouse or other beneficiary to the extent permitted therein,
- a paragraph 60(j.1) roll-over is available for the recipient of a retiring allowance to the extent permitted in that paragraph, assuming there is a designation under subsection 104(28) of the Act to include the amount in a beneficiary's income, and
- there are no tax consequences to the employee.
Q. (c) The policies are designed to provide sufficient death benefits and cash values after the employee's retirement to pay all amounts due under the SERP. The employer is the sole owner and beneficiary of the policies. The employee has no ownership or security interest in the policy. The terms of the SERP do not require the benefits under the plan to be secured in any manner.
A. (c) Where an employer acquires an interest in a life insurance policy on the life of an employee to provide sufficient funds for the retirement benefits, then the policy was "acquired to fund, in whole or in part, those benefits". Accordingly, it is our view that the provisions of subsection 207.6(2) of the Act would deem such a policy to be the subject property of a retirement compensation arrangement.
When an RCA has been established, the tax consequences are generally as follows:
- the employer will be deemed to be the custodian,
- the interest in the life insurance will be deemed to be the subject property of an RCA,
- twice the amount of premiums paid under the policy and the repayment of any policy loan are deemed to be contributions to an RCA,
- the deemed contributions are deductible to the employer under paragraph 20(1)(r) of the Act,
- 50% of the deemed contributions must be paid as the special refundable tax by the employer pursuant to subsection 207.7(1) of the Act,
- payments under the policy, including policy loans, are treated as distributions under an RCA and are taxable to the employee under paragraph 56(1)(x) and to the employer under paragraph 12(1)(n.3) of the Act, and
- 50% of all amounts paid as distributions will be refunded to the employer pursuant to subsection 207.7(2) of the Act.
Q. (d) The retirement income benefits under the SERP are funded by the employer on a pay-as-you-go basis. However, the employer has acquired insurance policies on the lives of the employees to recover all or a portion of the costs of the SERP on the death of the employee. The policies are maintained in force until maturity (i.e. death) and no cash withdrawals are made prior to maturity.
A. (d) This situation differs slightly from the one described in (c) above inasmuch as the policies are held until maturity (i.e. the death of the employee). Where the employer holds a number of policies on a number of employees lives, however, the effect may be to provide a stream of income to fund the SERP on an on-going basis. Even in the absence of a stream of income, and notwithstanding that any death benefits under the policy and the retirement benefits flow through the employer's working capital, in our opinion the recovery of costs after the death of the employee would constitute the "funding" of the benefits under the SERP. Therefore, our answer would be the same as for (c).
Q. (e) An RCA trust is established and contributions are made by the employer to fund the payment of retirement income benefits under the SERP. Insurance policies on the lives of the employees are acquired by the employer to recover the costs of funding the RCA upon the death of the employee.
A. (e) This is the same situation as that described in (d) except for the existence of a separate RCA under which the SERP is established. The fact that the SERP is an RCA is irrelevant to determining whether the life insurance policy may also constitute the subject property of an RCA. Our answer would be the same as that in (d) above.