Principal Issues: How to calculate a potential policy gain on the assignment of a part of an interest in a life insurance policy?
Position: None.
Reasons: Question of private law and it would be necessary to examine the agreements.
January 12, 2023
XXXXXXXXXX
Subject: Gift of part of an interest in a life insurance policy
Dear XXXXXXXXXX,
This is in response to your request, and subsequent correspondence, for our opinion on the tax treatment of a life insurance policyholder who donates a portion of the individual’s interest in a life insurance policy to a charity.
Unless otherwise indicated, all statutory references herein are to the provisions of the Income Tax Act (the "Act").
You described the situation where an individual resident in Quebec is the policyholder of a policy on the individual’s life. The coverage is $1 million, the cash surrender value is $250,000 and the adjusted cost basis ("ACB") of the policy is $150,000.
You indicated that this individual wishes to donate a portion of the individual’s interest in the policy to a registered charity and is considering two possible ways to make this donation. You described two possible situations that could be considered.
In the first situation, the individual would donate half of the life insurance policy, so that the registered charity would be a beneficiary with $500,000 of coverage on the individual's life and a cash surrender value of $125,000.
In the second situation, the individual would dispose of a portion of the individual’s interest, but in such a way that the individual would retain all of the cash surrender value of the policy while the registered charity would be able to benefit from half of the insurance coverage.
In light of the two situations described, you raised two questions.
In the first situation, you asked us to confirm that subsection 148(7) will require the individual to include in income a policy gain equal to $50,000, which is the difference between 50% of the cash surrender value ($125,000) and 50% of the ACB ($75,000).
With respect to the second situation, you asked whether the individual would have a policy gain to include in computing income.
Our Comments
This technical interpretation provides general comments about the provisions of the Act and related legislation. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC70-6R12, Advance Income Tax Rulings and Technical Interpretations.
Both of the situations you described involve an individual disposing of a portion of the individual’s interest in a life insurance policy to a registered charity in order to either share the insurance coverage and cash surrender value of the policy equally with the donee charity, or to share only the coverage with the charity. It is not explained, however, how the individual would dispose of part of the individual’s interest.
Although you do not refer to a claim for a charitable donation tax credit by the individual, it seems reasonable to believe that the transactions described are contemplated in a context where it is the individual's intention that the disposition of a portion of the individual’s interest in a life insurance policy be recognized as a charitable donation.
In order for an individual's gift of a life insurance policy to a registered charity to qualify for a donation tax credit, the policy must generally have been fully assigned to the donee and the donee must have been listed as a beneficiary of the policy.
In that context, the donor will wish to ensure that a new policy is not created and that the portion of the policy the individual wishes to donate has been fully assigned in order to qualify for a donation tax credit. The donor will also wish to ensure that the value of any advantage received in connection with the gift can be verified so that an amount can be recognized as a qualifying amount of a gift.
It is therefore not possible to infer how the donor will proceed and what precise terms would apply to such an assignment so that it would satisfy those conditions and be legally valid. It is also very difficult to infer what rights would actually be assigned and what fraction of an interest in the policy might represent those rights.
In this context, it is impossible for us to comment on the application of section 148 to such an assignment. Indeed, tax law is an accessory right whose effects are based on the rights and obligations arising from the applicable private law. Insofar as a life insurance policy is a contract that is composed of a set of rights and obligations, which are linked, it would be necessary to determine, inter alia, whether the gift of a portion of the policy can be made without resulting, for the purposes of the applicable private law, in a disposition of the entire interest in the policy rather than just a portion of it. On the other hand, where a gift to a person of a portion of an interest in a policy is intended to establish a type of arrangement commonly referred to as a life insurance interest sharing strategy (and assuming that such a sharing is possible without resulting in a disposition of the entire interest in the policy), in addition, it would be necessary to determine whether it is possible to determine what fraction of the whole represents the portion assigned to the donee and also whether, as a result of the assignment, the donor and donee would be joint policyholders or, rather, each would own a separate policy.
The determination of the tax consequences of such transactions is a question of fact and law that can only be resolved after a full review of all the relevant legal documents and facts surrounding each situation. A review of the law applicable to these transactions in terms of insurance and contract law should also be undertaken in order to remove any uncertainty as to the validity and effect of the transactions contemplated.
The tax consequences of the two situations described could therefore only be determined in the context of an audit or an advance ruling request (submitted in accordance with the procedures set out in Information Circular IC70-6R12) in respect of proposed transactions.
We hope our comments are of assistance.
Best regards,
Mélanie Beaulieu
Manager
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch