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.
FINANCIAL STRATEGIES AND INSTRUMENTS TAXATION ROUND TABLE
APFF - CONGRESS 2021
2. Donation of a portion of an interest in a life insurance policy to a registered charity
An individual resident in Quebec owns a life insurance policy. The coverage is $1 million, the cash surrender value is $250,000 and the adjusted cost basis ("ACB") of the policy is $150,000. He wishes to donate half of his interest in the policy to a registered charity. In effect, he wishes the charity to own $500,000 of coverage with a cash surrender value of $125,000.
Questions to the CRA
a) Can you confirm that by virtue of subsection 148(7), the individual will be required to include in income a policy gain equal to $50,000, being the difference between 50% of the cash surrender value ($125,000) and 50% of the ACB ($75,000)?
b) If, instead of disposing of one-half of his interest in the policy, the individual wished to dispose of one-half of the coverage, but retained all of the cash surrender value, would there be a policy gain to include in his income?
CRA's response
The two situations described in the statement of the question refer to the disposition by an individual 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 there is no reference in the question to a claim for a charitable donation tax credit by the individual, it seems reasonable to believe that the described transactions are contemplated in a context where it is the individual's intention that the assignment of a portion of the individual’s interest in a life insurance policy would 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 IC 70-6R11 (footnote 1)) in respect of proposed transactions.
Michel Ostiguy
438-356-2777
October 7, 2021
2021-089598
FOOTNOTES
Due to the requirements of our systems, the footnotes contained in the original document are reproduced below:
1 CANADA REVENUE AGENCY, Information Circular IC70-6R11, "Advance Income Tax Rulings and Technical Interpretations", April 1, 2021.