Principal Issues: (1) Whether subsection 106(3) takes precedence over subsection 148(7) where a discretionary trust transfers an interest in a life insurance policy to its corporate beneficiary as payment of a dividend in kind received by the trust? (2) Whether a corporate beneficiary receiving an interest in a life insurance policy from a trust as payment of a dividend in kind received by the trust should be considered as having given a consideration for the interest in the life insurance policy?
Position: (1) None. General comments provided. (2) Yes.
Reasons: (1) and (2) There will be a disposition of all or part of the beneficiary’s income interest in favor of the trust when the trust distributes the life insurance policy to its beneficiary in satisfaction of all or part of the beneficiary’s income interest. Determining the FMV of an income interest in a trust at any given time is a question of fact. To the extent that it is determined that at the time of disposition of the life insurance policy, the beneficiary’s income interest under the trust would include the right to enforce payment of an amount by the trust equal to the FMV of the life insurance policy, it could be argued that the consideration given by the beneficiary to the trust for the interest is equal to the FMV of that life insurance policy. In this context, the tax consequences that would arise from the disposition of the policy would be the same whether subsection 106(3) or 148(7) applies. Since it is not clear that such a result is consistent with tax policy, we will bring this issue to the attention of the Department of Finance.
XXXXXXXXXX 2016-065408 Nathalie Boyer
December 21, 2023
XXXXXXXXXX,
SUBJECT: Transfer of a life insurance policy between connected corporations through a trust
This letter is in response to your email of June 16, 2016, in which you requested our advice on the tax consequences where a trust transfers its interest in a life insurance policy to its corporate beneficiary in payment of trust income, in this case a dividend in kind that the trust received in the year. We apologize for the delay in responding to your request.
Unless otherwise indicated, all legislative references herein are to the provisions of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the "Act").
In your request, you briefly described the situation where a corporation, Opco, would own and be the beneficiary of a life insurance policy, for which it would pay the premiums, on the life of its controlling shareholder, Mr. X ("Policy"). You gave the example of a policy with a high fair market value ("FMV") and a cash surrender value ("CSV") of nil.
Under your example, all of the common and participating shares of Opco are held by a trust (the "Trust"). The Trust is a personal, discretionary trust. A corporation, Holdco, is both the capital and income beneficiary of the Trust. Holdco is a holding company controlled by Mr. X.
In the situation you described, Opco paid a dividend in kind to the Trust equal in value to the FMV of the Policy and the Trust included that dividend income in computing its income.
In the same taxation year, the Trust made a payment in kind, in an amount equal to the dividend in kind, by transferring ownership of the Policy to its beneficiary, Holdco, in accordance with subsections 104(6), (13) and (24), which the Trust's governing indenture permitted.
You inquired as to the consideration given by Holdco within the meaning of clause 148(7)(a)(ii)(B) on the transfer of the interest in the Policy by the Trust to its beneficiary Holdco as payment in accordance with subsections 104(6), (13) and (24). In your view, section 148(7) should apply on the transfer of the interest by the Trust to its corporate beneficiary and no consideration would be given by Holdco for the interest. You asked for our comments in this regard.
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.
For present purposes, we have assumed that Opco and Holdco are taxable Canadian corporations and are connected corporations within the meaning of subsection 186(4) by virtue of the application of subsection 186(2). There would be a non-arm's length relationship between Mr. X, Opco and Holdco. There would be sufficient safe income on hand attributable to the common shares of Opco held by the Trust in respect of the value of the proposed dividend. All parties involved would be resident in Canada.
The distribution by a corporation of its interest in a life insurance policy by way of a dividend in kind is a disposition to which subsection 148(1) applies. The gain in respect of such a disposition that the corporation must then include in computing its income pursuant to subsection 148(1) is the amount, if any, by which the proceeds of disposition of its interest that it acquired the right to receive exceed the adjusted cost basis ("ACB") to it of that interest immediately before the disposition. In this regard, paragraph 148(7)(a) would apply to deem Opco to become entitled to receive proceeds of the disposition equal to the greatest of (i) the FMV of the interest at the time of disposition (footnote 1); (ii) the FMV at the disposition time of the consideration, if any, given for the interest; and (iii) Opco's ACB of the interest immediately before the disposition time. Pursuant to paragraph 148(7)(b), the Trust who acquires the interest as a result of the disposition is deemed to acquire it, at the time of the disposition, at a cost equal to that same amount.
In this regard, the Canada Revenue Agency ("CRA") has previously indicated that it is of the view that there is no consideration given for the interest for the purposes of clause 148(7)(a)(ii)(B) in the case of the distribution of an interest in a life insurance policy by a corporation to its shareholder by way of a dividend in kind. To the extent that the CSV of the interest transferred by Opco to the Trust was nil, no policy gain would result to Opco from that transfer. The Trust would be deemed to acquire the interest in the Policy at a cost equal to the ACB of the interest to Opco immediately before the transfer. It would also be required to include in income a dividend in an amount equal to the FMV of the interest in the Policy.
In the situation you described, the Trust would then transfer the interest in the Policy to its beneficiary, Holdco. Where a trust transfers its interest in a life insurance policy to its corporate beneficiary as a payment pursuant to subsections 104(6), (13) and (24), it must first be determined whether the beneficiary would receive the interest in the life insurance policy in satisfaction of all or any part of the beneficiary’s income interest in the trust, in which case subsection 106(3) may apply. If this question is answered in the affirmative, the next step is to determine whether subsection 106(3) should then take precedence over subsection 148(7).
In order to conclude that Holdco would receive the interest in the Policy in satisfaction of its interest in the income of the Trust, it would be necessary, first, for the interest in the Policy to form part of the income of the Trust for private law purposes (taking into account subsection 108(3)) (footnote 2) and, second, for Holdco to be a beneficiary of the income of the Trust and to be entitled to receive the interest in the Policy in accordance with the terms of the deed governing the Trust.
The determination of whether property received by a trust by way of a dividend in kind would be income or capital to the trust receiving it is a mixed question of law and fact. Such a determination can only be made following an exhaustive analysis of the applicable private law (in the case of a trust governed by Quebec civil law, articles 909 and 910 C.C.Q.) as well as all the relevant facts and documents. As stated above, our understanding is that, generally speaking, under the applicable private law, the interest in a life insurance policy received by a trust by way of a dividend in kind paid by a corporation of which it is a shareholder would form part of the trust's income.
The distribution by the Trust of its interest in the Policy to its corporate beneficiary, Holdco, would result in a disposition by the Trust of that interest in the Policy. Where the income, for the purposes of subsections 104(6) and (13) (footnote 3), of a trust paid to a beneficiary is income within the meaning of the applicable private law and the trust pays that income in kind to its beneficiary by a distribution of property (such as an interest in a life insurance policy) in satisfaction of all or any part of the beneficiary's interest in the income of the trust (footnote 4), subsection 106(3) could apply. Subsection 106(3) provides that, in such a situation, the trust is deemed to dispose of the property for proceeds equal to its FMV.
Subsection 148(7) applies where an interest of a policyholder in a life insurance policy is disposed of in any manner to a person with whom the policyholder was not dealing at arm's length. Pursuant to paragraph 251(1)(b), a personal trust (footnote 5) and its beneficiary are deemed not to deal with each other at arm's length. Thus, subsection 148(7) could also apply where a trust transfers its interest in a life insurance policy to one of its beneficiaries.
As stated above, in the case of the distribution of an interest in a life insurance policy by a corporation to its shareholder by way of a dividend in kind, the CRA has previously indicated that it is of the view that there is no consideration given for the interest for the purposes of clause 148(7)(a)(ii)(B). This position does not apply to the situation described, where a trust transfers its interest in a life insurance policy to its beneficiary. When a trust transfers property to a beneficiary, whether in payment of the trust's income or capital under the applicable private law, the beneficiary gives consideration for the transfer. This consideration would be all or any part of the beneficiary's income or capital interest, as the case may be.
Determining the FMV of an income interest in a trust at a particular time is a question of fact that can only be determined after considering all the relevant facts, circumstances and documents. However, in the situation described, to the extent that it would be determined that at the time of the disposition of the Policy, for the purposes of clause 148(7)(a)(ii)(B), the Holdco beneficiary's income interest in the Trust included the right to require the Trust to pay an amount equal to the FMV of the Policy, it could then be argued that the part of the Trust's income interest that was given by Holdco for the interest in the Policy had an FMV equal to the FMV of the Policy. In that context, the consequences of the disposition of the interest in the Policy would be the same for the Trust and Holdco, regardless of whether subsection 106(3) or subsection 148(7) would prevail. It is not clear that such a result is consistent with tax policy. The CRA will bring this conclusion to the attention of the Department of Finance.
We hope you find our comments of assistance.
Best regards.
Mélanie Beaulieu
Manager
For the Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 "Value" is defined in subsection 148(9) and generally means the CSV of the Policy, where the interest includes an interest in the CSV of the Policy. According to the same definition, in other cases, the value is nil.
2 Subsection 108(3) provides that for certain specific purposes of the Act, including the definition of "income interest" in subsection 108(1), the concept of income means the income of a specified trust without regard to the provisions of the Act. Thus, for those purposes, the income of a trust governed by the civil law of Quebec is determined according to the rules of the Civil Code of Quebec (the "C.C.Q.").
3 Income as determined under the Act without reference to subsections 104(6) and (12).
4 According to the definition of the term "income interest" in subsection 108(1), a taxpayer's income interest of a trust includes a right to enforce payment of an amount from the trust where that right arises from the taxpayer's rights to receive income as a beneficiary under a personal trust.
5 Other than a trust described in any of paragraphs (a) to (e.1) of the definition "trust" in subsection 108(1).