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 2019-082212 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 request for an interpretation dated September 4, 2019, in which you asked for our opinion on the tax consequences when 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"). The Policy would have a fair market value ("FMV") of $100,000, a cash surrender value ("CSV") of $40,000 and an adjusted cost basis ("ACB") of $30,000.
In your example, all of the common and participating shares of Opco are held by the Trust. The Trust is a personal and 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, i.e. $100,000. The Trust included this $100,000 dividend income in computing its income.
You indicated that this would also result in a disposition of the Policy by Opco to the Trust to which subsections 148(1) and (7) would apply. You indicated that pursuant to subsection 148(7), Opco's disposition of the Policy and the Trust's acquisition of the Policy would be deemed to occur at the greatest of the value (footnote 1) of the Policy (i.e., its CSV of $40,000), the FMV of the consideration given ($0) and the ACB (footnote 2) of the Policy ($30,000), with the result that Opco would have a taxable policy gain of $10,000.
According to your example, in the same taxation year, the Trust made a payment in kind in an amount equal to the dividend in kind (equal to the FMV of the Policy, i.e. $100,000) by transferring ownership of the Policy to its beneficiary, Holdco, in accordance with subsections 104(6), (13) and (24), which the Trust's governing deed allowed.
You asked whether subsection 148(7) would apply on the transfer of the interest in the Policy by the Trust to its beneficiary, Holdco, as payment pursuant to subsections 104(6), (13) and (24) and, if so, what consideration would be given by Holdco within the meaning of clause 148(7)(a)(ii)(B). You also stated that you are of the opinion that the payment made by the transfer of ownership of the Policy to Holdco would come within subsection 107(2). In your view, subsection 107(2) should apply in this situation, since that subsection would prevail over subsection 148(7).
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.
In order to answer your question, it is first necessary to determine whether the transfer of the Policy by the Trust to its beneficiary Holdco as a payment pursuant to subsections 104(6), (13) and (24) would come within subsection 107(2). Our understanding is that, except in certain circumstances that are not apparent from your request, generally speaking, under the applicable private law, the receipt of an interest in a life insurance policy 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 income of that trust. Our comments are therefore based on the premise that the interest in the policy received by the trust in the situation described would form part of its income within the meaning of private law. Consequently, the issue in the situation described would be to determine whether subsection 106(3) or subsection 148(7) should apply to determine the consequences of the transfer.
In order to determine which of these two provisions should prevail, it must first be determined whether the Holdco 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, which would confirm whether subsection 106(3) would 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 3) 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 Trust X of its interest in the Policy to its corporate beneficiary, Xco, would result in a disposition by Trust X of that interest in the Policy. Where income, for the purposes of subsections 104(6) and (13) (footnote 5), 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 the beneficiary by the 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 6), 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.
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 4) , 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 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 5), 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. Under paragraph 251(1)(b), a personal trust (footnote 6) 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.
Where subsection 148(7) applies to a disposition occurring after March 21, 2016, the policyholder is deemed to become entitled to receive, at the disposition time, proceeds of the disposition equal to the greatest of (i) the value of the interest at the time of disposition (footnote 7); (ii) the FMV at the disposition time of the consideration, if any, given for the interest; and (iii) the ACB to the policyholder of the interest immediately before the disposition time. Pursuant to paragraph 148(7)(b), the person 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 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 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). 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 may be all or any part of the beneficiary's income or capital interest, as the case may be.
The determination of the FMV of an income interest in a trust at a particular time is a question of fact that can only be made 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 to 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
Due to the requirements of our systems, the footnotes contained in the original document are reproduced below:
1 As defined in subsection 148(9).
2 As defined in subsection 148(9).
3 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 ("C.C.Q.").
4 Income as determined under the Act without reference to subsections 104(6) and (12).
5 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.
6 Other than a trust described in any of paragraphs (a) to (e.1) of the definition of "trust" in subsection 108(1).
7 "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.