Principal Issues: (1) Does subsection 98(2) or subsection 148(7) apply in calculating the policy gain on the partnership's disposition of a life insurance policy when a partnership transfers ownership of the life insurance policy to a partner leaving the partnership? (2) For purposes of subsection 248(35) of the Act, is the period that a partnership holds a life insurance policy included in determining the period that a former partner owned the policy?
Position: (1) Where the conditions of subsection 98(2) of the Act are met, it is our general view that subsection 98(2) of the Act would take precedence over subsection 148(7) of the Act such that the proceeds of the disposition to the partnership of the exempt life insurance policy would be the policy’s fair market value. (2) The period that the partnership held the life insurance policy is not included in determining the period that individual C owned the policy for purposes of subsection 248(35) of the Act.
Reasons: The legislation.
FINANCIAL STRATEGIES AND FINANCIAL INSTRUMENTS ROUNDTABLE, 3 NOVEMBER 2023
2023 APFF CONFERENCE
5. Distribution of a partnership life insurance policy
Three individuals, A, B and C, carry on a business as a partnership. The partnership holds and is the beneficiary of life insurance policies, for which it pays the premiums, on the life of each partner. As provided in the partnership agreement, when a partner leaves the partnership, the partnership transfers ownership of the life insurance policy on the partner's life to the partner for no consideration.
Individual C leaves the partnership 10 years after it had acquired the life insurance policy. At that time, the policy's cash surrender value ("CSV") is $10,000, its adjusted cost basis ("ACB") is $4,000 and its fair market value ("FMV") is $25,000.
Two years after leaving the partnership, Individual C donates the life insurance policy to a registered charity when the FMV of the policy is $30,000, CSV is $11,000, and the ACB is $5,000.
Questions to the CRA
(a) For purposes of calculating the policy gain resulting from the disposition of the life insurance policy by the partnership to Individual C, will the proceeds of disposition be determined under subsection 98(2) of the Income Tax Act (footnote 1) or under subsection 148(7)?
(b) For the purposes of subsection 248(35), is the period during which the partnership held the life insurance policy included in the period during which the individual held the policy?
CRA Response to Question 5(a)
Subsection 98(2) generally provides that where a partnership has disposed of property to a taxpayer who was, immediately before that time, a member of the partnership, the partnership is deemed to have disposed of the property for proceeds equal to its FMV at that time and the taxpayer will be deemed to have acquired the property at an amount equal to that FMV.
Subsection 148(7) applies if an interest of a policyholder in a life insurance policy is disposed of (other than a deemed disposition under paragraph 148(2)(b)) by way of gift, by distribution from a corporation or by operation of law only to any person, or in any manner whatever to any person with whom the policyholder was not dealing at arm’s length. Where subsection 148(7) applies to a disposition that occurs after March 21, 2016, under paragraph 148(7)(a), the policyholder's proceeds of disposition are equal to the greatest of (i) the value of the interest at the disposition time (as determined under subsection 148(9)), (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. In addition, under paragraph 148(7)(b), the person that acquires the interest because of the disposition is deemed to acquire it, at the disposition time, at a cost equal to the amount determined under paragraph 148(7)(a) in respect of the disposition.
In the hypothetical situation described, where the conditions of subsection 98(2) are satisfied, we are generally of the view that subsection 98(2) would override subsection 148(7) so that the partnership's proceeds of disposition of the life insurance policy would be the FMV of the policy.
CRA's response to question 5(b)
Subsection 238(35) provides a special rule for determining the FMV of property that is donated to a qualified donee, such as a registered charity. If certain conditions are satisfied, subsection 248(35) deems the FMV of the gifted property to be the lesser of the FMV of the property otherwise determined and, in the case of a life insurance policy in respect of which the taxpayer is a policyholder, the adjusted cost basis (as defined in subsection 148(9)), of the property to the taxpayer immediately before the gift is made. Under paragraph 248(35)(b), this deeming rule applies in respect of a particular property (including a life insurance policy) if the taxpayer acquired the property:
(i) less than three years before the date that the gift is made; or
(ii) less than 10 years before the day that the gift is made and it is reasonable to conclude that one of the main reasons for the acquisition was to make a gift of the property to a qualified donee.
In the hypothetical situation described, it is our view that the period during which the partnership held the life insurance policy is not included in the determination of the period during which Individual C was the policyholder of the life insurance policy for the purposes of subsection 248(35).
Alexander Johnstone / Nathalie Boyer
November 2, 2023
2023-097856
FOOTNOTES
Due to the requirements of our systems, the footnotes contained in the original document are reproduced below:
1 R.S.C. 1985, c. 1 (5th Supp.) ("I.T.A.").