Principal Issues: 1) Opco is the owner, the beneficiary and pays the premiums of a critical illness insurance policy on the health of its shareholder. What are the tax consequences to Opco on the transfer of that critical illness insurance policy to another corporation?
2) Whether the transfer of a critical illness insurance policy is eligible for a section 85
Position: 1) Generally, the gain on the transfer of a critical illness insurance policy is not taxable and the loss is not deductible.
2) No
Reasons: 1) The gain is not a capital gain because of the exception in subparagraph 39(1)(a)(iii) and section 148 is not applicable to a policy that qualifies as a critical illness insurance policy under the private law and that does not qualify as life insurance.
2) A critical illness insurance policy is not an eligible property pursuant to subsection 85(1.1)
Financial Strategies and Financial Instruments Roundtable, October 9, 2015
2015 APFF Conference
Question 1
Transfer of a Critical Illness Insurance Policy to Non-Arm's Length Corporations
An operating corporation (Opco) subscribed several years ago to a critical illness insurance policy with respect to its shareholder, who is very involved in the day-to-day operations of the corporation. The beneficiary of the policy is the corporation, and it is also the corporation that pays all of the policy premiums.
The shareholder is about to sell Opco shares to third parties. Despite the sale of Opco, the shareholder still wishes to retain the critical illness insurance policy in some fashion. He is considering transferring the policy to an investment holding company he holds (Holdco). In this case, the policy would have a fair market value ("FMV") greater than the total premiums paid over the years.
While the tax consequences of a transfer of a life insurance policy are set out in section 148, there appears to be no legislative provision governing the transfer of critical illness insurance policies.
The only tax consequence that seems certain with respect to critical illness insurance policies is that the disposition of such a policy cannot generate a capital gain since an insurance policy is specifically referenced by an exception to paragraph 39(1)(a) (see, more specifically, subparagraph 39(1)(a)(iii)).
Questions to the CRA
(a)
(i) What are the tax consequences for Opco if it decides to transfer the critical illness insurance policy to Holdco?
(ii) Would it be possible for Opco and Holdco to make the rollover election provided in section 85(1) rollover in respect of the critical illness insurance policy?
(b) Would the tax consequences be the same if the transfer were to a corporation not related to Opco or to the shareholder?
C) Would your answer be different if the holder was not a resident of Québec?
CRA Response
The determination of the tax consequences to Opco of the above-mentioned transactions can be made only after an examination of all the relevant facts (including the contractual provisions). However, we can provide the following general comments respecting Opco.
We are of the view that the gain or loss realized on the disposition of a critical illness insurance policy is generally of a capital nature. However, by reason of the exception stipulated in subparagraph 39(1)(a)(iii) and 39(1)(b)(ii), this gain or loss will not be taxable as a capital gain or deducted as a capital loss for purposes of the Income Tax Act. Furthermore, the provisions of section 148 would not apply to a critical illness insurance policy which is not a life insurance policy and the Income Tax Act does not contain any other provision providing specifically for the tax treatment of the disposition of such property. In other words, the gain realized on the transfer of a critical illness insurance policy will generally not be taxable and the loss will generally not be deductible.
The rules stipulated in subsection 85(1) permit a taxpayer to transfer on a rollover basis an “eligible property” to a taxable Canadian corporation for consideration that includes shares of the capital stock of the corporation. Subsection 85(1.1) defines an eligible property, and that definition includes inter alia a capital property. The concept of a capital property is as defined in section 54 and includes any property whose disposition would produce a capital gain or loss for the taxpayer. However, as previously mentioned, the gain or loss resulting from a disposition of a critical illness insurance policy is not a capital gain or loss. Since a critical illness insurance policy is not a capital property and such property is not within any other part of the eligible property definition, this type of policy is not an eligible property as defined in subsection 85(2.1). Consequently, the rules stipulated in section 85 are not applicable to the transfer of a critical illness insurance policy to a taxable Canadian corporation.
Catherine Ayotte
(819) 243-7306
October 9, 2015
2015-058894