2013-0499501E5 RCA advantages-Life insurance policy held by an RCA

Principal Issues: Whether the RCA advantage tax rules apply in respect of a universal life insurance policy owned by an RCA trust on the life of a beneficiary under the RCA.

Position: The RCA advantage tax rules could apply.

Reasons: The legislation.

Author: Pietrow, Victor
Section: 207.5(1) "advantage"; 207.62

XXXXXXXXXX                                                                                                               Victor Pietrow
                                                                                                                                       2013-049950
December 14, 2015

Dear XXXXXXXXXX:

Re:  RCA advantage tax rules

We are writing in reply to your submission in your correspondence dated July 29, October 16, November 7 and 8, and December 4, 2013 and February 5, March 4, and March 19, 2014 and further to our various telephone discussions.

In your submission, you question the position that our Directorate took in response to a question at the CRA Roundtable session at the CLHIA Conference in May 2013 in connection with the applicability of the advantage tax rules in Part XI.3 of the Income Tax Act (the “Act”) where a retirement compensation arrangement (RCA) trust owns a life insurance policy (2013-0481421C6).  We stated that it is not clear under what circumstances an RCA would be holding a life insurance policy that provides for more than a nominal death benefit.  We expressed the view that the holding of such a life insurance policy would appear to have little to do with providing for benefits under the RCA in relation to retirement, a loss of an office or employment, or a substantial change in services rendered.  We concluded that the holding of such a life insurance policy by the RCA could give rise to an advantage in relation to the RCA and, therefore, advantage tax under section 207.62 of the Act.

In general, the determination as to whether an advantage in relation to an RCA arises, in a taxation year, because of a life insurance policy held by the RCA, and the determination of the amount of such an advantage, are questions of fact.  Given the broad variations in life insurance policies and RCAs, each situation must be considered based on its own facts, on a case-by-case basis.  This would normally be undertaken only in the context of an advance ruling request.  However, we provide the following comments for your assistance.  In the example provided in your submission, an RCA trust acquires and holds a universal life insurance policy on the life of the individual who is the sole specified beneficiary of the RCA.  The policy is set up to qualify as an exempt policy under the life insurance policy taxation rules in the Act.  Throughout the duration of the life insurance policy, the total proceeds payable under the policy to the RCA (which the policy calls the ‘death benefit’) upon the death of the individual is XXXXXXXXXX.  The death benefit includes the cash value of the policy immediately before the time of death. The difference between the death benefit and the cash value is the protection component of the death benefit.  The amount of the death benefit under the life insurance policy is constant over the duration of the policy as the cash value increases each year, whereas the protection component correspondingly decreases each year (from approximately XXXXXXXXXX at the end of policy year 1 declining to approximately XXXXXXXXXX at the end of policy year XXXXXXXXXX).

We note that, in your example, the amount of the protection component of the death benefit under the policy far exceeds the individual’s own entitlement to retirement benefits under the RCA.  The amount also far exceeds a reasonable level of survivor benefits and there is no actuarial basis to support the amount as being reasonable.  Upon the death of the individual, regardless of the individual’s number of years of service, salary history or age, the funds derived from the proceeds of the protection component of the death benefit (as well as the cash value and the policy’s side account) would become available to the individual’s spouse (or the individual’s estate if the spouse predeceases the individual).  That amount would be larger if the individual were to die during the early years of the life insurance policy.

Accordingly, in our view, the yearly life insurance coverage is a benefit enjoyed by the individual that is conditional on the existence of the RCA and therefore constitutes an advantage each year under paragraph (a) of the definition “advantage” in subsection 207.5(1) that is subject to advantage tax.

Although (as noted above) the determination of the amount of the RCA advantage in each year is a question of fact, the cost of equivalent term-life insurance coverage based on insurance underwriting considerations such as the individual’s age, gender, and health would be a relevant factor.

We note that the fair market value of the RCA’s property is reduced each year due to assets of the RCA being spent to pay for the life insurance coverage rather than being invested.  Therefore, in the alternative, this could give rise to an RCA strip each year and thus an advantage by virtue of paragraph (d) of the “advantage” definition.

We therefore confirm that the position set out in 2013-0481421C6 with respect to RCA advantages remains unchanged.

We trust that you will find these comments to be of assistance.

Yours truly,

Mary Pat Baldwin, CPA, CA
for Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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