2014-0555581E5 LIFE INSURANCE PROCEEDS ASSIGNED AS COLLATERAL

Principal Issues: Can a private corporation include in its CDA the proceeds received under a life insurance policy that was assigned to a financial institution as collateral for a loan. In the situation described, the corporation was both the policyholder and the beneficiary under the policy and the proceeds were received as a consequence of the death of the life insured.

Position: Yes, to the extent that the conditions in the CDA definition are met.

Reasons: The CDA definition requires that the amount of the life insurance proceeds be received by the corporation in consequence of the death of any person. The increase to the CDA is the amount which the life insurance proceeds exceed the adjusted cost basis of the policy immediately before the death.

Author: Johnstone, Alexander
Section: ITA 89(1) "capital dividend account"

XXXXXXXXXX

2014-055558
Alex Johnstone
(613) 410-9134

June 5, 2015

Dear XXXXXXXXXX:

Re: Life Insurance Proceeds

We are writing in response to your email dated November 6, 2014 requesting our comments on the tax consequences of the receipt of the proceeds of a life insurance policy by a private corporation as a consequence of the death of the individual whose life was insured under the policy.

In the situation described, the corporation was both the owner and beneficiary of an exempt life insurance policy. The corporation assigned the policy to a financial institution as collateral for a loan, the purpose of which was to earn income from business or property. On the death of the life insured under the policy, a portion of the life insurance proceeds was used to repay the bank loan.

Our comments

This technical interpretation provides general comments about the provisions of the Income Tax Act (the “Act”) and related legislation (where referenced). 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 IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.

Generally, when a policyholder disposes of an interest in a life insurance policy, the policyholder is required to include in income a gain to the extent that the proceeds of the disposition of the interest in the policy exceed the adjusted cost basis (“ACB”) of that interest immediately before the disposition. The full amount of the gain is included in computing income of the policyholder pursuant to paragraph 56(1)(j) and subsection 148(1) of the Act.

A disposition of an interest in a life insurance policy is defined in subsection 148(9) of the Act and specifically excludes a payment made under an exempt life insurance policy as a consequence of the death of a person whose life was insured under the policy. Consequently, the payment of a death benefit from an exempt life insurance policy is not a disposition and therefore can be received tax-free.

The capital dividend account (“CDA”) of a corporation is defined in subsection 89(1) of the Act. The CDA of a corporation generally includes, pursuant to paragraph (d) of the definition, life insurance proceeds received as a consequence of the death of a person whose life was insured to the extent that the proceeds exceed the corporation's ACB of the policy immediately before that person’s death.

The ACB to a policyholder of an interest in a life insurance policy is determined by a formula under subsection 148(9) of the Act. In general terms, the ACB is the amount by which the premiums paid by the policyholder (excluding premiums for accidental death benefits), and any income in respect of the interest in the policy that has previously been reported for tax purposes, exceeds the net cost of pure insurance under the policy.

As noted above, the requirement in the CDA definition that the life insurance proceeds be received as a consequence of the death of the life insured will be met where the proceeds are received by the corporation as the beneficiary of the policy. Where the life insurance policy has been assigned to a financial institution as collateral on a debt owed by the corporation to the financial institution and the corporation remains the beneficiary, the proceeds are considered to be constructively received by the corporation even though paid directly to the financial institution. Therefore, in the circumstances described, provided that the other conditions of the CDA definition in subsection 89(1) of the Act are met, the corporation can increase its CDA balance to the extent provided for in that definition.

Generally, when a capital dividend election is made by a private corporation, a tax-free distribution of the corporation’s CDA can then be made to its shareholders pursuant to subsection 83(2) of the Act. Interpretation Bulletin IT-66, Capital Dividends, discusses the procedures required to pay a dividend from a private corporation’s CDA. We trust that these comments will be of assistance.

Yours truly,

Jenie Leigh
Manager
Financial Institutions Section
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2015

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2015