2015-0618191E5 group term life insurance policy

Principal Issues: calculation of term insurance benefit in various scenarios

Position: See response

Reasons: See response

Author: Ryer, Andrea
Section: 6(4), Regulations 2701 and 2702

XXXXXXXXXX                                                                                                                    2015-061819
                                                                                                                                            A. Ryer
April 27, 2016

Dear Mr. XXXXXXXXXX:

Re: Group term life insurance policy

We are writing in response to your e-mail, dated November 16, 2015, enquiring about the calculation of the prescribed benefit to be included in an employee’s income in respect of group term life insurance. You write that the insurance is provided through an employer-paid group term life insurance policy that includes policy dividends (payable to the employer) based on claims experience. You have asked for guidance regarding the calculation of the amount to be included in income in the following situations:

A.    Under a policy where none of the premium rates depend on age or sex and the only amounts payable under the policy for term insurance in the year are regular premiums, can the policyholder elect to calculate the benefit under paragraph 2702(1)(a) of the Income Tax Regulations (Regulations), even though the policy includes policy dividends and experience rating refunds?

B.    Where the benefit is required to be calculated under paragraph 2702(1)(b) of the Regulations, do policy dividends and experience rating refunds that remain with the insurer, potentially reducing future premium levels, need to be included in the calculation of the average daily cost of insurance (ADCI)?

C.    When policy dividends and experience rating refunds that have accumulated with the insurer are paid to the policyholder, would such dividends and refunds reduce the ADCI, even if they relate to a long period of insurance and to some employees who are no longer covered under the plan in the year the dividends and refunds are paid?

Our Comments

This technical interpretation provides general comments about the provisions of the Income Tax Act (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 a particular transaction 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 70-6R7, Advance Income Tax Rulings and Technical Interpretations.

As defined in subsection 248(1) of the Act, a group term life insurance policy is one in which the only amounts payable by the insurer are (a) amounts payable on the death or disability of individuals whose lives are insured in respect of employment and (b) policy dividends and experience rating refunds. Subsection 6(4) of the Act applies to include a prescribed benefit (if any) in income from employment in respect of such insurance. The prescribed benefit is determined according to Part XXVII of the Regulations.

Section 2701 of the Regulations provides the amounts to be included in the calculation of the prescribed benefit. One component of the benefit that is required to be determined is the term insurance benefit, which is calculated under section 2702 of the Regulations. Generally, where the employer pays all the premiums under the policy and the policy does not include lump-sum or paid-up premiums, the amount of the prescribed benefit will be the amount of the term insurance benefit and the total of all sales and excise taxes payable on the premiums for the year.

Scenario A – Election of benefit under paragraph 2702(1)(a)) of the Regulations

Regardless of whether a group term life insurance policy includes policy dividends and experience rating refunds, the employer may calculate the benefit under paragraph 2702(1)(a) of the Regulations where the following requirements are met:

*     the policyholder elects to calculate the term insurance benefit under paragraph 2702(1)(a) for all individuals whose lives are insured under the policy;

*     no premium rate that applies for term insurance provided under the policy depends on the age or sex of an individual whose life is insured under the policy; and

*     no amounts are payable under the policy for term insurance on the lives of individuals in respect of the year other than premiums payable on a regular basis that are based on the amount of term insurance in force in the year for each individual.

Scenario B – Policy dividends and experience rating refunds in calculating the ADCI

Where paragraph 2702(1)(a) of the Regulations is inapplicable, the individual’s term insurance benefit is required to be calculated under paragraph 2702(1)(b) of the Regulations. This in turn requires the determination of the ADCI under subsection 2702(2) of the Regulations, using either the specified method under paragraph 2702(2)(a) or an alternative method under paragraph 2702(2)(b).

If the policyholder calculates the ADCI using the method specified in paragraph 2702(2)(a), the total amount of policy dividends and experience rating refunds paid to the policyholder in the year under the policy is included in the calculation of the ADCI for the premium category under variable C to the extent that the amount reasonably relates to term insurance on the lives of individuals in that premium category. Where there is more than one premium category, the policyholder must reasonably allocate the amount of policy dividends or experience rating refunds paid in the year under the policy among the premium categories.

In our view, a policy dividend or experience rating refund is paid under a policy when the insurer is under an obligation to pay it and discharges that obligation. Therefore, for an amount to be considered paid to a policyholder under the policy, there must exist under the terms of the policy an obligation to pay the amount to the policyholder. The actual discharge of that obligation would be considered, for the purposes of variable C in the formula in paragraph 2702(2)(a) of the Regulations, as an amount paid under the policy. The discharge can take the form of an unconditional credit (e.g., policy dividends or experience rating refunds that stay with the insurer and are applied to existing liabilities or to reduce future premiums) as well as a direct payment.

In contrast, a provision in the policy that allows the surplus is to remain within the jurisdiction of the insurer, with no obligation on its part to distribute any portion of the amount to the policyholder, will not result in an amount having been paid under the policy.

Scenario C – Policy dividends and experience rating refunds relating to a long period of insurance

If the policyholder calculates the ADCI using the method specified in paragraph 2702(2)(a), the total amount of policy dividends and experience rating refunds paid to the policyholder in the year under the policy is included in the calculation under variable C to the extent that the amount can reasonably be considered to relate to term insurance provided on the lives of individuals in the premium category. Policy dividends or experience rating refunds are included in variable C in the year they are paid, regardless of the period of accumulation to which such dividends or refunds relate and even if some individuals insured during that period are not covered under the policy when the dividends or refunds are paid to the policyholder.

However, where there may be significant fluctuations in the amount of policy dividends and experience rating refunds paid from year to year, the policyholder may choose an alternative method to calculate the ADCI. Alternative methods for calculating the ADCI for a premium category are permitted under paragraph 2702(2)(b) of the Regulations, which allows the policyholder to use a reasonable method that is substantially similar to the method set out in paragraph (a). For example, the policyholder may use a year-to-year averaging method to calculate the ADCI in order to level out the amount of the term insurance benefit to be included in income each year.

If an alternative method is used to calculate the ADCI, the onus is on the employer to demonstrate that the amount included in the employee’s income is reasonable in light of the employer’s actual cost to provide coverage. One measure for gauging the reasonableness of a particular method is whether the total amount of the term insurance benefit calculated over a number of years is substantially the same as the total benefit calculated for the same years under the specified method. It is generally expected that an employer will be consistent in the choice of methods used to determine the ADCI from year to year.

We trust these comments will be of assistance to you.

Sincerely,

Nerill Thomas-Wilkinson, CPA, CA
Manager
Business and Employment Income Section
Business and Employment Division
Income Tax Rulings Directorate

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, 2016

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, 2016