2019-0799051C6 2019 CLHIA Roundtable - 148(7) questions
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: Roundtable Question 2 deals with two scenarios and asks for CRA's views on the application of subsection 148(7) in those scenarios. The first scenario deals with the transfer of a corporate owned life insurance policy to a former shareholder of the corporation. We were asked whether the transfer would be considered to take place at non-arm's length such that subsection 148(7) applies. The second scenario deals with the transfer of a life insurance policy from an employer to a non-shareholder employee. We were asked whether subsection 148(7) and paragraph 6(1)(a) would apply to the transfer and what the tax implications would be to the employer and the employee.
Position: For the first issue - whether parties are dealing at arm's length is a question of fact. We also caution that if the purpose for structuring a transaction in a particular manner is to avoid the application of a subsection 15(1) benefit, we would need to consider the possible application of subsection 245(2) or 246(1). For the second issue - we confirm that subsection 148(7) and paragraph 6(1)(a) would generally apply to the situation described. The employer would realize a policy gain in this case by the excess of the CSV of the policy over the ACB of the policy at the time of the transfer. The employee would have an employment benefit under paragraph 6(1)(a) equal to the excess of the FMV of the policy at that time, over the amount of any consideration paid by the employee for the policy.
Reasons: For the first issue - Under subsection 251(2), whether two unrelated parties are dealing at arm's length is a question of fact. All of the facts relevant to a particular situation would need to be considered before determining whether parties to the transaction were dealing at arm's length. For the second issue, the application of subsection 148(7) and paragraph 6(1)(a) when a policy is transferred from an employer to a non-shareholder employee is a position we have taken in the past and remains our position.
Section: 148(7), 15(1), 245(2), 246(1), 6(1)(a), 148(1), 56(1)(j)
CLHIA Roundtable – May 2019
Question 2 – Application of 148(7) to Non-Arm’s Length Transactions
Subsection 148(7) of the Income Tax Act generally applies where an interest of a policyholder in a life insurance policy is disposed of by way of a 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.
Consider the following facts scenarios:
Individual A is the sole shareholder of Corporation A. Among the assets of Corporation A is a permanent life insurance policy on the life of Individual A. The death benefit of that policy is $1 million, the cash surrender value (CSV) is $50,000 and the adjusted cost basis (ACB) is $20,000. The fair market value (FMV) of the policy equals the CSV.
At a time after March 21, 2016, three independent business valuations indicate that the FMV of Corporation A, exclusive of any goodwill or expertise attributable to Individual A’s involvement in the Corporation but inclusive of the policy’s FMV, is between $9.5 million and $10.5 million.
Immediately following those valuations, at a time when there has been no known change in the value of Corporation A, Individual A sells the shares of Corporation A (which includes the policy) to Individual B for $10 million. Other information to be considered is as follows:
* Individual A and Individual B are not related persons before or after the sale of the shares of Corporation A;
* Individual A and Corporation A are related persons before the sale of the shares of Corporation A but are not related persons after the sale of the shares; and
* Individual B and Corporation A are not related persons before the acquisition of the shares of Corporation A but are related persons after the acquisition of the shares.
Subsequent to the sale of Corporation A’s shares to Individual B, Corporation A sells the policy to Individual A. At this time, Individual A is presumed by both parties to be in good health, with no expectation of premature death. The death benefit, FMV, CSV and ACB of the policy are unchanged. The agreed consideration for the sale of the policy is $1.
Based solely on the above facts, does CRA view the sale of the policy from Corporation A to Individual A to be a non-arm’s length transaction such that subsection 148(7) applies?
Whether the sale of the policy from Corporation A to Individual A, as described in the facts above, is a non-arm’s length transaction such that subsection 148(7) applies is a question of fact. Based on the limited facts that are provided, it appears that the sale of the shares of Corporation A and the sale of the policy to Individual A may be part of a series of transactions. All of the documentation and other facts relating to the sale of the shares of Corporation A and the policy transfer would need to be reviewed to determine whether the parties were in fact dealing at arm’s length. Further information in this regard is available in Income Tax Folio S1-F5-C1, Related Persons and Dealing at Arm’s Length.
If, in reviewing the specific facts of a particular situation there is evidence that the transactions have been structured to avoid the realization of a shareholder benefit under paragraph 15(1) or the application of subsection 148(7), the CRA would need to consider the possible application of subsection 245(2) or subsection 246(1).
Corporation A and its employee, Employee B, deal at arm’s length. Employee B is neither an executive nor shareholder of Corporation A, but her expertise and outstanding rapport with significant customers have made her a key employee of Corporation A. Consequently, Corporation A has owned a “key person” permanent life insurance policy on the life of Employee B for several years, recognizing that there could be significant disruption to the Corporation’s business in the event of Employee B’s death. The policy does not include a provision by which a different life can be substituted or added as a life insured.
Due to the changing nature of Corporation A’s business, employee B is no longer considered to be a key employee. As a result, the company is considering the surrender of the policy for its CSV. However, Employee B has learned of this and requested that the policy be transferred to her and the company has agreed to do so for no consideration. Employee B is presumed by both parties to be in good health, with no expectation of premature death.
At the time that Corporation A transfers the life insurance policy to Employee B the death benefit under the policy is $1 million, the CSV is $50,000 and the ACB is $20,000. The FMV of the policy is equal to the CSV.
The transfer of the policy from Corporation A to Employee B takes place at a time after March 21, 2016.
In CRA’s view:
a) Does the transfer of the policy from Corporation A to Employee B result in an employee benefit at FMV to Employee B under section 6?
b) Does subsection 148(7) apply to the transfer of the policy from Corporation A to Employee B?
c) Does the transfer of the policy result in Corporation A having to report a gain on disposition of the policy?
d) What would Employee B’s new ACB in the policy be where subsection 148(7) applies?
Subsection 148(7) generally applies where an interest in a life insurance policy is disposed of by way of a 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. For a disposition after March 21, 2016, where subsection 148(7) applies, paragraph (a) of the provision provides that the policyholder is deemed to receive proceeds in respect of the interest in the policy, at the time of disposition, equal to the greatest of three amounts:
* the value of the interest,
* the FMV of the consideration, if any, given for the interest, and
* the ACB of the interest.
Paragraph 148(7)(b) deems the person acquiring the interest in the policy to acquire the interest at the amount that is determined under paragraph 148(7)(a) to be the proceeds to the policyholder. The terms “value” and “adjusted cost basis” for these purposes are defined in subsection 148(9). Generally, where the interest being disposed of includes an interest in the CSV of the policy, the “value” of the policy for purposes of subsection 148(7) will be the CSV of the policy.
Paragraph 6(1)(a) of the Act provides that the value of benefits of any kind received by an employee in respect of, in the course of, or by virtue of an office or employment are included in income and subject to tax unless otherwise excluded by another provision of the Act. The definition of “value” in subsection 148(9) does not apply for purposes of paragraph 6(1)(a). The “value” of a benefit that must be included in a taxpayer’s income under paragraph 6(1)(a) is generally the FMV of the property received by the taxpayer less any amount paid by the taxpayer for the property.
With respect to Scenario 2, it is the CRA’s view that:
a) Employee B will have an employment benefit under paragraph 6(1)(a) for the year in which the policy is received. The amount of the paragraph 6(1)(a) benefit will be the amount that is the FMV of the interest in the policy at the time of the transfer less any amount paid by Employee B for the interest (in the described situation, no amount was paid by Employee B).
b) Subsection 148(7) would apply to the transfer of the policy from Corporation A to Employee B.
c) Under paragraph 56(1)(j) and subsection 148(1), Corporation A would report a policy gain of $30,000. This policy gain is computed as the greatest of the three amounts described in paragraph 148(7)(a), which would be the CSV of $50,000, less the ACB of the policy of $20,000.
d) Under paragraph 148(7)(b), Employee B will be deemed to have acquired the policy at a cost of $50,000 (which is the amount determined under paragraph 148(7)(a)).
May 14, 2019
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