2021-0882411E5 Partnership wind-up - life insurance

Principal Issues: 1- In the hypothetical scenario provided, where a Canadian partnership that owns an interest in an exempt life insurance policy ceases to exist and the requirements of subsection 98(3) are otherwise met, will subsection 98(3) take precedence over subsection 148(7) such that there would be a tax-deferred rollover of the life insurance policy? 2- In the hypothetical scenario provided, where a Canadian partnership that owns an interest in an exempt life insurance policy ceases to exist and the conditions under subsection 98(5) are otherwise met, will subsection 98(5) take precedence over subsection 148(7) such that there would be a tax-deferred rollover of the life insurance policy?

Position: 1 & 2 – Generally, yes.

Reasons: Based on the legislation.

Author: Johnstone, Alexander
Section: 98(3), 98(5), 148(7)

XXXXXXXXXX
                                                                                                2021-088241
                                                                                                Alex Johnstone

September 29, 2022

Dear XXXXXXXXXX:

This is in reply to your letter dated February 24, 2021, wherein you ask for our comments on subsections 98(3), 98(5), and 148(7) of the Income Tax Act (the “Act”) in respect of the transfer of a life insurance policy on the wind-up of a Canadian partnership. We apologize for the delay in responding.

In your request, you describe the following two hypothetical situations involving a Canadian partnership, as defined in subsection 102(1):

1. Two individuals carry on a business as a partnership. The partnership is the policyholder of an exempt life insurance policy on the life of each partner. The partnership ceases to exist and the partnership property is distributed to each partner such that each partner receives an undivided interest in the partnership property and the former partners jointly elect under subsection 98(3) with respect to the partnership property. You have asked whether the partnership’s proceeds with respect to the distribution of the interest in the life insurance policies arising from the cessation of the partnership and each partner’s cost of the interest in said policies would be determined under subsection 98(3) or subsection 148(7).

2. A limited partnership is formed with two individuals as limited partners and a corporation (Opco) as the general partner. The limited partnership is the policyholder of an exempt life insurance policy on the life of each limited partner. Each limited partner transfers their respective partnership interest to Opco utilizing the provisions of subsection 85(1) and electing an amount equal to the adjusted cost base of their respective partnership interest. As a result, the limited partnership ceases to exist and Opco carries on alone the business that was the business of the limited partnership. You have asked whether the partnership’s proceeds with respect to the distribution of the life insurance policies arising from the cessation of the limited partnership and Opco’s cost in said policies would be determined under subsection 98(5) or subsection 148(7).

Our Comments

This technical interpretation provides general comments about the provisions of 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 70-6R12, Advance Income Tax Rulings and Technical Interpretations.

In general terms, subsection 98(3) is an elective provision that applies, provided certain conditions are met, where a Canadian partnership ceases to exist and all of the property of the partnership has been distributed to the members of the partnership and each member receives an undivided interest in each partnership property equal to the member’s undivided interest in each other property distributed. In general, where all the requirements are met, subsection 98(3) permits, inter alia, property of a Canadian partnership which has ceased to exist to be distributed to its members at the cost amount of the property to the partnership. Subsection 98(3) is not applicable in any case in which subsection 98(5) or 85(3) [not discussed herein] is applicable.

Subsection 98(5), which is a non-elective provision, also contains rules which provide a tax-deferred transfer or “rollover” of a Canadian partnership's property where the partnership has ceased to exist. In general terms, the provision applies only in situations where a Canadian partnership ceases to exist and, within three months, one member (referred to herein as the “proprietor”) alone carries on the partnership business and continues to use the partnership property (which was received by the proprietor as proceeds of disposition of the proprietor’s partnership interest) in that business. Where all the requirements are met, subsection 98(5) provides that the partnership shall, inter alia, be deemed to have disposed of its property at its cost amount and sets out deeming rules for determining the proprietor’s proceeds of disposition of the proprietor’s partnership interest and the cost to the proprietor of the transferred property.

Subsection 148(7) applies when a policyholder’s interest in a life insurance policy is disposed of (other than a disposition under paragraph 148(2)(b)) by way of 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. Under paragraph 148(7)(a) the proceeds of the disposition to the policyholder is the amount that is the greatest of (i) the fair market value of any consideration given for the interest; (ii) the interest's value (as defined in subsection 148(9)); and (iii) the adjusted cost basis of the interest to the policyholder. Moreover, under paragraph 148(7)(b), the person that acquires the interest because of the disposition is deemed to acquire it, at the disposition time, at a cost equal to the amount determined under paragraph 148(7)(a) in respect of the disposition.

In the hypothetical situations you describe, where a Canadian partnership that owns an interest in an exempt life insurance policy ceases to exist and all the requirements of subsection 98(3) or 98(5), as the case may be, are otherwise met, it is our general view that those provisions would take precedence over subsection 148(7) such that there would be a tax-deferred rollover of the exempt life insurance policy.

We trust that our comments will be of assistance.

Yours truly,

Bob Naufal
Manager
for Director
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, 2022

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, 2022