2021-0884291C6 2021 CLHIA Roundtable - Q4 - Life insurance shares

Principal Issues: We were asked to confirm the CRA's position described in document 2005-0138111C6 regarding the allocation of the cash surrender value (CSV) of a life insurance policy for the purpose of determining the fair market value of property (shares) deemed to have been disposed as a consequence of death in accordance with subsection 70(5.3).

Position: Our position with respect to the allocation of the CSV for purposes of subsection 70(5.3) remains unchanged.

Reasons: Consultation with Business Equity Valuations Section in CPB.

Author: Danis, Sylvie
Section: 70(5.3)

CLHIA Roundtable – May 2021

Question 4 – Life insurance shares

Background

At the APFF 2005 Conference, CRA was asked to comment on a particular situation. See CRA document no. 2005-0138111C6, dated October 7, 2005. The question, as translated, was presented as follows:

The taxpayer is the sole shareholder of a private corporation (the “Corporation”). The Corporation wishes to acquire a universal life insurance contract (the “Policy”) on the taxpayer’s life, of which it will be the policyholder and beneficiary. On his death, the taxpayer wants the proceeds of the life insurance paid to a person (for example, the taxpayer's adult child), who is not the person (for example, the taxpayer's spouse) who will inherit the Corporation's common shares (which are the only shares issued and outstanding).

To reach the objectives of the Corporation and the taxpayer, the following transactions take place:

1.    a category of preferred shares is added to the Corporation's authorized share capital ("insurance shares"). The characteristics of the insurance shares are the following:

a)    they are non-voting;

b)    they do not entitle the holder to any participation in the Corporation's profits, other than the dividend described in paragraph (c) below;

c)    they entitle the holder to a dividend in an amount corresponding to the death benefit payable under the Policy. This dividend may only be declared, however, after the taxpayer's death;

d)    they are redeemable at the taxpayer's option:

i.    at any time before the taxpayer's death, for an amount corresponding to the cash surrender value of the Policy at the time of redemption. Payment of the redemption amount is, however, deferred until the Corporation receives the Policy's death benefit;

ii.   at any time after the taxpayer's death, for an amount corresponding to the difference between the amount of the Policy's death benefit and the amount of the dividend declared on them, if any. Once again, payment of the redemption amount is deferred until the Corporation receives the Policy's death benefit.

e)    they are redeemable at the Corporation's option at any time after the taxpayer's death, for an amount corresponding to the difference between the amount of the Policy's death benefit and the amount of the dividend declared on them, if any, payment of the redemption amount being, however, deferred until the Corporation receives the Policy's death benefit; and

f)    the cash surrender value described in paragraph (d) above is also the amount to which shareholders holding the insurance shares are entitled when the Corporation is liquidated.

2. The taxpayer’s adult child subscribes for one (1) life insurance share, for $1.

3. The Corporation underwrites the Policy.

When the Policy is underwritten (i.e. immediately after the life insurance share is issued), the cash surrender value of the Policy is nil, given the surrender fees applicable to it.

In document 2005-0138111C6, the CRA was asked to confirm that immediately before the taxpayer’s death, the Policy’s cash surrender value will not increase the fair market value of the common shares held by the taxpayer, since this value is reflected in the redemption amount of the insurance share held by the taxpayer’s adult child, in compliance with subsection 70(5.3) of the ITA.

The CRA provided the following response:

When the taxpayer dies, subsection 70(5.3) of the ITA establishes the value of the Corporation's asset, which is the insurance policy on the life of this taxpayer (or of any other individual not dealing at arm's length with the taxpayer at certain times stipulated in this subsection), for the purposes of determining the FMV of property held by the deceased immediately before his death. Subsection 70(5.3) of the ITA deems that the FMV of such a life insurance policy to be equal to the cash surrender value of the policy immediately before the taxpayer's death. Subsection 70(5.3) of the ITA does not specify how to distribute the cash surrender value of the life insurance policy between different categories of shares.  Generally, we are of the opinion that it would be reasonable to distribute the cash surrender value of a life insurance policy between the categories of shares based on the rights and conditions attached to them, in the same way as the overall value of a business would be distributed between the different categories of shares in circulation. In this situation, the category of insurance shares issued to the son is redeemable at the option of the holder immediately before the death of the insured party, at an amount equivalent to the cash surrender value of the said policy.  Moreover, given the facts provided in this case, it would not be unreasonable to allocate the amount of the Policy cash surrender value immediately before the death to the insurance shares. Accordingly, the value of the common shares held by the taxpayer in this situation would not take into account the cash surrender value of the Policy on the life of this taxpayer.

Question

Can the CRA confirm that the comments above continue to apply under this particular fact pattern?

CRA Response

The comments provided at the APFF 2005 Conference, described above, continue to apply to that identical fact situation.

However, please note that the purpose of this question was to obtain the CRA’s views on whether in applying subsection 70(5.3), immediately before the taxpayer’s death, the cash surrender value of the life insurance policy would be taken into account in determining the fair market value of the common shares or the fair market value of the special/insurance share and our comments at that time were limited to this narrow aspect of the question. Consequently, and given that the facts outlined in this question only summarize very briefly a hypothetical situation, the above comments should not, in any manner, be interpreted as being applicable to other tax consequences that may arise in a given situation and should not be construed as implying that the CRA has confirmed, reviewed or made any determination in respect of any other tax consequences that may arise in a given situation. 

The portion of the response confirming the 2005 position was prepared with the collaboration of the Business Equity Valuations Section
Tax Avoidance Division
Compliance Programs Branch

Sylvie Danis
May 19, 2021
2021-088429

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