2022-0928831C6 2022 CALU Roundtable - Q5 - Policy Loan Repayment

Principal Issues: Where a taxpayer repays a policy loan and is entitled to a deduction in accordance with paragraph 60(s) of the Act that exceeds the taxpayer's income for the year, can such excess amount be deducted by the taxpayer in any other taxation year?

Position: The excess amount cannot be deducted by the taxpayer in any other taxation year.

Reasons: Scheme of the Act.

Author: Szilagyi, Steven
Section: 3, 4, 56(1)(j), 60(s), 111(8), 148(1), 148(9)

2022 CALU CRA Roundtable – May 2022

Question 5 - Policy Loan and Deduction under Paragraph 60(s)

Background

For the purposes of section 148 of the Income Tax Act (the “Act”), taking a policy loan under a life insurance policy is a disposition of an interest of a life insurance policy. As a result, a policy loan is taxable to the policyholder to the extent that the amount exceeds the policy’s adjusted cost basis (ACB).

If a policyholder repays a policy loan, a deduction is permitted under paragraph 60(s) of the Act in the year of repayment to the extent of any amount previously included in the policyholder’s income. Because the deduction occurs in the year of repayment, there can be a situation where the deductible amount in respect of a policy loan repayment exceeds the policyholder’s income. This could occur, for example, if a policyholder repays the policy loan early in a taxation year, but shortly thereafter becomes unemployed such that by the end of the year their income otherwise determined was less than the deduction available under paragraph 60(s) of the Act.

It appears there is no provision in the Act that allows a policyholder to carry forward or back any unused deduction permitted under paragraph 60(s) of the Act to another taxation year. The CRA has confirmed that deductions permitted under section 60 of the Act cannot create a non-capital loss that can be carried forward or back so as to be utilized in another taxation year. Specifically, in document 2019-0824081E5, the CRA confirmed that legal fees deductible under paragraph 60(o) of the Act are included in the calculation of income under paragraph 3(c) of the Act, which cannot be a negative amount. As a result, a non-capital loss cannot be created where the deduction for legal fees exceeds the taxpayer’s income in the year.

Question

Where a taxpayer repays a policy loan and is entitled to a deduction in accordance with paragraph 60(s) of the Act that exceeds the taxpayer’s income for the year, can the CRA confirm that such excess amount in respect of the policy loan repayment is not available to be deducted by the taxpayer in any other taxation year?

CRA Response

We confirm that where a taxpayer repays a policy loan and is entitled to a deduction, in accordance with paragraph 60(s) of the Act, that exceeds the taxpayer’s income for the year, such excess amount cannot be deducted by the taxpayer in any other taxation year for the reasons set out in the paragraphs that follows.

In general terms, a policyholder includes in income, under paragraph 56(1)(j) and subsection 148(1) of the Act, a policy gain resulting from a disposition of an interest in a life insurance policy that is a policy loan. Paragraph 60(s) of the Act permits a deduction in a taxation year for the total of all repayments made in the year in respect of a policy loan. The amount deductible under paragraph 60(s) of the Act is restricted to the amount by which the policy gain included in income under subsection 148(1) of the Act in respect of the policy loan exceeds the amounts deductible in previous taxation years in respect of the policy loan repayments. No carry forward is available under paragraph 60(s) of the Act in respect of a policy loan repayment.

Section 3 of the Act sets out the basic rules for determining income of a taxpayer for a taxation year from all sources and section 4 of the Act provides general rules for determining income or losses from a particular source or a particular place. Under paragraph 3(a) of the Act, the taxpayer determines the amount of income for the year from a source, including, but not restricted to, income from each office or employment (determined under Subdivision A of the Act), business or property (determined under Subdivision B of the Act). The taxpayer would also include, under paragraph 3(a) of the Act, the taxpayer’s other sources of income, determined under Subdivision D of the Act, such as the amount of a policyholder’s gain resulting from a disposition of an interest in a life insurance policy that is a policy loan described above.

Under paragraph 3(c) of the Act, the taxpayer determines the amount, if any, by which

(i) the total determined under paragraph 3(a) of the Act (see the previous paragraph) plus the amount determined under paragraph 3(b) of the Act (i.e., net taxable gains)

exceeds

(ii) the total deductions permitted under Subdivision E of the Act (except to the extent that such deductions have already been taken into account in determining any of the net incomes from a source included in paragraph 3(a) of the Act).

Subdivision E of the Act includes the deductions permitted under section 60 of the Act such as the amount deductible under paragraph 60(s) of the Act described above. Subject to certain exceptions under subsection 4(3) of the Act, subsection 4(2) of the Act specifically denies the deduction of items in sections 60 to 64 of the Act in determining income from a particular source. Consequently, a deduction allowed under paragraph 60(s) of the Act is not tied to a particular source or to sources in a particular place.

The amount determined under paragraph 3(c) of the Act, which forms variable F of the “non-capital loss” definition in subsection 111(8) of the Act, will never be negative, and therefore deductions described in Subdivision E of the Act cannot create or increase the amount of a non-capital loss.



Steven Szilagyi
2022-092883
May 3, 2022

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