2023-0971701C6 Life insurance – contractual changes

Principal Issues: Does the endorsement to a defined set of policyholders of a benefit under an in-force exempt life insurance policy for no cost and no underwriting requirement constitute a disposition for tax purposes?

Position: The determination of whether endorsements adding certain benefits to a life insurance policy constitutes a disposition for income tax purposes can only be made on a case-by-case basis following a review of the facts and circumstances of a particular case.

Reasons: Whether policy amendments are so fundamental as to go to the root of the policy is a mixed question of fact and law.

Author: Johnstone, Alexander
Section: 148(10)(d)

CLHIA Roundtable – September 28, 2023

Question 1 – Life Insurance and contractual changes

Background

Insurers often include new benefits when designing products that were not available for previously issued policies (access to health advocate services, return of premium for certain situations, coverages for previously excluded activities, etc.). The insurer may feel that it would be appropriate and fair to extend those new benefits to existing policyowners by way of an endorsement creating a contractual obligation similar to that in newer policies. The endorsement would be offered at no cost to a defined set of policyholders (for example those issued after 2017, G3 contracts) without any other contractual changes, underwriting requirements, or any renegotiation of basic contractual obligations or benefits (basic death benefits, insureds under the contract, premium requirements, and values are not changed). This would be done to align them with newer issues that provide a similar benefit contractually and reflect the fact that the benefit wouldn’t have a material impact on the insurer as the risk of claim is much less likely and costly than other benefits provided.

Question

Can the Canada Revenue Agency (CRA) confirm that:

(a) An endorsement to provide a new benefit under an in-force exempt life insurance policy (not an annuity contract) for no cost and without any underwriting requirement, to a defined set of policyholders, would not constitute a disposition for tax purposes?

(b) More specifically, where the benefit added relates to a payout upon the death of an insured that was previously excluded in the life insurance policy contract, can the CRA confirm that such payment based on revised contract wording, would not constitute a disposition for tax purposes? (Consider contractual changes that would remove an excluded event, return of premium added for a death related to an exclusion, a lesser death benefit amount (less than full death benefit) provided for death resulting from an exclusion).

CRA Response

Where a policyholder under a life insurance policy has disposed of an interest in the policy in the year, subsection 148(1) of the Income Tax Act (“Act”) generally requires the policyholder to include, in computing income for the year, the amount by which the proceeds of the disposition in respect of that interest exceeds its adjusted cost basis. A disposition for this purpose is defined in subsection 148(9) of the Act to include a surrender or maturity of an interest in the policy or a disposition of that interest by operation of law only.

Paragraph 148(10)(d) of the Act provides that a policyholder will not be deemed to have disposed of or acquired an interest in a life insurance policy (other than an annuity contract) as a result only of the exercise of any provision (other than a conversion into an annuity contract) of the policy. In order to give meaning to the word “only”, it is our view that it is necessary to determine whether the changes that are made to the terms of the policy, including but not limited to endorsements providing additional benefits, are so fundamental as to go to the root of the policy. If this were the result, there would be a disposition of the policy and the acquisition of a new policy.

Where a policy is silent with respect to a particular type of change, the amending of the policy, if a material change, could result in a disposition of the existing policy and the acquisition of a new policy at law. It is a mixed question of fact and law whether particular changes to the terms and conditions of a life insurance policy are so fundamental as to result in a disposition of the policy and the acquisition of a new policy. Such a determination can only be made on a case by case basis.

Accordingly, in the situations described above, we would need to consider the changes to the terms of a particular life insurance policy resulting from the endorsements before expressing an opinion on whether a disposition of the policy has occurred for income tax purposes.

Alex Johnstone
2023-097170
September 28, 2023

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