2024-1007081C6 2024 CALU RT - Q5 - Gift of life insurance policy

Principal Issues: Determination of the policy gain under subsection 148(1) on the transfer of a life insurance policy and application of subsections 248(35) and (36) in the determination of the eligible amount of a subsequent charitable gift in the four scenarios provided.

Position: General comments provided.

Reasons: See response.

Author: Danis, Sylvie
Section: 74.1(1), 98(5), 148(7), 148(8), 148(8.1), 248(35), 248(36)

CALU Roundtable – May 2024

Question 5 – Transfers of Life Insurance Policies and Subsections 248(35) and 248(36)

Background

Subsection 148(7) of the Income Tax Act (Act) determines the proceeds of the disposition on certain dispositions of an interest in a life insurance policy, including a disposition by way of a gift of a life insurance policy. In such situations, the proceeds of the disposition will be equal to the greatest of (i) the adjusted cost basis (ACB) of the interest in the policy, (ii) the cash surrender value (CSV) of the interest in the policy, and (iii) the fair market value (FMV) of any consideration given for the interest in the policy. Moreover, under paragraph 148(7)(b) of the Act, the person that acquires the interest because of the disposition is deemed to acquire it at a cost equal to the deemed proceeds of the disposition.

In document 2021-0882411E5 dated September 29, 2022, the CRA opined that where there is a transfer of an interest in an exempt life insurance policy from a Canadian partnership to a partner in a situation where all the requirements of subsections 98(3) or (5) of the Act are met, these provisions would take precedence over subsection 148(7) of the Act such that there would be a tax-deferred rollover in respect of the transfer.

Where there is a gift of an interest in a life insurance policy to a qualified donee, including a registered charity, the charity can issue an official donation receipt for the eligible amount of the gift (generally computed as the FMV of the interest in the policy less any advantage received by the donor in respect of the gift). (endnote 1) The CRA has stated that in certain circumstances, the FMV of a life insurance policy may be greater than its CSV and the valuation factors identified in paragraphs 40 and 41 of Information Circular 89-3 must be taken into account to determine the FMV of the interest in the policy for purposes of determining the eligible amount of the gift.

However, it is important to note that pursuant to subsection 248(35) of the Act, the FMV of the life insurance policy gifted to the charity may be reduced in the following circumstances:

• The policy was acquired less than three years before the date the gift was made; or

•  The policy was acquired less than 10 years before the date the gift was made and one of the main reasons for the donor acquiring the policy was to gift it to a qualified donee.

In such circumstances, for purposes of computing the eligible amount of the gift under subsection 248(31) of the Act, the FMV of the policy will be the lesser of (i) the FMV of the policy, and (ii) the ACB of the policy immediately before the time of the gift. This amount will be further reduced by the amount of any advantage in respect of the gift. (endnote 2) Subsection 248(37) of the Act provides an exception to subsection 248(35) of the Act for gifts of certain types of property. However, a life insurance policy is not included in the list of excepted properties.

Another rule applies where the gifted policy was previously acquired by a person or partnership with whom the donor does not deal at arm’s length. Pursuant to subsection 248(36) of the Act, if the FMV of the interest in the gifted policy was reduced under subsection 248(35) of the Act because the donor acquired that policy (otherwise than upon death) within the 3-year or 10-year periods described in that provision, and the policy was, at anytime within the 3-year or 10-year periods, as applicable, acquired by a person or partnership that does not deal at arm’s length with the donor, the donor’s “cost” of the policy for purposes of subsection 248(35) of the Act will be deemed to be the lowest of the “cost” to the donor immediately before the gift or the “cost” to the non-arm’s length person or partnership immediately before their disposition. In this regard, the CRA stated in document 2017-0692361C6 dated May 18, 2017 that the ACB of an interest in a life insurance policy would be a reasonable proxy for the “cost” of an interest in a policy for purposes of subsections 248(35) and (36) of the Act.

More recently, in document 2023-0978561C6 dated November 2, 2023, the CRA provided its views on the transfer of a life insurance policy from a partnership to a partner and the subsequent gift of that policy by that partner to a registered charity.

The following hypothetical situations describe the transfer of an interest in a life insurance policy followed by the gift of the interest in the policy to a registered charity. For each scenario, none of the policies were acquired under a gifting arrangement that is a tax shelter nor were they acquired with the intention of making a gift. In addition, for each gift, the interest in the policy has been absolutely assigned to the charity and the charity has become the registered beneficiary of the policy. Furthermore, there is no advantage related to the gift of the policy.

Scenario 1 – Distribution of a Policy from a Partnership and Subsequent Gift to a Charity

Two individuals, A and B, operated a business as a Canadian partnership. The partnership bought a life insurance policy on each of the lives of Individual A and Individual B and the partnership was the named beneficiary of the two life insurance policies.

Ten years later, Individual B departs the partnership and the life insurance policy on Individual B’s life was transferred to Individual B. The business of the partnership continued to be carried on alone by Individual A (the proprietor) who continued to use, in the course of the business, the remaining partnership property, including the life insurance policy on Individual A’s life (the Policy) in accordance with subsection 98(5) of the Act.

Two years later, Individual A donates the Policy to a registered charity when the policy’s ACB is $5,000, CSV is $11,000 and FMV is $30,000.

Question

For the purposes of subsection 248(35) of the Act, would the period during which the partnership owned the Policy be included in determining the period during which Individual A owned the Policy?

CRA Response

As stated in document 2023-0978561C6 dated November 2, 2023, it is our view that the period that a partnership held a life insurance policy is not included in determining the period that a partner owned the policy for purposes of subsection 248(35) of the Act.

In scenario 1, where Individual A acquired the Policy within three years of the time of the gift to a registered charity, it is our view that:

•  Pursuant to subsection 148(7) of the Act, Individual A is deemed to become entitled to proceeds of the disposition in respect of the gift of the interest in the Policy equal to $11,000, resulting in a policy gain under subsection 148(1) of the Act of $6,000 ($11,000 - $5,000).

•  Pursuant to subsection 248(35) of the Act, the FMV of the interest in the Policy, for purposes of determining the eligible amount of the gift, is deemed to be $5,000, which is the lesser of its FMV otherwise determined ($30,000) and Individual A’s ACB of the interest in the Policy immediately before the gift is made ($5,000).

Scenario 2 – Transfer of a Policy from a Shareholder to a Corporation and Subsequent Gift to a Charity

Individual A purchased a life insurance policy (the Policy) on January 2, 2021 which has the following values as of February 1, 2024:

•  Adjusted cost basis (ACB) = $15,000

•  Cash surrender value (CSV) = $20,000

•  Fair market value (FMV) = $30,000

Consider the following scenarios.

Part A – Donation of the Policy by Individual A

Individual A transfers the Policy by way of gift to a registered charity on February 1, 2024.

The income tax consequences of the transfer for Individual A appear to be as follows:

•  Pursuant to subsections 148(1) and 148(7) of the Act, Individual A would report a policy gain on the disposition of the Policy equal to $5,000 ($20,000 - $15,000).

•  The eligible amount of the gift to Individual A would be $30,000.

Part B – Transfer of a Policy to a Corporation and Subsequent Gift to a Charity

On March 1, 2021, Individual A transferred the recently acquired Policy to a wholly owned corporation (Opco) for no consideration. At that time (March 1, 2021), the Policy had an ACB, CSV and FMV of nil. On February 1, 2024, Opco transfers the Policy by way of gift to a registered charity. The Policy’s ACB, CSV and FMV at this time (February 1, 2024) are noted above.

The income tax implications of the transfer for Individual A and Opco appear to be as follows:

•  Pursuant to subsections 148(1) and 148(7) of the Act, Individual A would not realize a policy gain on the disposition of the Policy to Opco on March 1, 2021. Opco would acquire the Policy at a cost equal to nil.

•  For purposes of determining the eligible amount of the gift of the Policy by Opco on February 1, 2024, the deemed FMV of the gifted Policy to Opco would be restricted to $15,000 because of subsection 248(35) of the Act since Opco would have acquired the interest in the Policy less than 3 years before the gift is made.

•  Under subsections 148(1) and 148(7) of the Act, Opco would realize a policy gain of $5,000 ($20,000 - $15,000) on February 1, 2024 in respect of the disposition by way of gift of the interest in the Policy to the registered charity.

Question

Can the CRA confirm the tax implications are as described in each of Part A and Part B?

CRA Response

Part A – Donation of the Policy by Individual A

In part A of scenario 2, where Individual A gifts the interest in the Policy acquired on January 2, 2021 to a qualified donee that is a registered charity, we agree that:

•  Pursuant to subsection 148(7) of the Act, Individual A is deemed to become entitled to proceeds of the disposition equal to $20,000 resulting in a policy gain under subsection 148(1) of the Act of $5,000 ($20,000 - $15,000).

•  Subsection 248(35) of the Act does not apply to reduce the FMV of the interest in the Policy for purposes of determining the eligible amount of the gift of the Policy. Accordingly, the eligible amount of the gift would equal the FMV of the interest in the Policy ($30,000).

Part B – Transfer of a Policy to a Corporation and Subsequent Gift to a Charity

In part B of scenario 2, where Individual A transfers the recently acquired interest in the Policy to Opco, a non-arm’s length party, for no consideration and Opco donates the Policy to a registered charity within three years of that transfer, it is our view that:

•  Pursuant to paragraph 148(7)(a) of the Act, Individual A is deemed to become entitled to proceeds of the disposition equal to nil on the transfer of the interest in the Policy to Opco, resulting in no policy gain under subsection 148(1) of the Act.

•  Under paragraph 148(7)(b) of the Act, Opco is deemed to acquire the interest in the Policy at a cost equal to nil.

•  Subsection 148(7) of the Act applies to the disposition that is the gift of the interest in the Policy by Opco to the registered charity, resulting in a policy gain under subsection 148(1) of the Act of $5,000 ($20,000 - $15,000).

•  Since Individual A, the person non arm’s length to Opco, did not acquire the interest in the Policy within the 3-year or 10-year period of the gift, subsection 248(36) of the Act does not apply for purposes of subsection 248(35) of the Act.

•  Pursuant to subsection 248(35) of the Act, for purposes of determining Opco’s eligible amount of the gift of the interest in the Policy, the FMV of the interest in the Policy is deemed to be $15,000, which is the lesser of its FMV otherwise determined ($30,000) and Opco’s ACB of the interest in the Policy immediately before the gift is made ($15,000).

Scenario 3 – Transfer of a Policy from Parent to Child and Subsequent Gift to a Charity

Parent A purchased a life insurance policy (the Policy) on their child’s life (Child B) when Child B was 8 years old. Parent A is the owner and pays the premiums on the Policy. The ownership was set up in this manner because the child was a minor.

The Policy is transferred by Parent A to Child B at age 21. At the time of transfer the Policy’s ACB is $2,000, CSV is $5,000 and FMV is $6,000. Pursuant to subsection 148(8) of the Act, the transfer of the Policy from Parent A to Child B is deemed to occur at the Policy’s ACB ($2,000).

Within three years of the transfer of the Policy from Parent A to Child B, Child B donates the policy to a registered charity when the policy’s ACB is $2,200, CSV is $5,500 and FMV is $7,000.

Question

Does subsection 248(35) of the Act apply to deem the FMV of the gifted Policy to be equal the Policy’s ACB ($2,200) rather than the Policy’s FMV ($7,000), for purposes of determining the eligible amount of the gift of the Policy by Child B?

CRA Response

In scenario 3, where the Policy is transferred by Parent A to Child B pursuant to subsection 148(8) of the Act and Child B subsequently donates the Policy to a registered charity within three years of that transfer, it is our view that:

•  Subsection 148(7) of the Act applies to the disposition that is the gift of the interest in the Policy by Child B to the registered charity, resulting in a policy gain under subsection 148(1) of the Act of $3,300 ($5,500 - $2,200).

•  Since the interest in the Policy was acquired by Parent A more than 10 years before the time of the gift by Child B, subsection 248(36) of the Act does not apply for the purposes of subsection 248(35) of the Act.

•  Pursuant to subsection 248(35) of the Act, for purposes of determining Child B’s eligible amount of the gift of the interest in the Policy, the FMV of the interest in the Policy is deemed to be $2,200, which is the lesser of the Policy’s FMV otherwise determined ($7,000) and Child B’s ACB of the interest in the Policy immediately before the gift is made ($2,200).

Scenario 4 – Transfer of a Policy to a Spouse and Subsequent Gift to a Charity

Part A - Application of Subsection 248(35)

Spouse A is the owner and pays the premiums on a life insurance policy (the Policy), purchased 15 years ago, on Spouse A’s life. Spouse A transfers the Policy to Spouse B for no consideration. At the time of the transfer of the Policy, the Policy's ACB was $20,000, CSV was $60,000 and FMV was $70,000. No election is made in Spouse A’s return of income in respect of the transfer of the Policy. As a result, subsection 148(8.1) of the Act deems the transfer from Spouse A to Spouse B to occur at the Policy’s ACB ($20,000).

Within 3 years of the transfer of the Policy from Spouse A to Spouse B, Spouse B donates the Policy to a charity. At the time of the gift, the Policy's ACB is $22,000, CSV is $62,000 and FMV is $75,000.

The income tax implications of the gift of the Policy by Spouse B to the charity appear to be as follows:

•  For purposes of determining the eligible amount of the gift of the Policy by Spouse B, the deemed FMV of the gifted Policy to Spouse B would be restricted to the Policy’s ACB ($22,000) because of subsection 248(35) of the Act since Spouse B would have acquired the interest in the Policy less than 3 years before the gift is made.

•  Under subsections 148(1) and 148(7) of the Act, Spouse B would realize a policy gain of $40,000 ($62,000 - $22,000) in respect of the disposition by way of gift of the interest in the Policy to the registered charity. This policy gain would be attributed to Spouse A pursuant to subsection 74.1(1) of the Act.

Part B – Application of Subsections 248(35) and (36)

Spouse A is the owner and pays the premiums on a life insurance policy (the Policy), purchased 2 years ago, on Spouse A’s life. Spouse A transfers the Policy to Spouse B for no consideration. At the time of the transfer of the Policy, the Policy’s ACB is $10,000, CSV is $20,000 and FMV is $22,000. No election is made in Spouse A’s return of income in respect of the transfer of the Policy. As a result, subsection 148(8.1) of the Act deems the transfer from Spouse A to Spouse B to occur at the Policy’s ACB ($10,000).

Within a year of the transfer of the Policy from Spouse A to Spouse B, Spouse B donates the Policy to a charity. At the time of the gift, the policy's ACB is $12,000, CSV is $22,000 and FMV is $25,000.

The income tax implications of the gift of the Policy by Spouse B to the charity appear to be as follows:

•  For purposes of determining the eligible amount of the gift of the Policy by Spouse B under subsection 248(35) of the Act, subsection 248(36) would apply since Spouse A would have acquired the Policy within the 3 year period before the gift is made. Consequently, the deemed FMV of the gifted Policy to Spouse B would be restricted to Spouse A’s ACB in the Policy ($10,000) immediately before the transfer to Spouse B.

•  Under subsections 148(1) and 148(7) of the Act, Spouse B would realize a policy gain of $10,000 ($22,000 - $12,000) in respect of the disposition by way of gift of the interest in the Policy to the registered charity. This policy gain would be attributed to Spouse A pursuant to subsection 74.1(1) of the Act.

Question

Can the CRA confirm the tax implications are as described in each of Part A and Part B?

CRA Response

Subsection 148(8.1) of the Act generally applies to an inter vivos transfer of a policyholder’s interest in a life insurance policy (other than exceptions related to certain plans or contracts such as registered plans) to (i) the policyholder's spouse or common-law partner, or (ii) a former spouse or common-law partner in settlement of rights arising out of their marriage or common-law partnership, where both the policyholder and transferee are residents of Canada at the time of the transfer. Where subsection 148(8.1) of the Act applies, unless an election is made in the policyholder's return of income, the interest is deemed to have been disposed of by the policyholder for proceeds of the disposition equal to the ACB to the policyholder immediately before the transfer and to have been acquired by the transferee at a cost equal to those proceeds.

Generally, subsections 74.1(1) and 74.2(1) of the Act contain the attribution rules for transfers of property to a spouse. These rules generally attribute the income or losses and capital gains and losses of the transferee on the transferred property back to the transferor, while the transferor is alive. Section 74.5 of the Act provides certain exceptions to these attribution rules.

Part A - Application of Subsection 248(35)

In Part A of scenario 4, where the interest in the Policy is transferred by Spouse A to Spouse B pursuant to subsection 148(8.1) of the Act and Spouse B subsequently donates the Policy to a registered charity, it is our view that:

•  Since the interest in the Policy was acquired by Spouse A more than 10 years before the time of the gift by Spouse B, subsection 248(36) of the Act would not apply for the purposes of subsection 248(35) of the Act.

•  Pursuant to subsection 248(35) of the Act, for purposes of determining Spouse B’s eligible amount of the gift of the interest in the Policy, the FMV of the interest in the Policy gifted is deemed to be $22,000, which is the lesser of the Policy’s FMV otherwise determined ($75,000) and its ACB immediately before the gift is made ($22,000).

•  Subsection 148(7) of the Act applies to the disposition that is the gift of the interest in the Policy by Spouse B to the registered charity, resulting in a policy gain under subsection 148(1) of the Act of $40,000 ($62,000 - $22,000).

•  Pursuant to subsection 74.1(1) of the Act, Spouse B’s policy gain would be attributed to Spouse A.

Part B – Application of Subsections 248(35) and (36)

In Part B of scenario 4, where the interest in the Policy acquired by Spouse A two years prior is transferred to Spouse B pursuant to subsection 148(8.1) of the Act and Spouse B donates the Policy to a registered charity within a year of the transfer, it is our view that:

•  Since the interest in the Policy was acquired by Spouse A within the 3 year period before the time of the gift by Spouse B, subsection 248(36) of the Act would apply for the purposes of subsection 248(35) of the Act to restrict the FMV of the interest in the gifted Policy to $10,000, which is the lesser of (i) the Policy’s FMV otherwise determined ($25,000) and (ii) the lesser of Spouse B’s ACB immediately before the gift is made ($12,000) and Spouse A’s ACB immediately before Spouse A’s transfer to Spouse B ($10,000).

•  Subsection 148(7) of the Act applies to the disposition that is the gift of the interest in the Policy by Spouse B to the registered charity, resulting in a policy gain under subsection 148(1) of the Act of $10,000 ($22,000 - $12,000).

•  Pursuant to subsection 74.1(1) of the Act, Spouse B’s policy gain would be attributed to Spouse A.

Sylvie Danis
2024-100708
May 7, 2024

ENDNOTES

1 Subsection 248(31) of the Act. See also CRA TI 2007-0241901C6 dated October 5, 2007 and CRA TI 2012-0432601E5 dated August 13, 2012.

2 See also CRA TI 2010-0363091C6 dated June 8, 2010 and CRA TI 2017-0692361C6 dated May 18, 2017.

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