Introduction

The Canada Revenue Agency (the “CRA”) recently released an interesting interpretation (2015-0608261E5 (the “Interpretation”)) regarding the “splitting” of a universal life insurance policy between the two lives insured under the policy. More particularly, the CRA was asked whether there is a disposition under subsection 148(1) of the Income Tax Act (Canada) (the “Act”) when the holder of a universal life insurance policy exercises his or her contractual right (under the policy) to split the policy between the two lives insured, and whether paragraph 148(10)(d) of the Act would otherwise apply to exempt such a disposition. Additionally, the CRA was asked how the exemption test policy, accumulating fund and adjusted cost basis of the two policies would be determined if the policies were to be “split”.

The Multiple Life Policy

Based on the information provided in the Interpretation, the universal life policy in question provides life insurance coverage on the lives of the taxpayer who requested the Interpretation and the taxpayer’s child. Cost of insurance charges under both of these coverages apply for a ten-year period and provide coverage for as long as the life insured is alive. The CRA notes that the cost of insurance charges for each coverage, as well as guaranteed cash values, are based on the age, gender and smoking status of each life insured at the time of the policy’s issuance. The policy provides the taxpayer with the contractual right to “split” the coverage on the child and to set up the same policy for the child with the same death benefit, cost of insurance charges and guaranteed cash values which would have been provided in the original policy covering both lives. If the taxpayer exercises his right to “split” the policy in this manner, the taxpayer could choose to be the owner of the separate policy on the life of the child; otherwise the child would become the owner of the policy on his or her own life.

The CRA’s Response

In responding to the taxpayer’s questions, the CRA notes that subsection 148(1) of the Act generally provides that, when the holder of a life insurance policy has disposed of his interest in the policy during the year, he or she is to include the difference between the proceeds of disposition of the policy and its adjusted cost basis in his or her income for the year. A disposition, in the context of a life insurance policy, is defined in subsection 148(9) to include, among other things, a surrender or maturity of an interest in a life insurance policy or a disposition of the interest by operation of law.

Subsection148(10) of the Act generally deals with life annuity contracts and is composed of five conjunctive paragraphs (a) through (e). Paragraph (d) provides as follows:

(d) except as otherwise provided, a policyholder shall be deemed not 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; and

In considering the language of paragraph 148(10)(d), in the Interpretation, the CRA takes the view that, to give meaning to the word “only”, “it is necessary to determine whether the changes that are made to the terms of the policy, including but not limited to the premium structure, are so fundamental as to go to the root of the policy.” If the changes went to the “root of the policy”, then the CRA states that there would be a disposition of the policy and the acquisition of a new policy.

In the circumstances of the Interpretation, the CRA notes that the Act does not contemplate the “splitting” of a life insurance policy into multiple policies. Although the CRA does point out the legislative amendments affecting life insurance policies (in Bill C-43) specifically provide for life insurance policies with multiple coverages, the amendments do not provide for specific rules regarding the “splitting” of life insurance policies. In the case presented in the Interpretation, the CRA takes the position that the legislative purpose behind paragraph 148(10)(d) of the Act was not to provide for the non-disposition of a life insurance policy in cases where the policy is “split” into two separate policies under the contractual terms of the policy.

In the Interpretation, the CRA declines to provide a definitive response as to whether the taxpayer would be deemed to have disposed of his or her interest in the life insurance policy in question if he or she was to exercise the contractual right to “split” the policy between the two lives insured. Rather, the CRA states that this is a determination of fact and law which would require a review of the specific policies. This would require a case-by-case review and, in this regard, the CRA invited the taxpayer to request an advance income tax ruling in respect of any actually contemplated transaction.

Although the CRA takes the position that the “splitting” of a life insurance policy is not contemplated by the Act, only limited guidance is provided on how to deal with the sorts of policies that appear to be contemplated in the Interpretation. In this regard, although the CRA refers to “changes” to the terms of a life insurance policy, including “fundamental changes” which go to the root of a policy, it does not appear to respond to the circumstances of a thorough and well-drafted policy that clearly contemplates the “splitting” of the policy between the lives insured and the implications of such an action. It is in no way clear from the Interpretation that the exercise of a contractual right to “split” such a policy would impose a fundamental change to the terms of the policy or go to the “root of the policy” so as to result in a disposition of the holder’s interest under subsection 148(1). Additional guidance and clarification appears to be required on this point.