ESTATE DILEMMAS
BY KEVIN WARK
Gifting Insurance Policies CRA Responds to CALU inquiry
A
popular method of making a charitable donation is to gift an existing life insurance policy to a registered charity. However, tax issues can arise where the client converts a term policy and subsequently gifts the converted policy to a charity. Before reviewing this potential tax issue, let’s examine the more general tax rules governing the gift of an existing life insurance policy. The donation of a life insurance policy is treated as a disposition of the policy for tax purposes. The Income Tax Act (the Act) provides that the policyholder is deemed to receive proceeds of disposition equal to the greatest of: • the value of the life insurance policy (defined to be the policy’s cash surrender value (CSV)); • the adjusted cost basis (ACB) of the policy; and • the fair market value (FMV) of the consideration received by the donor. As a result, where an existing policy is gifted to a charity, the deemed proceeds will be the greater of the policy’s ACB and CSV immediately before the gift. This will result in a taxable policy gain to the policyholder where the policy’s CSV exceeds its ACB. The policyholder will be entitled to receive a charitable tax credit equal to the FMV of the policy, less the amount of any advantage received in making the gift. The FMV of the insurance policy would normally be determined through an actuarial valuation. Of note, the Canada Revenue Agency (CRA) has indicated that the donation tax credit is not an advantage for these purposes. It is therefore advantageous to gift an existing policy where the FMV of the
policy exceeds its CSV, as the value of the charitable tax receipt will likely offset any gain that might arise from the disposition of the policy. But there is a question of whether the same tax benefits will arise where the donated policy originated from a term conversion. For example, assume Ms. A acquired a 10-year term insurance policy that she does not plan to renew. Her advisor indicates that the policy may have value due to recent changes in her health status, which is subsequently confirmed by an actuarial valuation. So instead of terminating the policy, Ms. A plans to convert the term policy and then donate that policy to a charity in return for a donation receipt. Ms. A’s advisors need to consider the rules in subsection 248(35) before finalizing the term conversion. These rules provide that the FMV of the gifted life insurance policy (unless the gift arises on death) will be the lesser of the ACB and the FMV of the policy immediately before the gift in the following two circumstances: • The donor acquired the policy less than three years before the day the gift is made; or • The donor acquired the policy less than 10 years before the day that the gift is made, and at the time the donor acquired the policy, one of the main reasons for acquiring the policy was to gift it to a registered charity. Thus, if the conversion of a term policy results in the acquisition of a new insurance policy, this will restart the applicable three- or 10-year period from the date of the conversion. In Ms. A’s case, the donation credit would be reduced to be equal to the ACB of the policy, which would likely be nominal.
CALU asked the CRA to specifically comment on whether a term conversion would result in the acquisition of a new policy for purposes of these rules. The CRA responded as follows: … whether the conversion of a term life insurance policy to a permanent life insurance policy results in a new policy acquired by the policyholder at the time of the conversion … is a mixed question of fact and law and can only be determined on a case-by-case basis. All the provisions of an insurance policy should be reviewed to determine whether the changes are so fundamental as to go to the root of the policy.1 Given the uncertainty on this issue, the following planning should be considered when contemplating the gift of a term policy: • If a policyholder has already converted the term policy, and at that time was not planning to gift the policy, they should wait for the expiry of the three-year period before donating the policy. However, if a charitable gift was intended at the time of conversion, the policyholder will unfortunately need to wait for 10 years to pass from the conversion date before gifting the policy to ensure the charitable receipt will be equal to the FMV of the policy. • If the policyholder has not yet converted the policy, the best approach may be to gift the term policy to the charity and have the charity convert the policy. 2 In summary, donors and advisors need to consider the application of subsection 248(35) to any gift of life insurance, and in particular, investigate whether the policy in question resulted from a term conversion. KEVIN WARK, LLB, CLU, TEP, is the managing partner of Integrated Estate Solutions and tax advisor to the Conference for Advanced Life Underwriting (CALU). He is the author of the bestselling consumer book, The Essential Canadian Guide to Estate Planning (2nd Edition). A version of this article was previously published in CALU InfoExchange and is being published with the permission of CALU. For CALU membership information please go to www.calu.com.
1 CRA Technical Interpretation 2021-088239. 2 This also assumes that the term policy is not caught by the applicable three-year or 10-year time period as specified in subsection 248(35). If the term policy is subject to subsection 248(35), the donor will need to wait for the expiry of that time period before donating the term policy, and in some cases the policy owner may have to renew the policy at the expiry of a term.
30 FORUM FEBRUARY 2022
