By: Florence Marino B.A., LL.B., TEP | Vice President, Tax & Estate Planning
This is the first in a mini-series on exiting Canada and life insurance. It addresses: What are the tax consequences and other issues to consider when an individual moves out of Canada with an exempt life insurance policy issued on their life while a Canadian resident? It’s a lot more complicated than you might think!
Part II (in a future article) will address life insurance issues when the shareholder of a private company exits Canada.
Rules on emigration
In general, an individual who departs Canada is deemed to dispose (and reacquire) each property they own immediately before departure for proceeds of disposition equal to the fair market value (FMV) at the time (subparagraph 128.1(4)(b) of the Income Tax Act, “the Act”). This results in a realization of accrued gains at the time of departure. An election (Form T1244) to defer the tax payable may be made (subsection 220(4.5) of the Act) and security posted for the tax liability.
Exclusion for life insurance
Certain property is not subject to the deemed disposition rule. A “life insurance policy in Canada”, defined in subsection 138(12) of the Act as a policy on the life of a Canadian resident at the time the policy was issued, is one such property. Life insurance is considered an “excluded right or interest” (subsection 128.1(10)(l) of the Act) and is not deemed to be disposed of at the time of departure.
Asset reporting at the time of departure
Even though there is no deemed disposition of a Canadian life insurance policy, the departing individual must report their worldwide property if the total FMV is greater than $25,000 (subsections 128.1(9) and (10) and Form T1161 “List of Properties by an Emigrant of Canada.) The FMV of a life insurance policy in Canada would be included in this reporting. For purposes of section 128.1, FMV of a life insurance policy under which the departing individual is the life insured (or those not dealing at arm’s length with the individual at the time of issuance of the policy) is deemed to be its cash surrender value (CSV) pursuant to subsection 70(5.3).
Insurer reporting of reportable accounts
For policies with cash value, a permanent change of address of the policyholder to outside of Canada would require the insurer to share information about the policy/policyholder with the CRA (Parts XVIII and XIX of the Act). Information such as, name, address, tax jurisdiction, SIN, date of birth of the policyholder, are shared with the CRA to share with foreign tax authorities. Under the Foreign Account Tax Compliance Act (FATCA) this is required where the cash value exceeds US $50,000 for US persons. For the Common Reporting Standard (CRS) any amount of cash value with no minimum threshold will require reporting.
Canadian tax after departure on dispositions
After departure dispositions of a policy would have Canadian tax consequences. Any policy gain on disposition would be considered taxable income earned in Canada by the non-resident policyholder (subparagraph 115(1)(a)(vi) of the Act). Compliance with section 116 which sets out requirements for notifying the CRA of a disposition, obtaining a Certificate of Compliance and the withholding and remittance of tax in respect of the disposition, is necessary.
For certain dispositions, the insurer, deemed to be a “purchaser” (under 116(5.4) of the Act), is required to notify the CRA, withhold and remit tax payable in respect of the disposition (Form T2062B and Schedule 1 thereto). These are dispositions where the insurer would be making a payment to the policyholder and thus would have proceeds to withhold from – the payment of policy dividends, a surrender of the policy, a policy loan or maturity of the policy. Provided that the policyholder authorizes this, withholding is made at marginal tax rates under Part I of the Act. If the policyholder does not authorize the insurer, withholding would be at 50% of the proceeds of the disposition. The now non-resident policyholder would then have to file a Canadian tax return for the year of disposition to recover any excess amount withheld.
For other dispositions, (where the insurer is not deemed to be a purchaser), for example a transfer of ownership to a trust or family member, the transferor (vendor) and transferee (purchaser) are responsible for reporting the disposition on form T2062B and any tax withholding on the transfer. If this doesn’t occur, there would be an obligation on the purchaser to withhold and remit 50% of the FMV of the policy (subsection 116(5.3) and paragraph 116(5.1)(f) of the Act). Note that FMV for these purposes is not deemed to be CSV, as subsection 70(5.3) does not apply in these circumstances. FMV would then have to be established using normal valuation principles and reference made to the factors in paragraph 40 of Information Circular IC-89-3 which include: CSV; the policy’s loan value; its face value; the state of health and life expectancy of the life insured; conversion privileges and other policy terms; and the policy’s replacement value.
The non-resident policyholder vendor can comply with section 116, pay an amount for tax under Part I that is acceptable or provide security. If this is done, this may reduce or eliminate any amount the purchaser would be liable to withhold and remit (#2013-0481411C6). Canadian life insurers may facilitate section 116 compliance in these circumstances where the non-resident policyholder authorizes the insurer to act as their agent in applying for the Certificate of Compliance.
Death benefits
A payment in consequence of death of a life insured under an exempt policy is not a disposition. Where a policy is held after departure until the death of the life insured, the life insurance death benefit proceeds would be paid to the beneficiary tax-free. There would be no tax withholding from the payment of death benefit proceeds by the insurer.
Submitting a death claim involving a life insured that is a non-resident at the time of death may require additional supporting documents. For more information concerning the death claims process in general see: Demystifying life insurance claims – How instant is “instant liquidity”? – Tompkins Insurance).
And possibly the most important consideration of all
The tax consequences of an individual holding a Canadian policy in the intended jurisdiction of residence should be investigated, ideally, before departure. A policy that is exempt in Canada may not be considered “exempt” in other jurisdictions. Also, the new jurisdiction may require foreign financial account reporting in respect of the Canadian policy. Advice in the new country of residence is needed.
FOOTNOTE:
This publication is protected by copyright. Tompkins Insurance is not engaged in rendering tax or legal advice. TOMPKINSights contains a general discussion of certain tax and legal developments and should not be construed as tax or legal advice.
Should you wish to discuss this or any other TOMPKINSights article, please contact
florence@tompkinsinsurance.com
