By: Florence Marino B.A., LL.B., TEP | Vice President, Tax & Estate Planning
A recent CRA technical interpretation (#2024-1018491E5) outlined the tax treatment to a non-resident individual who owns a foreign life insurance policy (in this case a UK endowment policy) when they move to Canada. The analysis in this response would apply for any foreign policy issued to a non-resident individual when they immigrate to Canada.
Is it a life insurance policy?
Step 1 is to determine if the contract in question is a life insurance policy. This term is broadly defined in subsection 138(12) of the Act. The CRA stated that “while not necessarily conclusive, where a particular product provides for a death benefit or constitutes an annuity arrangement, it may be suggestive that the product could be a life insurance policy.”
Rules on immigration
In general, an individual who becomes a resident of Canada is deemed to dispose of each property they own immediately before entry for deemed proceeds of disposition equal to the fair market value (FMV) at that time (paragraph 128.1(1)(b) of the Act). This results in the individual having a bumped-up cost base to the FMV of the property upon entering Canada.
Certain property is not subject to the deemed disposition rule. In the context of a life insurance policy, if the policy is a “life insurance policy in Canada” it is not subject to the deemed disposition on entry since, it is considered an “excluded right or interest.” A life insurance policy in Canada is defined (at subsection 138(12) of the Act) as a life insurance policy issued or effected by an insurer upon the life of a person resident in Canada at the time the policy was issued or effected.
In the case of a foreign policy issued on the life of a non-resident, the policy would clearly be within the deemed disposition on entry and not an excluded right or interest. Subsection 70(5.3) would operate to deem the FMV of the foreign life insurance policy to be its cash surrender value (CSV) for purposes of this disposition. The CSV would become the adjusted cost basis (ACB) of the policy at the time of entry.
Canadian life insurance policy tax rules apply go forward
The foreign life insurance policy will be seen as “last acquired” at the time the individual becomes a Canadian resident. The foreign policy will be subject to annual accrual taxation under subsection 12.2(1) of the Act for the amount by which its “accumulating fund” (defined in section 307 of the Income Tax Regulations) exceeds the policy’s ACB unless the policy qualifies as an “exempt policy”.
CRA puts the concept of an exempt policy and the testing required to establish that, in this way:
“An “exempt policy” is a life insurance policy that satisfies certain criteria, set out in section 306 of the Regulations. The rules in section 306 of the Regulations apply on a policy-by-policy basis and require actuarial calculations and information that only the issuing insurer will possess. In broad terms, an exempt policy is a policy that is primarily designed to fund a death benefit, rather than one designed to be an investment and savings vehicle. A life insurance policy issued by a non-resident insurer is not specifically precluded from qualifying as an exempt policy and thus, such a policy could qualify as an exempt policy provided the criteria in section 306 of the Regulations are satisfied.”
Annual exempt testing of a foreign life insurance policy would require specialized actuarial expertise at a cost. As well, where the foreign policy is denominated in a foreign currency, this can have an impact in the exempt testing process since amounts would have to be converted to Canadian currency at the time of testing (i.e. at each policy anniversary) (see: #2004-0065391C6).
Where the policy is an “exempt policy” a payment resulting from the death of the insured person is not a disposition and is received tax-free. However, where there is a disposition of an exempt policy, a taxable policy gain is realized where the proceeds of the disposition exceed the ACB of the policy. (In the context of the recent CRA interpretation – that of an endowment policy – the maturity of the policy is a disposition.)
Life insurance is not capital property therefore the full amount of any policy gain is included in the policyholder’s income. Again, the CRA cautioned that in respect of a foreign policy, the determination of the amounts that are used to compute any policy gain such as the ACB or the proceeds of the disposition, generally would require information that is available only in the accounts of the issuer insurer. So, it may be difficult for the policyholder to obtain the correct information about their policy in terms that relate to Canadian taxation of their policy.
The bottom line is the policyholder is on the hook. They must find a way to determine if their foreign policy is exempt or is subject to accrual tax. And they must report any income in respect of their foreign policy.
Foreign property reporting
The Act requires a person who owns “specified foreign property” (defined in subsection 233.3(1)), the total cost of which exceeds $100,000 at any time in the year to file a T1135 form by the person’s normal tax filing deadline. The $100,000 test is applied to the aggregate cost amount of all specified foreign property held by the taxpayer even where no particular property has a cost amount exceeding that threshold. A foreign life insurance policy would be one such property.
Things to think about
Before entering Canada an individual may want to understand whether it makes sense to retain personal ownership of the foreign policy and explore what other options for ownership of the policy there might be. Eventually, too, they may consider purchasing a Canadian policy. However, as a new immigrant to Canada, it may take time to establish the Canadian risk or liability to be insured. Life insurance requires financial justification for the amount of the coverage based on the risk of loss or liability. In general, it is the wealth and assets within Canada and their associated liability that brings about a Canadian nexus for insurance coverage even if there is significant wealth or assets outside of Canada.
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.
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florence@tompkinsinsurance.com
