15 December 1999 Internal T.I. 9925357 - PEIB Q&A DEMUTUALIZATION BENEFITS

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: 3 PEIB documents dealing with demutualization benefits

Position: See attached.

Reasons: Notice of Ways and Means Motion tabled on December 7, 1999 and draft legislation released on December 15, 1998.

Demutualization Benefit

Question:

A policyholder entitled to receive a demutualization benefit dies before payment is made to the policyholder. What are the tax consequences to the policyholder on death and to the estate on the receipt of the demutualization benefit?

Answer:

The draft legislation on the demutualization of life insurance companies released on December 15, 1998 does not address this issue. However, this issue is currently under review by the Department of Finance and it is our understanding that they are considering an amendment to treat the right to receive a demutualization benefit as having a fair market value of nil for the purposes of section 70 of the Income Tax Act (the "Act").

Based on this amendment and the other proposals in the December 15, 1998 draft legislation, it is our view that:

• There will be no tax implications to the deceased policyholder arising on the deemed disposition of a right to receive a demutualization benefit.
• Where the estate receives cash as a demutualization benefit, it is deemed to have received at dividend at that time. When the estate distributes the dividend to a beneficiary, to the extent that subsection 104(19) of the Act is applicable, the dividend will be deemed not to have been received by the estate and to have been received by the beneficiary. Where the estate receives shares as a demutualization benefit and distributes the shares in satisfaction of a beneficiary's capital interest in the estate, subsection 107(2) of the Act will apply to provide a rollover. As a result, the trust will be deemed to have disposed of the shares for proceeds of nil and the beneficiary will be deemed to have acquired the shares at a cost of nil.
• Where the estate, in the process of winding up, distributes the right to receive a demutualization benefit to a beneficiary, it is our view that subsection 107(2) of the Act will apply. Since the estate acquired the right at a cost of nil, there will be no tax consequences to the estate on distribution. The beneficiary will be deemed to have acquired the right at a cost of nil and the tax treatment of the demutualization benefit when received by the beneficiary will depend on whether cash or shares are received.

We understand that the amendment will apply to demutualizations that occur after December 15, 1998. It is expected that the Department of Finance will release an updated version of the December 15, 1998 draft legislation in the late fall which will include amendments pertaining to this issue.

September 13, 1999

Demutualization Benefits - Group Policies

Question:

An employer holds a group life insurance policy for its employees. The employer and the employees pay the premiums on a 50/50 basis. The employer receives a demutualization benefit in the form of a cash payment. If the employer distributes 50% of the cash payment to its employees, what are the tax implications to the employer and employees?

Answer:

The draft legislation on the demutualization of life insurance companies released on December 15, 1998 does not address the situation where an employer receives a demutualization benefit and distributes all or part of it to the employees covered by the group policy. It is our understanding that the Department of Finance is currently considering the possibility of adding a flow-through provision which will effectively treat the employer as a conduit in such circumstances. It is expected that the Department of Finance will release an updated version of the December 15, 1998 draft legislation in the near future.

Absent a specific flow-through provision, it is our view that the tax implications to the employer and employees will generally be as follows:

• the employer will be required to include the cash payment in income as a dividend which may qualify for the intercorporate dividend deduction;
• if the employer distributes all or part of the cash it received as a demutualization benefit to its employees, the employer may be entitled to deduct the cash distribution and the cash distributed to the employees will be fully taxable to the employees as employment income;

The above tax implications would apply where the employer distributes the demutualization benefit to its employees regardless of whether the group policy was fully funded by the employer, fully funded by the employees, or funded on a share basis.

November 10, 1999

Demutualization Benefits

The Notice of Ways and Means Motion tabled in the House of Common on December 7, 1999 contains the income tax amendments relating to the demutualization of insurance corporations that were released on December 15, 1998.

In PEIB document IHME990922A, we indicated that the Department of Finance was considering an amendment to deal with the disposition of a right to receive a demutualization benefit on death. Included in the Notice of Ways and Means Motion is new paragraph 139.1(4)(h) of the Income Tax Act (the "Act") which deems the fair market value of rights to demutualization benefits before the time of receipt to be nil for the purposes of section 70, subsection 104(4) and section 128.1 of the Act.

In PEIB document IHME991122, we outlined the tax implications where an employer receives a demutualization benefit in the form of cash and distributes the benefit to its employees covered by the group policy. Our response was premised on the fact that the December 15, 1998 draft legislation did not provide for a flow-through rule. We note that the Notice of Ways and Means Motion includes new subsections 139.1(16) and (17) of the Act which provide for the flow-through of cash payments and shares, respectively. Generally, the employer will have to elect to have these rules apply. Therefore, subject to the new flow-through rules, if no election is made, our position as stated in the PEIB Q & A tax still applies.

December 15, 1999