All About Estates

Inclusion of Life Insurance loan in Income

In Neszt v. The Queen 2019 DTC 1105, the taxpayer held two life insurance policies with a life insurance company. He subsequently took personal loans against his life insurance policies. The amount of each such loan was greater than the adjusted cost base of each policy, (being the sum of premiums paid by the insured minus dividends declared and cost of insurance.)

The life insurance company issued two T5 slips in the taxation year for the amounts taken in excess of the adjusted cost base with such amounts characterized as “other source of income”.

The taxpayer did not report such amounts as income in his return for the year. However, The Canada Revenue Agency (“CRA”) subsequently reassessed the taxpayer for inclusion of income for tax purposes.

The taxpayer appealed the re-assessment arguing that both amounts are non-taxable in nature because they arose from personal loans taken from two personal whole life insurance policies under his name. In his opinion, this was analogous and similar to having taken out personal loans with a financial institution, such as a chartered bank. Monies received from a personal loan from a chartered bank are non-taxable in nature.

The Tax Court held that the tax treatment of life insurance policy loans were governed by specific provisions of the Income Tax Act, and that the combined operation of such provisions provides for the inclusion in income (for tax purposes) of the amount by which the proceeds of disposition of a policyholder’s interest in a life insurance policy to which he became entitled to receive in the year exceeds the adjusted cost base to the policyholder of that interest immediately before the disposition. The term “disposition” in relation to an interest in a life insurance policy includes a policy loan made after March 31, 1978.There are exceptions to the rules but none were applicable in this case.

Basically the purpose of these complex rules is to ensure that a policyholder will include in his income any policy loan amount that is greater than the adjusted cost basis of his interest in the policy.

The Court found no evidence that the amounts indicated on the two T5 slips issued by the life insurance company were incorrectly computed. The taxpayer had requested from the Ombudsman’s Office of the insurance company, the issuance of revised T5 slips for income tax purposes but his request has been dismissed because the amounts reported on the T5 slips were correctly calculated.

His appeal from the assessment of such amounts as income was therefore dismissed.

It may be worthwhile here to mention that when a policy loan is repaid, the policyholder is entitled to claim a deduction for the total of all repayments made in the year in respect of the policy loan. If the amount of the repayments is greater than the amounts that were included in his income for the year or a preceding taxation year from a disposition of an interest in a life insurance policy, the excess will be added to the adjusted cost base of the policy.

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About Steven Frye
Baker Tilly WM LLP is a leading, independent audit, tax, and business advisory firm based in Vancouver and Toronto, serving clients across Canada. Drawing on well-trained teams across a variety of disciplines, we ensure the alignment of our professional’s skills and experience with client requirements, resulting in exceptional service and business outcomes.

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