Ownership of insurance on the lives of children by a spousal trust – Same old problem?

The Canada Revenue Agency (CRA) has a problem with life insurance on a spouse that’s owned by spousal or common-law partner trusts. The thinking is that the premium payments would result in someone other than the spouse being able to “receive or otherwise obtain the use of” trust income or capital. (refer to previous AAMOT-Life interest trusts and life insurance – Why is there a problem? and What’s the problem with trusts and life insurance?).

At the APFF Conference on October 5, 2018 CRA Round Table Question 7, the CRA was asked if their position would be different if the life insurance were:

on the spouse’s children (residual beneficiaries of the trust);

transferred to the trust on the death of the testator; and,

the trust is named as the revocable beneficiary of the policies.

The CRA’s short answer was no. This difference would not change their position.

The CRA still sees the premium payments as maintaining the right to receive the insurance proceeds in the future, and according to an unofficial translation, the beneficiary “could at any time be a person other than the surviving spouse or common-law partner.” In short, the CRA does not view the trust as qualifying as a spousal or common-law partner trust and therefore it would not be entitled to a rollover of capital property on the creation of the trust.

As I said in earlier articles on this subject, these CRA positions are questionable. Where a life interest trust is the owner and the beneficiary of a life insurance policy, it’s arguable that the requirement that “no

person other than the life interest beneficiary can receive or otherwise obtain, before that person’s death, use of the trust capital or income” is satisfied. It is arguable that the payment of insurance premiums under a life insurance policy that will pay proceeds to the trust as beneficiary of the policy should be considered like any action to preserve or increase the capital of the trust.

The payment of an expenditure on account of capital should not be confused with an encroachment on capital which is dispositive. The CRA appears to be suggesting that the payment of a premium for life insurance held by the trust, where the trust is the beneficiary, is an encroachment on capital in favour of someone other than the spouse.

On the facts of this question, a policy on a child was being transferred to the spousal trust. If the policy were transferred to the spouse (and not a spouse trust) under the will, or via a successor owner designation under the policy, the policy itself could qualify for a rollover if the other elements of subsection 148(8.2) were met (i.e. both spouses are resident in Canada at the time of death). This could then allow all other assets to pass to the spousal trust on a rollover basis.

Is it the revocability of the beneficiary designation under the policy that leads to this problem for the CRA? Whether revocable or irrevocable, the trust is beneficiary of the policy. Again, I come back to my original concern with this position: owning a life insurance asset and paying premiums under it does not mean the trust is enabling someone other than the spouse to receive or obtain the use of trust income or capital.

Somehow, I feel like we are just singing into the wind on this one.