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Ottawa, December 15,1998
1998-125

Government Releases Draft Income Tax Legislation on the Demutualization of Life Insurance Companies

Related documents :

• Backgrounder on Proposed Income Tax Changes on Demutualization.
• Draft Legislation on the Tax Consequences of Demutualization (Adobe Acrobat Version).
• Explanatory Notes to Draft Income Tax Legislation on Demutualization of Insurance Companies (Adobe Acrobat Version).

Secretary of State Jim Peterson (International Financial Institutions) today released for public comment draft legislation dealing with income tax consequences in the event of the demutualization of life insurance companies.

Demutualization is a process by which mutual companies convert to stock companies. Since last December, Canada's four large mutual life insurance companies have announced their intention to pursue demutualization, subject to the approval of policyholders. These companies are: The Mutual Life Assurance Company of Canada, The Manufacturers Life Insurance Company, Sun Life Assurance Company of Canada and The Canada Life Assurance Company.

On August 27, 1998, Secretary of State Peterson released a consultation paper on a proposed regulatory regime that set out the steps and controls involved in any proposed demutualization of federally regulated life insurers – with priority being given to the principle of ensuring fair treatment for policyholders. Legislation to implement this regime was tabled on November 30, 1998. The consultation paper also contained a brief outline of the proposed income tax rules that would apply to the benefits that policyholders receive in exchange for their mutual ownership rights when a company demutualizes.

The draft income tax legislation released today, which was developed with input from the four large mutual life companies, sets out the full details of these proposed income tax changes. The draft legislation applies to all demutualizations, whether or not they are subject to the proposed regulatory regime.

The proposed income tax rules clarify the timing of the recognition of demutualization benefits for income tax purposes and the character of those benefits for income tax purposes. The proposed rules also eliminate the administrative burden of filing income tax elections to prevent the immediate taxation of demutualization benefits received in the form of shares.

The attached backgrounder provides an outline of the proposed income tax rules. Detailed commentary is contained in the attached explanatory notes. Public and stakeholder comments on the draft legislation will be given full consideration prior to formal introduction as part of an income tax bill.

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For further information:

Backgrounder on Proposed Income Tax Changes on Demutualization

The description below highlights the proposed income tax changes on demutualization. It sets out the general principles and highlights two special purpose rules contained in the draft legislation. A detailed explanation is provided in the explanatory notes accompanying this release.

General Principles

Where an insurance corporation demutualizes, there will be no immediate taxation of demutualization benefits that are in the form of shares of the capital stock of either the insurance corporation or a holding corporation in respect of the insurance corporation. Instead, the shares will be deemed to be acquired for no cost. When the shares are disposed of, taxpayers resident in Canada would be subject to capital gains tax.

Other forms of demutualization benefits (e.g., cash) are treated as ordinary corporate dividends from a taxable Canadian corporation, so that policyholders resident in Canada will be entitled to the dividend tax credit in respect of these benefits. Non-resident policyholders will be subject to Part XIII withholding tax in connection with these demutualization benefits.

Group Insurance Policies

Some employers will receive demutualization benefits because of their interests in group insurance policies funded by their employees. The draft income tax legislation accommodates these arrangements by allowing employers to apply demutualization benefits towards the enhancement of benefits under group policies, without tainting these policies for income tax purposes. As a consequence, employees will continue to be allowed to receive benefits from these group policies on a tax-free basis. (No deduction will be allowed for the employer's contribution in these circumstances.)

Social Insurance Numbers

Some demutualization proposals involve an insurance corporation establishing a new corporation to hold most of the shares of the capital stock of the insurance corporation. Policyholders of the insurance corporation become shareholders of the new corporation on demutualization.

The insurance corporation, in these circumstances, would be expected to have a data base of social insurance numbers that it uses to complete information forms required by Revenue Canada. A narrow change is proposed so that a related corporation such as a holding corporation may use these social insurance numbers to satisfy its own tax reporting obligations.