There are many cir-cumstances under which clients may want to alter or dispose of life insurance assets. And the rules and tax implications are as varied as the types of policies they may own.

For example, clients may want to access the cash in their policies, or they may want to transfer policies to other individuals or charities.

“My experience with insurance is that there are as many policies as people,” says Steven Blau, associate partner in the private client unit at Deloitte & Touche LLP in Toronto. “They are all unique. So, you have to be careful.”

Here are some circumstances and their associated tax issues:

> Disposition For Financing. If the holder of a permanent life policy has a financial need for the assets within the policy, he or she may access some or all of the cash surrender value of the policy. But several tax issues should be considered.

“From a tax perspective,” says Blau, “it’s a function of premiums you pay, the cash surrender value, the loans — there is a whole bunch of things that come into play.”

When the policyholder withdraws part of the cash surrender value, the gain is taxable. The gain is equal to the proceeds of the disposition minus the adjusted cost base of the policy.

“It’s similar to the withdrawal of non-registered investment,” says Scott Plaskett, certified financial planner and owner of Ironshield Financial Planning in Toronto. “When the client redeems the assets, he or she pays taxes on the difference between the cost base and the market value. Insurance policies have a different way of calculating what the cost base is.”

Generally, during the first few years of policy ownership, the Canada Revenue Agency determines the cost value to be very close to the market value and there are no tax implications, Plaskett says. Over time, the cost base shrinks. At a certain point, any withdrawal is taxable to some extent.

“The longer you hold [the policy],” he says, “the greater the percentage of the withdrawal that will attract taxation.”

In cases of partial or full withdrawal of the assets, the policyholder receives a T-4 slip from the policy manufacturer in the amount of the cash surrender value. It is often classified as “other income” and is taxed as earned income.

> Financing Options With Insurance. As an alternative, insurers are happy to set up lines of credit equal to the cash surrender value of the policy. AEGON Canada Inc. says that, based on its policy loan figures, about 25% of its universal life premiums are borrowed back.

In most cases, there are no tax consequences. But if the credit is used for investment purposes, the interest paid on the loan could be deducted from the client’s taxable income.

“It’s a maybe,” cautions Joel Cuperfain, lawyer and tax consultant to advisors under Toronto-based Manulife Financial Corp. ’s umbrella. “Depending on the circumstances, it might be possible [to deduct the interest]. But there is no general ‘Yes’ or ‘No’ answer.”

Making use of the CRA’s “reasonable expectation of profit” rule, the taxpayer may be able to write off interest on a loan when it’s being used to generate income for business or investment purposes.

> Transfer Of Policy To A Child Or Spouse. Transfer to the policyholder’s spouse or child is generally not considered to be a disposition and, therefore, no tax implications are involved. But the Income Tax Act can be very restrictive, especially when children are involved. The main stipulation, explains Cuperfain, is that there can be no consideration for the transfer.

“If the client has leveraged the policy in an investment somehow, the client can’t transfer it to a child,” he says, “because the assumption of the debt is a consideration.”

Also, the transfer must be direct. It can’t be made through a will or indirectly through a trust. However, Cuperfain notes, the CRA says this year that it will accept the transfer through a trust if the rollover is to a guardian of the child’s estate.

In each instance, the expanded definitions of “spouse” and “child” take effect. “Child” includes grandchildren, great-grandchildren and a minor child who is wholly dependent on the taxpayer for support and of whom the taxpayer has custody.

The definition of “spouse” includes common-law partners and same-sex partners. During the policyholder’s lifetime, this definition also includes former spouses or common-law partners when the transfer is being made in settlement of rights arising from the dissolution of the marriage or common-law partnership.

@page_break@> Transfer To A Charity. If the policy is absolutely transferred to a charity — meaning, the charity becomes the policyholder and the beneficiary — and the former policyholder chooses to pay the premiums, each of the premium payments qualifies as a non-refundable charitable tax credit. The death benefit, at the time of the insured’s death, flows to the charity tax-free.

If the death benefit is transferred to a charity at the death of the policyholder, his or her estate is assigned a nonrefundable tax credit in the amount of the death benefit, which flows to the charity tax-free.

> Emigration. For most people who officially declare another country as their residence, the CRA imposes an emigration tax, and all assets — bank accounts, investment accounts, real estate — are deemed to be disposed of. But the Life Insurance Act includes an exclusion for personally owned life insurance, so there are no tax implications. All policies are considered in force and payable, regardless of the client’s country of residence.

However, if a client owns a private corporation that, in turn, owns an insurance policy on his or her life, the value of the policy must be included in the disposition of the private corporation. “If you emigrate, you’re deemed to have disposed of shares, including those in a private corporation,” says Cuperfain. “So, you have to factor in the value of the policy in determining the value of the shares in your company at the time of emigration.”

> Sale. Insurance sales are overseen by provincial regulators. In most provinces, the sales of insurance policies are allowed only by the manufacturers themselves. The exceptions are Nova Scotia and Quebec, in which the sale of a policy is treated as taxable income. IE