DAVID WILKENFELD, CPA, CA, canadian tax CONSULTANT

Life insurance and Shareholder Benefits

In Canadian Income Tax, Life Insurance, Shareholder Benefits on February 18, 2010 at 12:57 pm

Corporate-owned life insurance is always a hot topic. Generally, a corporation will be the owner and beneficiary of a policy. The proceeds received on death are tax-free to the corporation. However, a whole life policy is also an investment vehicle which has an adjusted cost base (“ACB”) for tax purposes. Only the excess of the proceeds over the ACB of the policy can be distributed to the shareholders on a tax-free basis via the Capital Dividend Account (“CDA”). For this reason, it is often recommended that the beneficiary be separated from the corporate owner so that the full amount of the proceeds can be received tax-free.

If the beneficiary is different from the corporate owner, questions arise as to whether a benefit is being conferred by the corporation. If the beneficiary is an individual shareholder, the CRA has stated that a taxable benefit will arise.

During the 2009 Canadian Tax Foundation Conference, the CRA announced a change in its policy regarding the holding of life insurance by a corporation with a holding company as the beneficiary.

The CRA was asked for its view on the application of subsection 15(1) (shareholder benefit) in the following situation: A, an individual, wholly owns Parentco, which in turn wholly owns Subco. Subco has a life insurance policy on the life of A and pays the policy premiums. The beneficiary of the policy is Parentco. This strategy is often useful because the full amount of the insurance proceeds in this structure gets added to the CDA account of Parentco and is not reduced by the policy’s ACB.

In previous policy statements, the CRA stated that the shareholder benefit provisions would not operate in these circumstances to include a benefit in the income of Parentco.

However, the CRA has announced a change to this administrative position. In a situation such as the one described above, the CRA now considers that subsection 15(1) will operate to include a benefit in the income of Parentco as a consequence of Subco paying the policy premiums. This benefit would be income from property.

The CRA stated that this change in its position is to be applied prospectively for new policies issued in 2010 and later. For policies already issued, the amount of the benefit incurred will be included in the shareholder’s income as of the 2011 calendar year. The CRA also noted that the General Anti-Avoidance Rule could apply to reduce the amount of Parentco’s CDA upon receipt of the proceeds of the life insurance policy unless there was a bona fide reason for the insurance holdings.

  1. Does this apply to term policies having no cash values?
    Example: Individual A wholly owns Parentco and Subco, however, sells 10%/year of Subco to employee(B). A 10 year term policy is purchased with B as the insured, Subco as owner and Parentco the beneficiary. Can the life insurance proceeds still flow through Parentco’s CDA as a tax free captial dividend to owner A?

    Just to clarify… if, using the same example I’ve provided, individual owner(A) is named the beneficiay. Life insurance proceeds would then be considered a taxable benefit and inculded in the owners income in the year they were received?

    • Yes, it applies to term policies as well. The life insurance proceeds would be added to the CDA of Subco, and could be paid out to A through Parentco. If A is the beneficiary there will be a benefit, but not the insurance proceeds, just the premiums paid. The insurance proceeds are always tax free.

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