Recent Tax Developments Impacting Insurance Planning

Transcription

1 Recent Tax Developments Impacting Toronto, LL.B, CLU, TEP Overview Exempt Test Update New Charitable Gifting Legislation Trust Legislation LIA Grandfathering CRA Update Life insurance in spousal trusts Life insurance in Retirement Compensation Arrangements (RCAs) 2

2 Exempt Test and Policyholder Tax Legislation 3 Primer on Life Insurance Taxation Exempt Test governs how much can be accumulated in a life insurance policy without being subject to accrual taxation Section 148 governs taxation of tax-deferred accumulations within an exempt policy upon disposition occurring prior to death Investment Income Tax a minimum tax on the inside build-up: paid by insurance companies but cost passed onto policyholders 4

3 Review and Revision of Current Legislation Budget 2012 announced review of current tax rules Extensive consultation with insurance industry culminating with release of final legislation in fall 2014 New legislative generally effective for policies issued or deemed issued after 2016 Ongoing discussions relating to fine-tuning some aspects of the legislation including the grandfathering rules 5 Impact of the Revised Exempt Test Rules Changes are Evolutionary - Not Revolutionary Rules will generally permit similar funding levels in the first years with lower maximum funding levels thereafter Larger reduction in longer-term maximum funding levels for UL LCOI, particularly with face plus death benefit No tax shelter advantage for policies with high early surrender charges Single premium policis will no longer be possible 6

4 Impact of the Section 148 Changes Multi-life policies new rules relating to a death benefit funded by the cash value of the policy will reduce the policy s ACB and may result in a taxable disposition Joint policies death or disability benefits funded by cash value of the policy will continue to be tax-free but will reduce the ACB of the policy where the policy continues in force Policy loans rule changes to eliminate avoidance of partial disposition rules under subsection 148(4) 7 Net Cost of Pure Insurance ( NCPI ) NCPI is a notional mortality charge defined in the ITA The NCPI is deducted in determining the policy s ACB and relevant to collateral insurance deduction under para 20(1)(e.2) The mortality table for determining a policy s NCPI will be changed to a more recent table (CIA tables) The net amount at risk (upon which the mortality rates are applied) will generally be lower 8

5 Net Cost of Pure Insurance ( NCPI ) This will result in lower NCPI deductions against the policy s ACB - especially at older ages In turn this will result in higher ACBs and lower CDA credits/ncpi deductions under paragraph 20(1)(e.2) BUT - substandard ratings will now impact NCPI (having the opposite effect) 9 Investment Income Tax (IIT) IIT is designed to generate a minimum level of tax on the inside build-up of exempt insurance policies IIT payable on UL LCOI policies will be higher as the embedded reserve will be included in the tax base In-force UL LCOI policies will be grandfathered but any coverage increases with medical evidence will become subject to the new rules The amount of IIT payable will not change for other types of policies 10

6 Grandfathering Rules A policy issued before 2017 will be treated as issued after 2016 for purposes of section 148; exempt testing and NCPI calculations (but not IIT) the first time after 2016 at which life insurance in respect of which a particular schedule of premium or COI rates applies is: converted into another type of coverage (other than only because of a change in premium or COI rates); or insurance is added to the policy (other than insurance paid for with policy dividends or is reinstated) that is medically underwritten after 2016 (other than to obtain a reduction in premiums or rates) The industry is still in discussions with Finance on these rules. 11 Prescribed Annuity Contracts ( PACs ) Prescribed annuities are not subject to accrual tax rules instead each payment is a prescribed portion of capital and income The capital portion of a life annuity payment will be based on a 2000 Annuity table rather than 1971 tables this will result in a higher taxable portion at most ages BUT for substandard annuities the reduced life expectancy will be taken into account and can result in a higher non-taxable portion for each payment PACs and certain locked-in deferred annuities issued prior to 2017 will continue to use the 1971 tables 12

7 To Consider Before 2017 UL LCOI type policies Term conversions before 2017 Term vs. Permanent for new coverages Substitute life or coverage increases before To Consider Before 2017 Substandard lives may benefit from purchasing term and converting after 2016 NCPI Changes impact on ACB, CDA and para 20(1)(e.2) Get the insurance application in early! Purchase prescribed annuity before 2017 (unless substandard rating might apply) 14

8 15 Donations Involving Private Shares or Real Estate Starting in 2017, individual and corporate donors are exempt from capital gains arising from the sale of shares of private corporations or real estate to an arm s length party, if cash proceeds are donated within 30 days of the transaction, and the taxpayer is resident in Canada at the end of the taxation year No exemption for recapture of depreciation on the sale of real estate or for real estate that is inventory But corporate donors will also benefit from higher credit to capital dividend account (tax-free portion of capital gain will increase) 16

9 Determination of the Amount of the Exemption: A x (B-C)/D A= the capital gain on the disposition of the property B= lesser of the actual cash gift and the amount of cash received from the disposition of the property prior to the time of the gift C= the amount of the advantage in respect of the gift D= the taxpayer s proceeds of disposition 17 Example: Ms. A disposes of real estate for $1 million with $200,000 ACB Ms. A then makes a cash gift of $200,000 to a qualified donee within 30 days from the disposition A x (B-C)/D = $800,000 x ($200,000/$1 million) = $160,000 Ms. A s remaining gain will be $640,000 18

10 Special Rules Applicable on Death after 2016: The deceased taxpayer realizes a capital gain from the deemed disposition of shares in a private corporation or real estate (the property ) by virtue of subsection 70(5) of the Act The taxpayer s graduated rate estate (GRE) disposes of the property and makes a cash gift to which subsection 118.1(5.1) applies to a qualified donee within 30 days after the disposition The estate designates the gift for use by the legal representatives of the deceased in his or her terminal return 19 Determination of the Exemption in Terminal Return: A x (B-C)/D A= the capital gain from deemed disposition of property under s. 70 B= lesser of the actual cash gift and the cash received from the subsequent disposition of the property by the estate prior to the time of the gift C= the amount of the advantage in respect of the gift D= the GRE s proceeds of the subsequent disposition 20

11 Example: Ms. A dies owning real estate worth $1 million with $200,000 ACB Ms. A s GRE disposes of the real estate and makes a cash gift of $200,000 to a qualified donee within 30 days from the disposition Property appreciated to $1.2 million before disposition by the GRE A x (B-C)/D = $800,000 x ($200,000/$1.2 million) = $133,333 Ms. A s remaining gain will be $666,667 Question can estate also claim a pro rata exemption of $33,333 against its gain of $200,000? 21 Anti-Avoidance Rules (Only a Partial List ) Purchaser has to be at arm s length and not affiliated with the taxpayer and the qualified donee There cannot be an agreement that provides the taxpayer with all or any portion of the risk of loss or opportunity for gain in respect of the property with the purpose of otherwise avoiding these rules The property cannot be acquired in the year it is disposed by the taxpayer or the qualified donee If the property is a share, that share cannot be redeemed or cancelled in the year at a time when the taxpayer (or estate) is non-arm s length or affiliated with the corporation 22

12 Anti-Avoidance Rules (Only a Partial List ) Exemption will be clawed-back with interest if certain transactions take place outside the year of disposition but within 60 months of disposition If taxpayer ceases to exist, special rules will transfer the clawback obligation to certain non-arm s length persons who acquire an interest in the property within 60 months of the disposition 23 Concerns and Issues: Requirement to be resident at end of year implications for year of death or wind up of a trust 30 day time period to make the gift is too short Impact of claiming a capital gains reserve on the exemption? Exemption formula may not work properly when shares are redeemed from the estate 24

13 Concerns and Issues: Exemption not available if shares redeemed or acquired in year of disposition impact on pre-sale corporate reorganizations and transfer of property to the deceased s estate Application of anti-avoidance rule may create harsh and unfair results in certain situations Calculation of interest needs to be modified 25 Buy-sell Arrangements and Life Insurance Life insurance could ensure cash available within the prescribed time period to make the gift for buy-out on death Timing of purchase should coincide with availability of insurance Share redemption vs. cross purchase may be influenced by relationship between shareholders and the corporation Amount of money received as proceeds from the disposition a promissory note (even if repaid prior to the gift) could limit access to the exemption 26

14 Buy-sell Arrangements and Life Insurance (cont d) What does proceeds of subsequent disposition mean? Is it reduced by deemed dividends? Holdco buy-sell arrangements opportunity for enhanced CDA credit on share purchase Spousal roll and redeem strategy evaluate benefits where charitable gift by estate is contemplated (should consider tax situation for all shareholders) 27 Mr. A Ms. B 100% 100% Holdco A FMV = $1 M. ACB = NIL Holdco B FMV = $1 M. ACB = NIL OPCO FMV = $2 Million 28

15 Assume Holdco C (arm s length) acquires Holdco A s shares in OPCO and pays cash of $200,000 with a promissory note of $800,000 payable over 5 years Holdco A (not Mr. A) makes a cash donation of $200,000 within 30 days of disposition Holdco A claims a reserve of $800,000 for the deferred payment; as a result Holdco s capital gain under the ITA is $200,000 What are the implications of claiming a capital gains reserve? 29 Year 1: Exemption = $200,000 x $200,000/$1 million = $40,000 Charitable credit of $200,000 Total capital gain reported - $160,000 CDA credit $120,000 Year 2 Year 5 (??) Exemption in each year = $200,000 x $200,000/$1 million = $40,000 Total capital gain reported in each year = $160,000 Total CDA credit over 5 years = $600,000 Seeking Confirmation from Finance 30

16 Mr. A FMV = $1.2 Million ACB = NIL Ms. B 60% 40% FMV = $800,000 ACB = NIL OPCO FMV = $2 Million 31 OPCO owns $1.2 million of insurance on Mr. A and $800,000 of insurance on Ms. B Mr. A and Ms. B have utilized their lifetime capital gains exemption Hybrid buy-sell agreement corporate redemption and/or cross purchase at option of deceased s estate Mr. A dies and his GRE makes a gift of $200,000 to a favourite charity What is the best way to proceed in terms of implementing the buy-sell on Mr. A s death? 32

17 Conclusions: New rules will introduce significant complexity to estate planning for business and property owners where donations are contemplated New rules will be one more tax consideration in structuring buysell agreements flexibility will be key Insurance can play significant role in providing funding for cash gifts via the estate 33 Budget 2014 Testamentary Trusts and Related Changes 34

18 Testamentary Trusts Flat top-rate taxation will apply to testamentary trusts and grandfathered inter vivos trusts effective in 2016 Two exceptions are provided to flat top-rate taxation: Graduated rate estates (GREs) Qualified disability trusts (QDTs) 35 Testamentary Trusts Important Things to Remember: These changes will apply to existing testamentary trusts and those to be created under existing wills after 2015 A life insurance testamentary trust will be subject to flat top-rate taxation in 2016 unless it is a qualified disability trust Impact on multiple will planning and insured share redemption on death - appropriate planning to ensure one estate tax return??? 36

19 Taxation of Spousal and Alter Ego/Joint Partner Trusts on Death Current Rules Spousal Trust Deemed disposition of assets and income inclusion to trust in year of death Spousal Beneficiary 37 Taxation of Spousal and Alter Ego/Joint Partner Trusts on Death After 2015 Spousal Beneficiary Spousal Trust Deemed disposition of assets and income inclusion to deceased in year of death 38

20 Taxation of Spousal and Alter Ego/Joint Partner Trusts on Death Important Things to Remember: These changes will apply to existing spousal, alter ego and joint partner trusts where death occurs after 2015 Must ensure that life insurance is in the right place (life interest trust or estate of deceased life interest) to cover tax liabilities arising on the death of the life interest Might be able to use loss creation strategies in the life interest trust to offset gains in the year of death of the life interest beneficiary in turn can reduce or eliminate taxes to the estate of the life interest beneficiary 39 Charitable Donations on Death Important Things to Remember: These changes will apply to gifts made by will or designated gifts where death occurs after 2015 These rules apply to life insurance designated gifts The gift must be made by the GRE within 36 months from the date of death or it will lose the ability to carry the gift back to the terminal return of the deceased Guarantee donation in terminal return through designated life insurance gift 40

21 Discussions with Finance CALU/STEP and CPA/CBA Joint Tax Committee have held joint meetings with Finance to discuss our concerns with the new legislation and available options Canadian Association of Gift Planners has also made representations The ball is in Finance s Court Budget 2013 LIA Policies A LIA policy is an arrangement where life insurance in combination with a life annuity is used to secured a loan for the purpose of earning income from a business or property Budget 2013 eliminated many of the tax benefits associated with leveraged insured annuity arrangement New definition of LIA policy in ss 248(1) will apply if a person becomes obligated after March 20, 2013 to repay an amount to another person determined by reference to the death of an individual whose life is insured under a life insurance policy 42

22 LIA Policies Grandfathering Explanatory Notes: An LIA policy does not include a policy in respect of which the amount of borrowings outstanding as of March 21, 2013 does not increase on or after that date 43 LIA Policies Grandfathering CRA s Position on Grandfathering: If a new loan comes into existence after March 20, 2013 then the person has become obligated after that date to repay an amount Therefore if the loan is increased or replaced after March 20, 2013 the arrangement will not be grandfathered Changes to the terms of the loan while not increasing the borrowing may not affect grandfathering Replacement of insurance should not impact grandfathering 44

23 LIA Policies Grandfathering CALU discussed further with the CRA, who indicated that the assignment of the loan to a new lender without an increase in the outstanding amount may not affect grandfathering Finance is aware of our concerns with the CRA s position on grandfathering and we have requested an amendment to the LIA policy definition to permit refinancing up to the amount of the loan outstanding on March 20, 2013 as contemplated in the explanatory notes 45 CRA Update 46

24 Life Insurance in Spousal Trusts Spouse beneficiary is the life insured Trust is owner and beneficiary of insurance proceeds Trust pays premiums from trust capital Spousal Trust Insurance proceeds to pay tax liabilities triggered on spouse s death 47 Life Insurance in Spousal Trusts CALU 2012 CRA Roundtable* The CRA is of the view that a duty to fund a life insurance policy out of trust capital or trust income would be one under which a person other than the survivor may obtain the use of the trust income or capital The CRA is also of this view even if there is a mere power to encroach on capital of the trust * Released as CRA TI C6 dated May 8,

25 Life Insurance in Spousal Trusts The CRA is unable to confirm that the transfer of shares in a private corporation to a spousal trust, where the private corporation has acquired life insurance on the life of the surviving spouse, would not taint the status of a testamentary trust If the CRA is correct, this would result in a deemed disposition of all assets being transferred to the spousal trust at fair market value! 49 Life Insurance in Spousal Trusts CALU Submission April 2014 Subpara. 70(6)(b)(ii) does not require that the spouse actually receive or otherwise benefit from the trust property while alive; it only requires that no other person receive or otherwise obtain the use of the property; and The fact that a residual beneficiary will benefit from expenditures made by the trust while the spouse is alive does not mean that the residual beneficiary receives or otherwise obtains the use of trust property while the spouse is alive 50

26 Life Insurance and Spousal Trusts Current Work-Arounds The testator tries to ensure the policy is paid-up before death to ensure no trust capital or income is expended by the trust (APFF 2012 CRA Roundtable) Another trust or corporation is used/established to hold the insurance with the spousal trust as the beneficiary 51 Life Insurance in Retirement Compensation Arrangements (RCAs) 2012 Federal Budget made several changes to the rules governing RCAs to deal with leveraging arrangements that typically involved life insurance Also introduced a special 100% penalty tax on any advantage extended to or received by the RCA, a specified beneficiary or any non-arm s length person CRA indicated that an insurance policy with a non-nominal death benefit held by an RCA (including a deemed RCA) can result in an advantage (CRA TI C6) 52

27 Life Insurance in Retirement Compensation Arrangements (RCAs) Employer Contributions Premiums Permanent insurance on lives of key employees RCA Trust RCA is the owner/beneficiary Top up plan for key owner/managers 53 Life Insurance in Retirement Compensation Arrangements (RCAs) Question - Does this fact pattern result in an advantage and if yes, what is the amount of the advantage? CRA declined to comment and invited a more detailed submission from CALU 54

28 Life Insurance in Retirement Compensation Arrangements (RCAs) CALU Submission August 2014 Review of legislative history of advantage rules for RRSPs Discussion of the deemed RCAs (ss 207.6(2)) and lack of transitional provisions for these types of RCAs Review of the definition of advantage (ss 207.5(1)) in the context of a cash value life insurance policy owned by an RCA Conclusion that none of the advantage provisions should apply to the ownership of life insurance by an RCA 55 Recent Tax Developments Impacting, LLB, CLU, TEP 56