A discussion of corporate-owned life insurance

Transcription

1 A discussion of corporate-owned life insurance Persons who seek their livelihood in business are often motivated by a need to place their fate in their own hands. Of course, the desire to make money for themselves and their families is not the least of their drives. As such, our life insurance products must be adapted to meet the needs and desires of this special class of person the Canadian businessperson. As you are aware, in the course of running a business, many owners choose to incorporate their business. Corporations issue shares and the shareholders own the business. The shareholders may be hired by the corporation and, as employees; they are paid salaries in addition to all other benefits the corporation can provide to its employees. Most of these shareholders would prefer to see, in the event of death, his/her shares pass on either to family members or fellow shareholders. The major concern is that the family will have sufficient money to maintain the kind of lifestyle that it has become accustomed to. If family members are not able to assume control of the business, a practical solution to this problem is to enter into a buy-sell agreement amongst the other shareholders. As a funding means, corporate-owned insurance is an attractive option. However, it should be recognized that buy-sell funding is not the only reason why business people should consider having their corporation purchase life insurance. Why buy corporate-owned life insurance? Life insurance provides for the payment of cash at death, a financial benefit that is unique and incomparable. Business people need life insurance for these key reasons: 1. To provide funds for the family to pay estate debts and taxes on capital gains and to give the family a sum of money independent of the risks and hazards of private business. 2. As noted above, to provide funds to fulfill the terms of a buy-sell agreement amongst shareholders. 3. To pay the debts of the corporation so that creditors claims are satisfied and the business can either continue on a profitable basis or can be sold at a maximum price. Preferred shares can be redeemed and/or common shares repurchased where permitted by company articles. 4. To provide funds to help offset the economic loss of the death of the key employee. Life insurance funds will allow time to hire, promote and train new key people. 5. To provide funds for a death benefit to the insured s widow(er). The amount paid out is deductible to the corporation. The amount received by the surviving spouse is tax-free to the extent of the lesser of $10,000 and the employee s annual salary. 6. Where the policy has cash values, these appear as an asset on the corporate balance sheet. The cash values can be utilized as additional collateral or emergency funds during the insured s lifetime. During their accumulation period, the increases in cash values are tax sheltered.

2 Advantages of corporate-owned life insurance Where the corporation is eligible for the small business deduction and other corporate tax credits, there is a significant savings in the before-tax earnings required to pay premiums. These savings can become quite substantial as premiums are paid year after year. 1. Corporate-owned life insurance can use the capital dividend as a route to pay the proceeds without tax at the death of an insured shareholder; whether the corporation or the surviving shareholders purchases the shares from the deceased shareholder s estate. A further advantage of capital dividends is they do not reduce the adjusted cost basis of the shares. 2. In a situation where the insurance is required to fund a buy-sell agreement, there will be more than one insured shareholder. There will probably be different ages and unequal premium rates. There may also be cost differences among shareholders due to underwriting premium ratings. Corporate-owned policies help to equalize the resulting premium differences. 3. Again, where insurance is being used to fund a buy-sell agreement, the surviving insured shareholders do not have to purchase the policies owned by the deceased shareholder on their lives as would be the case if they owned the insurance individually. The corporate-owned policies simply remain in force on the surviving shareholders. 4. Where the corporate-owned policies have cash surrender values, such values are an asset of the corporation, and would show as an asset on the balance sheet. Any investment gain during the accumulation period is tax sheltered and is not exposed to corporate investment tax rates. A disposition, such as cashing in the policy or taking a policy loan where the proceeds exceed the cost base, would result in a taxable gain. 5. From a psychological standpoint, there is a preference among shareholders to spend corporate dollars rather than personal dollars. An expenditure on life insurance premiums is more favourably regarded when the disbursement is made from the corporation s surplus rather than the shareholder s personal wallet. Disadvantages of corporate-owned life insurance 1. As the corporation is the beneficiary of the insurance policy, the proceeds may be subject to the claims of any corporate creditors. Creditor protection under the various insurance acts does not extend to corporations. 2. If creditor claims are seen as a problem, then business loan insurance should be purchased on key executives. The premiums for corporate-owned insurance are non-deductible except for premiums on collateral term insurance. 3. For purposes of the deceased shareholder s tax return and the capital gains calculation, the deemed disposition at death must take into account the cash surrender value of life insurance policies owned by the corporation. In a non-arm s length sale, the receipt of life insurance proceeds by a corporation potentially can increase the value of the shares for purposes of a sale of the shares by the estate after death. 4. Under the new Family Law Act in Ontario, shares purchased by the surviving shareholder from the deceased s estate using life insurance proceeds would not fall into the net family property of the surviving shareholder. Where the shareholder purchases the shares using a tax-free capital dividend from the

3 corporation, it is not clear whether this would be considered using life insurance proceeds to avoid the net family property calculation. 5. Corporate-owned insurance can potentially affect the status of shares for purposes of qualifying as small business shares under the $500,000 capital gains exception. The definition requires that substantially all (90 per cent or more, Canada Revenue Agency (CRA) view) of the assets be used in an active business. CRA takes the position that normally an insurance policy is not considered to be used in an active business nor do life insurance proceeds qualify as active assets. In the case of a deemed disposition at death, in determining whether a corporation qualifies as a small business corporation at the time of death, the value of the policy is determined immediately before death and is not limited to cash surrender value. Rather consideration could also be given to the life expectancy of the insured according to mortality tables and the state of health of the insured as it is known to others. It is further arguable by CRA that the holdings of insurance policies on shareholders who have not died may also have an impact on the share valuations at death and, presumably, to the status of the company as a small business corporation. Conclusion Despite some of the concerns raised above, the many significant advantages of corporate-owned insurance means that this type of ownership should be considered by all business people and their financial advisors. TM Trademark of The Canada Life Assurance Company. This information is provided by Canada Life. The above should not be taken as providing legal, accounting or tax advice. You should obtain your own independent professional advice from your lawyer and/or accountant to take into account your particular circumstances.

4 Should my policies be corporate owned or personally owned? Part 1 the basic issues In the business life insurance market, the question of ownership of policies is often raised. A business owner may have many reasons for preferring that his company own the policies. However, it is important to consider all the issues before a decision is made. Personal need or business need The first question to answer before deciding if insurance should be owned by the company or personally is whether the insurance protection is needed for personal or for business purposes. 1. Personal need The cautious and conservative approach would be not to mix personal and business affairs. One cannot go wrong by personally owning insurance needed for personal protection. Every step is easier, from the completion of the application, to the possible future withdrawal of the cash values. Despite this element of ease, many business owners still prefer that their company own the policy. Also, it is often difficult to isolate the business needs from the personal needs. 2. Business need In the case of a business need, such as funding a buy-sell agreement, or for key-person protection, it is more common to have the corporation own the policy. Some situations are quite straightforward, such as in a case where the key-person protection is needed as working capital for the company. In case of the death of a key employee, the owner and beneficiary of the policy will likely be the company. Other situations are not quite as obvious, like the funding of a buy-sell agreement in case of the death of a shareholder. The purpose of this article is not to cover the different mechanisms of a buy-sell. However, it is important to discuss some general rules. In the case of policies funding a buy-sell agreement on death, the most important rule is to issue the policies so that they respect the terms of the agreement. If the agreement is already in force, a copy should be examined to ensure the policies conform to the agreement. If the agreement is not written at the time of issue of the policies, they should be issued in anticipation of the desired buy-sell mechanism by the shareholders, and by taking into account other elements to be mentioned in this article. If the agreement is written later and does not correspond to the way the policies were previously issued, it would then only be necessary to have the proper transfers of ownership made. If the transfer is made in the first years after the policy is issued, it is possible that the transfer would not trigger a policy gain.

5 Can the death benefit be received tax-free? The company, as owner and beneficiary of a policy will receive the death benefit tax-free. If the company is a private corporation, most of the amount may be paid to the Canadian resident shareholders by way of a tax-free capital dividend. The maximum capital dividend is dependent on the balance in the cumulative Capital Dividend Account balance. This balance will increase as a result of the insurance by an amount equal to the death benefit minus the adjusted cost basis of the policy at the time of death. Every portion of the death benefit that exceeds the capital dividend account may also be paid, but as a taxable dividend to the shareholder. Sole shareholder or multiple shareholders Having a company own the policies for personal needs may create a delicate situation if the company is owned by multiple shareholders. The shareholders might find it useful to seek legal advice to inform them about questions like the actual control over the policy and eventually over the death benefit, and the possible tensions between shareholders. In the case of a buy-sell agreement on death, the policies are often issued before the agreement is drafted. A buysell agreement should be discussed before the policies are issued. Also, how to give maximum security to the estate of the deceased is another matter that should be examined before issuing the policies. In the absence of an agreement, policies issued criss-cross (i.e., on the life of one shareholder, and owned by the other shareholders) do not give much power of negotiation to the estate for the sale of its share in the business. Actually, the surviving shareholders may continue to operate the company. In addition, they could cash in a substantial amount of the death benefit. For corporate owned policies, the estate would have at least an indirect interest in its share of the death benefit cashed by the company. The question of creditors A major obstacle to the ownership of a policy by the corporation may be the company s creditors. Up front, if the company owns the policies, the trustee in bankruptcy (in case of bankruptcy) has access to the cash values or the death benefit. Life insurance policies may offer some creditor protection in certain cases, but if the company is owner and beneficiary of the policies, there is no special creditor protection. Some problems may arise upon death if the company has outstanding debts. It is common to see clauses in loan agreements that limit the company s ability to pay dividends. In a buy-sell scenario on death, the capital dividend usually paid with the death proceeds may not be paid at all as a result of these clauses. All the planning would be short-circuited because the money would not be available to the surviving shareholders when it is needed most. A way to get around this could be for the client to buy some additional protection to cover the loan on death. Some companies may also get around the grasp of the company creditors, by having their holding companies (if they exist) own the policies. While this does not entirely protect the cash from the operating company s creditors, it provides an extra corporate layer that creditors have to access. Cost of life insurance premiums The lower, net after-tax cost of life insurance premiums is usually the main reason the business owner would prefer to have the company own the life insurance policies. It is worthwhile to emphasize again the fact that life insurance premiums are generally not tax-deductible, even if paid by the company. However, there still remain some tax advantages in having the company pay for the premiums, namely when the tax rate of the company is lower than the shareholder s marginal tax rate. The bigger the difference, the bigger the tax benefit.

6 Client has the last word Usually, if the company is chosen as owner, it will be named as beneficiary as well. There may be a personalized ownership structure, but every non-standard ownership structure may create delays in the issue of the policies as well. Finally, once the client has analyzed the relevant elements, it will be the client s decision to choose the type of ownership that will best suite their situation and meet their goals. TM Trademark of The Canada Life Assurance Company. This information is provided by Canada Life. The above should not be taken as providing legal, accounting or tax advice. You should obtain your own independent professional advice from your lawyer and/or accountant to take into account your particular circumstances.

7 Should my policies be corporate owned or personally owned? Part 2 Dealing with permanent policies In the business life insurance market, the question of who owns a policy the corporation or the individual is important. Deciding whether a permanent insurance policy should be issued to an owner or manager s company or to him personally is a complex question. Two reasons for this are that cash values are an additional asset on the balance sheet and that permanent policies are often used to accumulate savings for retirement. Shareholders often have personal plans for cash values which, consequently, might be withdrawn from the policy and distributed to the shareholder. Policies as balance sheet assets The cash value policy constitutes an asset for the company and may have a significant impact on the balance sheet. The cash value of a policy would normally be shown under the long-term assets section of the balance sheet. In negotiating company credit, long-term assets ratios are sometimes taken into account. Increase in share value on death With a corporate-owned policy, the cash values are an asset of the company and will be included in the valuation of the fair market value (FMV) of the company for purposes of the deemed disposition of the shares on the death of the shareholder. This will have the effect of increasing the taxable capital gain on death. One might argue that the asset would be reflected in another item of the balance sheet, such as investments. In this situation, owning a permanent policy would not create the effect of increasing the value of the shares. This element impacts each business differently, and must be examined on a case-by-case basis. Capital gain exemption on qualified shares Ownership of permanent policies by a corporation could jeopardize the qualification of the shares for the $500,000 enhanced capital gains exemption on the death of the owner, and for the surviving shareholders. This may not necessarily be the case, but is a possibility that a policyowner should review with the help of his or her professional advisors. It could be that the shareholder is not eligible for the exemption either way. Will the policy eventually be transferred to the shareholder? Another important question to consider when a permanent policy is involved is the intention of the shareholder to eventually sell the shares. The buyer will not likely be interested in a life insurance policy that insures the life of the previous shareholder. The policy is usually transferred to the life insured, and a potential policy gain may be generated, taxable to the company transferring the policy. The transfer may also generate taxes payable by the transferee life insured as the policy is considered to be transferred at fair market value. The company will pay the tax related to the policy gain, which may affect the sale price of the shares of the company by decreasing it accordingly. This puts less money into the hands of the former shareholder, just as if he had paid the tax himself. Of course, a corporate term policy won t create this situation because there is no cash value in the policy and the policy gain upon the transfer will be deemed to be zero. If the shareholder has become uninsurable, this transfer of a term policy could also give rise to a taxable benefit to the shareholder.

8 The second question is on the tax treatment of the transfer of a policy. Here there are several possibilities: The transfer of the policy may be a reimbursement of an outstanding loan of the shareholder to the company. In this case, there would be no taxable amount to the shareholder following the receipt of the policy. The transfer of the policy may be considered as a dividend or a bonus and, consequently, be taxable to the shareholder. The company may use the funds from a policy loan to pay a retiring allowance to the retiring owner. The retiring allowance could then be transferred into his or her RRSP (under certain limits), in addition to his usual contributions. This would generate a deduction to the company for the payment of the retiring allowance that would offset the additional policy loan interest. Later, he or she could receive the policy that contains the loan and would then be taxed on the lowered value of the policy, which is diminished by the policy loan. Seek professional advice Owning a permanent policy in a private corporation may have other significant tax implications for both the corporation and shareholders. Before deciding to have the company own the policy, the client should always seek independent professional advice. TM Trademark of The Canada Life Assurance Company. This information is provided by Canada Life. The above should not be taken as providing legal, accounting or tax advice. You should obtain your own independent professional advice from your lawyer and/or accountant to take into account your particular circumstances.

9 Purification strategies life insurance To determine whether the lifetime capital gains exemption is available to a small business owner, you might ask, what is the best way to remove a life insurance policy as an asset from the company? (Cash value for the life insurance policy is considered a non-active asset.) The excerpt below from Canadian Tax Highlights (May 1993) addresses this issue. Purification strategies The enhanced capital gains exemption of shares of a qualified small business corporation (QSBC) hinges on the relative fair market value of company assets used in an active business. CRA takes the position that a life insurance policy is not normally so used if proceeds are earmarked for dividends or to fund a buy-sell. Policies on shareholders lives are valued at their cash surrender value (CSV) for these purposes; otherwise, policies are valued on normal principles, including state of health and life expectancy, policy face amount and other special contract features. If the policy value throws the QSBC shares offside, the following purification strategies might be considered. Transfer to shareholder A gain is not realized unless the CSV is greater than the ACB. A transfer in consideration for a reduction in PUC (paid up capital) or amounts owing to the shareholder should not trigger income to the shareholder. However, if the policy is transferred at less than fair market value, even if it is transferred at CSV, the shareholder realizes a taxable benefit. Transfer as a dividend-in-kind may permit recouping of refundable tax. If desired, the shareholder can designate the corporation as beneficiary. Policy withdrawal Policy withdraws are a partial policy disposition and may trigger a gain calculated by prorating the ACB by the portion of CSV withdrawn. Proceeds can be used to pay down debt, distribute to shareholders, or acquire business assets; in the last case, the impact is double because non-qualifying assets are reduced as qualifying assets are increased. This is a convenient temporary fix before a sale or crystallization. Policy loan A policy loan is a partial disposition that triggers a gain only if the loan exceeds the ACB. Although the loan does not reduce policy value, the proceeds can be used to acquire further business assets. Transfer to subsidiary Transferring the policy to a wholly owned subsidiary for assumptions of debt replaces one non-qualifying asset with another. However, the value of the shares for these purposes is much lower; the amount of the debt assumed less the policy CSV. This strategy may be open to challenge under GAAR if purification is its only purpose.

10 Policy transfer to a sister corporation There is a disadvantage to butterflying the policy to a sister corporation in that the policy is not a capital property and cannot be rolled. It should be kept in mind that the dividends may be recharacterized as capital gains if a thirdparty disposition is ultimately involved. Business asset transfer to a sister corporation The transfer of business assets to a sister corporation can be both complex and costly, and is feasible only if the policy value is significant and the tax and other costs of other strategies are prohibitive. TM Trademark of The Canada Life Assurance Company. This information is provided by Canada Life. The above should not be taken as providing legal, accounting or tax advice. You should obtain your own independent professional advice from your lawyer and/or accountant to take into account your particular circumstances.

11 Shared ownership Shared ownership refers to a method of paying the insurance premium on a permanent life insurance policy and owning the policy on a joint basis. It is also commonly referred to in the life insurance industry as split-dollar. There are a number of situations in which the shared funding concept can be utilized, in particular, in the business situation where the company and the business owner(s) share in the cost of the premium deposits. Nevertheless, many commentators have suggested over the years that this is a concept that often gets talked about but rarely gets implemented. This apparent reluctance to adopt this funding approach is likely due to the uncertainty of the tax consequences of these plans. Canada Revenue Agency s (CRA) position In the case where the corporation pays the bulk of the premium on a split-dollar policy, the concern is CRA may determine the shareholder be required to pay tax on the benefit in relation to the insurance coverage. It appears that the Department of Finance will continue to show reluctance to adopt specific rules to value respective interests where the policy is jointly owned. Instead, CRA will continue to analyze each case applying general valuation principles in regard to the particular rights and obligations of the parties. The remarks made at the 1992 annual meeting of the Conference for Advanced Life Underwriting (CALU) by a senior official of CRA have been consistently repeated at subsequent sessions. He stated that the primary indicator of value of each party s interest in the policy is the premium that would be payable for comparable rights available in the marketplace under a separate insurance policy. The CRA has also expressed the view in a tax interpretation bulletin dated April 7, 1999 ( ) that no general assessing position could be taken with respect to the determination of a taxable benefit in the context of a universal life policy which was subject to a shared ownership agreement. Instead, the CRA s view was that a benefit, if any, must be determined on a case by case basis. The rationale for the CRA s position was that universal life policies are extremely flexible and that the tax status of any particular arrangement can only be determined by reviewing the facts of the particular arrangement. This view has been raised when providing advice on the merits of shared ownership or a life insurance contract in general. With this position from CRA, it is apparent that there is a greater sense of direction from the Department in regard to shared ownership arrangements and accordingly this program has and will continue to increase in popularity. Types of shared ownership agreements Executive supplementary retirement funding The corporation and the executive jointly own interests in a policy. The executive s interest is designed to fund supplementary retirement income. The corporation s interest is designed so that it recovers the bonuses given to the executive to pay premiums as well as the premiums it paid. This sharing arrangement can be effective in funding a supplementary retirement plan for an executive and yet potentially avoid classification as a retirement compensation agreement (RCA).

12 Funding shareholder agreements A policy can be owned jointly by a shareholder, the operation company and/or shareholder s holding company to fund a buy-sell. The respective interests of the parties in the cash values and other benefits can be defined to allocate the funding costs among the shareholders. This arrangement will optimize use of the capital dividend account (CDA), and avoid the build-up of cash values in the corporation to preserve the capital gains exemption. Documentation Planning, structuring and implementing any of these strategies requires knowledge and attention to valuation and tax issues as well as the legal formalities. Therefore, the financial advisor must apply considerable diligence in the documentation supporting the sale to effectively market the concept. A formal shared ownership agreement must be carefully drafted and signed. It requires skillful tailoring in accordance with the clients specific needs and consultation with specialists, lawyers and accountants to ensure that the design is effective and that all the requirements are in place. Ongoing review and monitoring are necessary to keep pace with changing needs, tax legislation and circumstances. For more information, please refer to the shared ownership guide. TM Trademark of The Canada Life Assurance Company. This information is provided by Canada Life. The above should not be taken as providing legal, accounting or tax advice. You should obtain your own independent professional advice from your lawyer and/or accountant to take into account your particular circumstances.

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14 Corporate-owned insurance policies transfers of ownership For many reasons, business relationships do end. When a company owns a life insurance policy on a departing shareholder or key executive, a decision must be made: What should be done with the policy? Life insurance and business planning Life insurance plays an important role in business planning. A company may purchase and own life insurance policies for one or more of the following reasons: On the life of each of the shareholders for funding a buy-sell agreement in the event of death. On the life of a key employee (including the owner/manager of the business) to protect the business against the sudden death of the employee. On the life of the owner/manager to cover bank loans and other indebtedness in the event of death. When the relationship ends There are several reasons why business relationships end. The reasons include: One of the shareholders is bought out by the remaining shareholders or by a third party. All of the shareholders sell their shares in the business. The business closes its doors and is wound up. A key employee retires from the company or is terminated. What to do with the policy? If the company owns a life insurance policy on the departing shareholder or key employee, there are three options available: 1. keep the policy 2. surrender the policy, or 3. transfer ownership of the policy to the life insured. The choice usually depends on: the type of insurance policy (i.e. term insurance or permanent insurance) the policy s cash values (if any) the age, health and personal insurance needs of the life insured, and the related income tax implications for both the transferor (the company) and the transferee (the departing shareholder or key person).

15 However, the option chosen may also depend on the relationship between the company s management and the departing shareholder or key employee and on any legal agreements already in existence between the parties. For example, a buy-sell agreement may set out the procedures to follow in the case of a departing shareholder. The shareholder may have the option to purchase the policy for an amount equal to the policy cash values, or if the option to purchase is not exercised, the company may be required to surrender the policy. Income tax implications There are three areas that must be considered: 1. tax implications to the corporation 2. tax implications to the life insured, and 3. tax implications with respect to the policy. To help review the alternatives and the related income tax implications, we will use an example of a life insurance policy owned by the corporation with a cash surrender value (CSV) of $50,000 and an adjusted cost basis (ACB) of $10,000. Let s look at each of the alternatives in turn. Keep the policy The corporation may keep the policy, continue to pay the premiums, and eventually receive the tax-free proceeds on death of the life insured. There are no legal requirements for the corporation to surrender or transfer ownership of the policy, unless this has been covered in a separate legal agreement between the parties. This alternative has no immediate tax implications to consider. Premiums continue to be non-deductible for income tax purposes (to the corporation) and the proceeds on death would be tax-free to the corporation. The excess proceeds on death over the ACB of the policy at the time of death would be credited to the corporation s capital dividend account (assuming the corporation is a private corporation) and may then be paid out as a tax-free capital dividend to the shareholders of the corporation. Amounts up to the ACB of the policy and paid as a dividend will be taxable to the shareholders This alternative is not usually chosen. Surrender the policy Under this alternative, the policy is surrendered by the corporation for its cash surrender value and the policy is terminated. For income tax purposes, the surrender is a disposition, and the corporation will be taxed on any accrued policy gain. In our example, the policy gain is $40,000 ($50,000 CSV less the $10,000 ACB). The $40,000 policy gain is included in the corporation s taxable income in the year the policy is surrendered and taxed accordingly. There are no further tax implications to consider. (Please note that if the company is a Canadian Controlled Private Corporation (CCPC), the taxable gain creates RDTOH (refundable taxation).) The corporation may use the cash received from the surrender of the policy for any purpose. Transfer ownership of the policy to the life insured Under this alternative, the policy is transferred to the life insured with or without compensation being paid. The transfer of ownership results in a disposition of the policy for income tax purposes. The proceeds of disposition are defined in Section I48 of the Income Tax Act as the cash surrender value of the policy. Accordingly,

16 the corporation will be taxed on the accrued policy gain at the time of transfer. In our example, the policy gain would be $40,000. If the policy is transferred to the life insured for consideration equal to the cash surrender value (i.e. the life insured writes a cheque for $50,000 in our example, payable to the corporation) there might be no further tax implications to consider for the individual. However, if the FMV of the policy exceeds CSV a benefit can be conferred on the employee/shareholder. If the policy is transferred to the life insured for no consideration, or for consideration that is less than the cash surrender value of the policy, the life insured will be taxed on a benefit equal to the fair market value of the policy (less any amount actually paid by the life insured). Lastly, if the life insured was an employee and the transfer is treated as a form of bonus, withholding taxes must be paid by the corporation to Canada Revenue Agency (CRA). In our example, the net bonus would be $50,000 (i.e., the cash surrender value) and assuming the employee s tax rate is 50%, the gross bonus would have to be $100,000; $50,000 in withholding tax would be paid by the corporation to CRA. The corporation would be entitled to deduct the gross bonus of $100,000 for income tax purposes. The employee would report the $100,000 as income for the year and the $50,000 remitted by the corporation as taxes withheld at source. Conclusion There are several alternatives to consider when deciding what to do with a corporate-owned insurance policy when the business relationship ends. Generally, it is a good idea for the corporation and the life insured to review the alternatives with their professional advisors before deciding upon a course of action. TM Trademark of The Canada Life Assurance Company. This information is provided by Canada Life. The above should not be taken as providing legal, accounting or tax advice. You should obtain your own independent professional advice from your lawyer and/or accountant to take into account your particular circumstances.

17 Ownership transfers of life insurance policies in business situations From time to time questions arise on the tax implications of transferring a life insurance policy to a new owner, particularly in the case where the transfer is from a corporate owner to an individual shareholder of the corporation. In addressing these questions in the business insurance context, certain rules in the Income Tax Act (the "Act") will need to be considered. Further, valuation issues may come into play when assessing the amount of any benefit to a shareholder that may arise under the transaction. What are the tax implications for a corporation that transfers a life insurance policy to a shareholder? An absolute assignment or ownership transfer of a corporate-owned life insurance policy to a shareholder will give rise to a disposition under subsection 148(7) of the Act. Therefore, any cash values in the policy above the adjusted cost basis will be reportable as a taxable policy gain to the corporation. The gain is fully taxable investment income and cannot be considered a capital gain since life insurance is not a capital asset as defined in the Act. What are the tax implications to an individual who receives a life insurance policy from a corporation of which he or she is a shareholder? Because the transfer involves a shareholder, the rules in subsection 15 (1) of the Act will need to be considered. This provision addresses benefits "conferred on a shareholder". While there is no specific rule that addresses a transfer of a life insurance policy to a shareholder, it can be presumed that subsection 15 (1) will apply to the transaction. Accordingly, a shareholder benefit may result to the extent the fair market value ("FMV") of the policy exceeds the amount of consideration paid by the shareholder for the policy. If a taxable benefit is conferred under subsection 15(1) of the Act, the corporation is not entitled to a deduction for the taxable benefit. A transfer at FMV in consideration for a reduction in paid-up capital or amounts owing to the shareholder by the corporation will generally not give rise to income to the shareholder in respect of a benefit for the policy value. If the policy were transferred as a dividend-in-kind to the shareholder, the amount of the dividend would equal the FMV of the life insurance policy transferred. If the policy is paid to an individual shareholder, the transfer may provide the corporation the opportunity to regain refundable tax previously paid by the corporation. As noted above, the disposition that occurs on the transfer of the policy would give rise to a tax reporting to the corporation of any taxable gains. What is the value of the policy when assessing a taxable benefit to the shareholder? The basic approach is to assign a cash value plus accumulated dividends plus pre-paid premiums less any policy loan and interest. "Value" has been defined as "cash surrender value" ("CSV") under subsection 148 (9) of the Act for certain non-arm s length transactions where life insurance policies are disposed of by way of gift (subsection 148 (7)). This provision would not necessarily apply to a benefit under subsection 15 (1) if there were other attributes of the policy that could be considered in determining value.

18 Information Circular 89-3 issued by the Canada Revenue Agency (CRA) addresses valuation considerations. It sets out that the value of the policy would be determined based on a number of factors such as the life insured s expected mortality, his or her current state of health as it would be known to others and a variety of other factors. On this basis the value of the policy for purposes of assessing the taxable benefit to the shareholder may be any amount between the policy s CSV and its face amount. What is the case where at the time of the transfer the policy has a "hidden" cash value? In the case where a policy has no cash value in a particular year, but has a large cash value in later years (such as the case with certain term to 100 plans), the value of the policy at the time of the transfer to the shareholder may exceed considerably the actual cash surrender value at the time of the transfer. In this case, it is a question of fact as to whether or not the shareholder has enjoyed a taxable benefit. The CRA might want to argue that the benefit that is derived from such a transfer would reflect the present value of the anticipated cash value of the policy and not just the value at the time of the transfer. That is, if there is likelihood that the policy will be credited with a cash value that can be related to the premiums paid by the corporation and not to those paid by the shareholder, then the CRA might have an argument that the corporation conferred a benefit on the shareholder. The FMV of such a policy could depend on a number of factors such as: how close in time one is to receiving the cash value whether a third party would be willing to purchase such a policy and at what price whether the shareholder is obtaining some value as a result of the corporation paying the premiums for a number of years, and so forth. What if the policy is transferred to another corporation? If the policy is transferred to another corporation, this will give rise to a disposition in most cases including the transfer from an operating company to a holding company that may have been set up to hold an individual's shares in the operating company. In the view of the Department of Finance, rollover provisions are available only in the case where there are corporate amalgamations and windings-up. If the policy is transferred as a dividend-inkind to a holding company, the dividend in this case will generally be received tax-free. The Act does make provision under section 85 for transfers of certain property to a corporation on a rollover basis so capital gains are not realized on the transaction. Because life insurance is not included as eligible property for purposes of this rollover, no argument can be made that section 85 should apply to a transfer of life insurance to a corporation either by another corporation or by an individual. From a planning perspective, in the case of an individual owning shares in an operating company, should ownership of the policy be arranged at a corporate level if it is anticipated that individual ownership will be required at some time in the future? In this case, the tax consequences of an ownership transfer of a corporate-owned policy to a shareholder will need to be considered. Depending on the facts, it may be more appropriate to set up the ownership outside of the corporation either at an individual level or through a holding company so as to reduce the potential of having to transfer the policy in the future. TM Trademark of The Canada Life Assurance Company. This information is provided by Canada Life. The above should not be taken as providing legal, accounting or tax advice. You should obtain your own independent professional advice from your lawyer and/or accountant to take into account your particular circumstances.