Significant Changes to Tax Planning Related to Life Insurance Policies
The planning surrounding life insurance policies held by private corporations is a model that has been in use for the better part of two decades. While Canada Revenue Agency (CRA) always acknowledged the existence of certain life insurance planning techniques and their associated benefits, some professionals felt it was only a matter of time until these benefits were reduced or wiped out entirely. We have outlined below two key changes that will impact life insurance planning both now and in the future.
2016 Federal Budget
Prior to budget day, many professionals recommended a plan that involved the transfer of a life insurance policy from an individual shareholder to their private corporation. The shareholder would sell their policy to their corporation for Fair Market Value (FMV). The taxable gain on the transfer would be based on the difference between the taxpayer’s proceeds of disposition and the Adjusted Cost Basis (ACB). Generally speaking the proceeds of disposition are defined in subsection 148(9) of the Income Tax Act (ITA) as the Cash Surrender Value (CSV) of the policy. In many cases there would be no CSV and therefore the proceeds of disposition would be determined to be $nil. For example, a personally held $300,000 life insurance policy with a CSV of $nil, ACB of $nil and a FMV of $80,000 could be transferred to a private corporation with the following results:
- The individual shareholder could take $80,000 out of their corporation without personal tax implications;
- There would be no gain as a result of the transfer and therefore no taxes owing on the transfer; and
- There would be no adjustment to the ACB of the policy after the transfer.
The ITA has been revised to ensure that the taxpayer’s proceeds of disposition include the FMV of consideration received from the transferee corporation. Therefore, in our example above, the gain to the individual shareholder on the transfer would be $80,000 as opposed to $nil and the ACB of the policy inside the corporation would be increased to $80,000. Careful consideration will need to be taken with this type of planning moving forward as there still may be benefits in having a corporation be the holder of a life insurance policy, however there may be a large gain in the hands of the individual shareholder when transferred, which could reduce the tax free advantages of this plan. These changes were effective Budget Day 2016, being March 22, 2016.
2017 Life Insurance Changes (Bill C-43)
In addition to the above changes, the federal government has passed new tax legislation (Bill C-43), which revised the rules that determine how life insurance policies are taxed. These new rules will provide increased consistency in the tax treatment of life insurance products by the many different insurance providers. These changes will take effect on January 1, 2017, with any new policies issued after that date being subject to the new rules.
The biggest change comes in the form of the potential reduction to the inclusion of death benefit proceeds to the Capital Dividend Account (CDA) balance for private corporations. The CDA is a balance that a private corporation accumulates and can pay out tax free to its shareholders at any time. Among other things, it consists of the untaxed portion of capital gains as well as death benefit proceeds received from a life insurance policy. Prior to the changes in Bill C-43, the death benefit of a life insurance policy received by a private corporation, less the ACB of the policy to the corporation, was credited to the CDA balance. It became common practice for professional corporations to hold life insurance policies for the ultimate benefit of their shareholders, as the premiums could be paid with corporate dollars and the death benefit could be taken from the corporation with minimal or no tax consequences. For almost 20 years the CRA had acknowledged the existence of this planning, but had noted in more recent years that it was being reviewed.
The new rules have imposed changes to the mortality tables that impact the calculation of Net Cost of Pure Insurance (NCPI). Going forward there will be reductions to the NCPI which will increase the ACB of polices as well as increases to the mortality tables used, which means that it will take longer for the ACB to reach zero as the insured individual ages. The ultimate consequence is a reduction in the amount of CDA received by a private corporation upon the passing of the insured individual which therefore reduces the amount that can distributed tax free to the individual shareholders.
There are still situations where a corporate owned life insurance policy will provide benefits to professionals. It is important to discuss this with your accounting and insurance professionals as soon as possible to ensure the changes don’t negatively affect your tax planning. Please contact one of our professionals if you would like to discuss this further.