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CALU Tax Bulletin

December 2009

The Canada Revenue Agency (CRA) recently announced a change in assessing practice that will affect certain planning structures involving corporate owned insurance. The purpose of this bulletin is to review the announced changes and how they will affect current and new insurance structures.

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In dealing with shareholders of a private corporation, it is not unusual to see individual shareholders holding their shares of an operating company ("OPCO") through one or more holding companies ("HOLDCO"). This is done for a variety of reasons including dividend planning, creditor protection of corporate profits, income splitting and succession planning.

In these situations it is possible to structure the ownership of life insurance on an individual shareholder´s life within the HOLDCO(s) or within the OPCO. There is also the flexibility to designate a beneficiary who is different from the owner of the policy. There are a number of factual and tax considerations that must be considered in determining who will be the owner and beneficiary of the insurance policy in these situations.

In certain circumstances it may make sense for OPCO to be the owner of the insurance policies with one or more HOLDCOs being the beneficiaries of the insurance proceeds.

For example, let´s assume Mr. A, Mr. B and Mr. C started up an OPCO a number of years ago, with each individual shareholder having an equal ownership interest. At a later date each individual shareholder transferred their shares into his own HOLDCO to crystallize his capital gains exemption. The individual shareholders and their HOLDCOs have entered into a buy-sell agreement that requires the individual shareholders to purchase a deceased shareholder´s shares of his HOLDCO. This will allow the deceased to benefit from the capital gains exemption.

In terms of structuring the insurance to fund this buy-out, one possible approach would be for the three HOLDCOs to own and be the beneficiaries of policies on the lives of the other individual shareholders. The downside of this approach is that it requires the other shareholders to "police" the payment of premiums by the other HOLDCOs. As well, if there are significant discrepancies in age or health status between the shareholders this will result in differences in the cost of each policy. Where the policies are owned by each HOLDCO and funded by dividends from OPCO, there may be insufficient funds in a HOLDCO to fund the insurance premiums.

To address these issues, OPCO could own the three insurance policies on the lives of the individual shareholders.[1] This ensures that the premium costs will be borne by each HOLDCO in proportion to its shareholdings in OPCO (equally in this situation). To creditor protect the death benefit it is possible to have the HOLDCOs of the surviving shareholders designated as the beneficiaries of the policy on the life of the deceased shareholder. This provides the funds to buy a HOLDCO´s shares from deceased´s estate. This structure also ensures a full capital dividend account (CDA) credit for the insurance paid to the HOLDCO as it will have no adjusted cost basis in the policy.

In the past one concern with this structure was whether the ownership and payment of premiums by the OPCO would result in a shareholder benefit to the HOLDCOs, since the HOLDCOs would be the recipients of the insurance proceeds.

In a CRA technical interpretation (TI) released in December 1998 the CRA was asked to respond to this question. The CRA´s indicated the view that:

"Generally subsection 15(1) of the Income Tax Act (ITA) would not apply to include a benefit in a beneficiary´s income as a consequence of the policyholder paying the premiums due under the policy or upon the receipt by the beneficiary of the proceeds of the insurance policy as a consequence of the death of the life insured".

However, the CRA also indicated that:

"unless there are bona fide reasons, other than to obtain a tax benefit, for the structure described above, it is our opinion that there may be a reasonable argument for applying subsection 245(2) of the Act (the General Anti-Avoidance Rule or "GAAR") to reduce the amount of the life insurance proceeds to be included in the recipient´s CDA by the adjusted cost basis of the policy."

Based on this TI, these corporate insurance structures have been implemented without any significant concern of the assessment of a shareholder benefit to HOLDCO under subsection 15(1) of the Act.

Copyright the Conference for Advanced Life Underwriting, December 2009

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CRA Announces Change in Assessing Practice

At two recent tax conferences the CRA indicated that it is now of the view that where OPCO owns and pays the insurance premium, and the death benefit is payable to a HOLDCO, subsection 15(1) will apply and they will assess a shareholder benefit equal to the premiums paid by OPCO. This is based on the view that OPCO has been "impoverished" by the payment of the insurance premiums, and that HOLDCO has the ultimate benefit from the insurance policy (click on the PDF item below to view Schedule A for a diagram of this structure).

The CRA also announced this change will only apply prospectively as follows:

The CRA also restated their earlier view that the GAAR could apply if the holding of the insurance was structured to unduly increase the capital dividend account.

Copyright the Conference for Advanced Life Underwriting, December 2009

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Commentary on the New CRA Position

It appears difficult to challenge the CRA´s view that a benefit has been conferred on a shareholder where an OPCO owns and pays for an insurance policy with HOLDCO being the beneficiary of such policy. This has been the accepted position in similar situations where the beneficiary of corporate owned insurance is an individual shareholder. There does not appear to be a strong argument to take a different view where the beneficiary is a corporate shareholder.

The CRA has also acknowledged the fact that time will be required for professional advisors to consult with their clients and modify current arrangements to avoid the assessment of a taxable benefit. So the deferral of the assessment of a taxable benefit for existing policies until January 1, 2011, is appreciated. The CRA has also confirmed to CALU that policies issued between the date of their announcement and the end of 2009 will qualify as "existing policies". However, it was also noted that GAAR could be applied "where the primary purpose of the arrangement is to obtain an inappropriate increase to the capital dividend account.

There are some issues arising from the new assessing practice and transitional provisions that will need to be clarified with the CRA. For example:

  1. What changes, if any, to an "existing policy" will be allowed and still benefit from the deferral of the assessment of a shareholder benefit until January 1, 2011?
  2. How will this new assessing policy apply to situations where OPCO is paying premiums in excess of the cost of insurance, and such premiums are not reflected in the death benefit payable under the policy to HOLDCO due to surrender charges or the death benefit structure?

Advisors will also need to review how to structure or restructure the ownership and/or beneficiary designation in a corporate setting to avoid the assessment of a shareholder benefit. The most likely options include:

  1. OPCO changing or making itself the beneficiary under the insurance policy.
  2. Retaining the current ownership/beneficiary structure but having the HOLDCO reimburse OPCO for the premium costs to avoid the assessment of a shareholder benefit.
  3. Structuring ownership/beneficiary designations at the HOLDCO level, presumably funded with tax free inter-corporate dividends. It should be noted that for existing arrangements, the transfer of a policy will result in its disposition and possible tax reporting. As well, the HOLDCO will have to pay "fair market value" for the insurance policy or risk the assessment of a shareholder benefit. This might be avoided by having OPCO declare a tax free inter corporate dividend equal to the fair market value of the insurance policy, and then transferring the policy to the HOLDCO as a dividend in kind.

>As noted, it is our intent to follow up with the CRA to clarify outstanding issues and ensure that members can respond appropriately to the needs of their clients and as well as questions from other professional advisors.

Copyright the Conference for Advanced Life Underwriting, December 2009

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[1]  It should be noted that there are a number of issues related to owning insurance within an operating company that may mitigate against using this strategy. These include concerns with creditors gaining access to the policy or policy proceeds, how to deal with the policies on the sale of the business and generally less planning flexibility.

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