For corporate-owned policies, the general guideline is to have both the corporate policyowner and beneficiary be the same entity. In certain circumstances, a related subsidiary corporation (Subco/Opco) or parent corporation (Holdco) may also be a beneficiary. We often come across clients of closely held private corporations who wish to have the life insurance proceeds paid directly to a named beneficiary such as their spouse or child. In this article, we’ll touch upon some of the issues involved in naming someone other than the corporate owner as a beneficiary of the policy.
Opco/Holdco policyowner and Individual beneficiary:
Here we find that either the shareholder’s estate or someone related to the shareholder is the beneficiary of a corporate-owned policy. In this case, CRA considers the shareholder to have received a taxable shareholder benefit from the corporation equal to the premiums paid. This amount will be included in the shareholder’s income each year the premium is paid by the corporation. Since it’s considered a shareholder benefit under section 15(1) of the ITA there’s no corresponding deduction for the corporation. From a tax perspective, there’s truly no reason for a shareholder to designate someone other than their corporation as a beneficiary. In the end, the shareholder’s estate or family members may receive all or a substantial portion of the insurance death benefit tax-free, via the corporation's capital dividend account depending on the policy’s ACB at death.
If an employee of the corporation (not a shareholder) designates a family member or related party to their corporate-owned policy, the premiums paid by the corporation are considered a taxable employment benefit to the employee. Unlike the shareholder benefit scenario above, the corporation is allowed to deduct the premiums as an expense.
Holdco policyowner and Opco beneficiary:
Before the rule changes in 2016 it was quite common to see this arrangement. Holdco owned the policy and Opco was named beneficiary. Holdco owned the policy to shield the cash value from potential Opco creditors and Opco received the insurance proceeds as the beneficiary to deal with either the funding of a buy-sell agreement, key person protection, or other liquidity issues that arise due to the death of a shareholder. The ACB followed the policyowner and NOT the beneficiary. After 2016, this all changed. Not only is there no pro-rating of the ACB in cases when more than one corporate beneficiary exists but the ACB is also double counted. Double whammy! Hopefully, CRA will address this discrepancy in future legislation.
In this scenario, CRA considers Holdco to have conferred a benefit to Opco based on subsection 246(1) of the ITA assuming the entities are non-arms length. Although it’s not clear how the benefit will be quantified most experts believe it’s the insurance premium paid which is consistent with the shareholder benefit status described above. Many experts disagree with the 246(1) assessment and believe Opco should not be assessed any taxable benefit AT ALL since it’s not a shareholder receiving a benefit but rather a subsidiary of a shareholder (Holdco). The reason behind this opinion follows the more common scenarios where shareholder(s) (whether individual or corporate) can loan money to their respective Opcos and not be seen to have conferred a benefit to Opco.
Opco policyowner and Holdco beneficiary:
This situation is not as common but exists, nonetheless. The same taxable benefit issues experienced in the situation above (Opco/Holdco policyowner and Individual beneficiary) apply here. A taxable shareholder benefit (subsection 15(1)) would be assessed to the Holdco beneficiary equal to the premiums paid. Assuming a connection does exist between these two entities there’s usually no reason for this structure to exist. The Opco can simply pay a tax-free intercorporate dividend to the Hold allowing Holdco to use these funds to pay the premium on a Holdco-owned policy. Read my article titled: “Intercorporate dividends: Are they always tax-free” (see link below).
What about Life insurance shares?
Life insurance shares or tracking shares may offer a solution to estate equalization concerns in a family-operated business. It’s an effective way to guarantee insurance proceeds that are received by the corporation are distributed or flow to specific beneficiaries (i.e. children who are not involved in the family business). In this scenario, the corporate policyowner and beneficiary are the same entity and therefore you don’t run afoul of any taxable benefit situations mentioned above. For more information on this topic, please read my article: “Life Insurance Shares: What are they and when to use them?” (see link below).
For many family-operated businesses, having the same corporation as both policyowner and beneficiary can address most of their estate planning objectives. Taxpayers with existing arrangements that are offside based on subsections 15(1) and 246(1) mentioned above may need to review and revise beneficiary designations to ensure the issue doesn’t give rise to negative tax consequences.
Footnotes:
“Intercorporate dividends: Are they always tax-free?” Intercorporate Dividends: Are they always TAX FREE?(Issues related to insurance solutions) (qfscanada.com)
“Life Insurance Shares: What are they and when to use them?” Life Insurance Shares: What are they? And when to use them? (qfscanada.com)
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