Category: Insurance Journal

Government scrutiny of 10-8 insurance programs

At issue

The 2013 Federal Budget took aim at a number of items of concern to the government in terms of unintended tax benefits, including 10/8 life insurance programs.

A 10/8 arrangement involves investing in a life insurance policy with a view to borrowing against that investment for the purpose of creating an annual interest-expense tax deduction for a long period of time (i.e., until the death of an individual whose life is insured under the policy).

Since 2008, the Canada Revenue Agency has publicly expressed its interest in examining and understanding these arrangements.  In a sense, the proposed Budget measure may be seen as the government’s legislative response to the lack of success of the CRA on this compliance front. 

CRA roundtable, Canadian Tax Foundation Conference – December 2008

During the CRA Roundtable portion of the annual CTF conference, CRA officials commented that the GAAR (General Anti-Avoidance Rule) committee had recently reviewed a 10/8 plan submitted for review.  The details of the review were not disclosed, other than to remark that there was a question about interest deductibility.

Initially the industry expectation was that CRA may begin pursuing and challenging such plans under the GAAR.  Instead, efforts seem to have been directed toward gathering more information by expanding the scope of insurance company audits.  

MNR v RBC Life, 2013 FCA 50

In a series of ex parte motions (ie., moving party alone before the court) in 2009 and 2010, the CRA obtained judicial authorization to require four life insurers to disclose information and documents relating to their respective 10/8 plan holders.  Each motion rested on the premise that the “information was required in order to verify that these persons are in compliance with the [Income Tax] Act.”

The desired personal information included names, social insurance numbers, business numbers and trust numbers.  The plan and activity requests covered policy numbers, loan amounts, cash surrender values, and interest particulars.

The insurers successfully challenged the orders at the Federal Court.  The presiding judge had in fact sat on two of the original ex parte motions.  The reasons cast the CRA in an unfavourable light, documenting in detail a failure to make “full and frank disclosure” during the ex parte motions.  In particular, the judge was critical of the CRA’s intention to “send a message to the industry” by way of an “audit blitz” to “chill” 10-8 plan business.

CRA appeal to the Federal Court of Appeal, but was denied.

Federal Budget – March 21, 2013

The Budget document referred to the government’s efforts to challenge 10/8 arrangements under existing income tax provisions. However, due to time-consumption and costs, the determination was made to introduce legislative measures to prevent 10/8 arrangements from being used in the future.

As proposed, for taxation years ending on or after March 21, 2013, where one of these policies is pledged as security for borrowing, the following income tax benefits will be denied:

  • Deductibility of interest;
  • Deductibility of insurance premiums; and
  • Increase in the capital dividend account otherwise occurring on the payment of a death benefit to a private corporation.

Generally these changes are proposed to apply to payments occurring and periods commencing after 2013.  

Practice points

  1. Individuals contemplating or already holding an insurance policy that has or may have a borrowing component should verify with their insurance advisor whether these proposals may apply to them.
  2. Existing 10/8 holders should consult with their insurance advisor and a tax advisor to consider options.
  3. Generally, a withdrawal from an insurance policy has tax consequences.  The Budget proposes to provide some tax relief for a 10/8 holder who makes a withdrawal in order to repay associated borrowed funds.  As proposed, this relief will only be available for withdrawals before January 1, 2014.

Deductibility of securities trading losses

At issue

Business losses incurred in the course of securities trading may be deductible to a taxpayer where it can be shown that they arose while the person was either a “trader” as defined under the Income Tax Act, or was otherwise engaged in an “adventure in the nature of trade”.  To determine whether this latter characterization applies, a court will generally weigh five factors:

  1. Frequency of transactions
  2. Duration of holdings
  3. Intention to acquire for resale at a profit
  4. Nature and quantity of securities
  5. Time spent on activity

Whether considering any one of the factors or the set of five together, there is no bright line test to know for certain that a given taxpayer has satisfied the requirements.  So while there is plenty of case law fleshing out these factors, taxpayers who are at odds with the Canada Revenue Agency are often left to plead their unique facts before a judge. 

Here’s how a few taxpayers fared recently in litigation.

Walsh v. The Queen, 2011 TCC 341 

Mr. Walsh had retired from his chartered accountancy practice due to health issues, but wished to continue in a business that was compatible with his skill set.  Eventually he settled upon securities trading, purchased a sophisticated software package and participated in both online and in-person training and discussion groups.

For the two years in issue, there was only a small amount of trading activity, but this was not determinative against him.  

The claimed expenses were not aggressive attempts to allocate household expenses to a home-office or the like, but were specifically related to the investing activity.  The bulk of them were however for training, and the relative timing of the outlays was critical.  Rather than being in the preliminary exploitation of a business opportunity, Mr. Walsh was held to be in a pre-exploitation stage, and therefore the $26,500 losses were held to be personal and not deductible.

Zsebok v. The Queen, 2012 TCC 99

The taxpayer filed his 2001 to 2004 tax returns together in 2006, claiming business losses due to online trading.  These losses were denied, and thus the appeal to the court.

Though trades occurred on only 5-10% of the available trading days, there was a discernible strategy for identifying highly volatile shares trading in high volume, and trades ensued therefrom.  At one point, Mr. Zsebok even dipped into his RRSP account to fund his non-registered margin account, exacerbating the losses with the fact that he had to pay tax on those withdrawals.  

At points the judge viewed the activities as “feverish”, “foolishly” undertaken, and in pursuit of “get rich quick dreams”, though in the end unsuccessful.  Despite these impressions and misgivings about the late-filed returns, the issue before the court was whether the actions constituted an adventure in the nature of trade.  On this point, the taxpayer won on 3 of the 4 years’ assessments.

Mittal v. The Queen, 2012 TCC 417

Reproduced in this judgment is a nine-part business plan that includes personal development goals, buy and sell rules, monetary and time commitments, and even a contingency plan: “Take one week off from the markets to reevaluate my trading, current market conditions, my risk management and my mental and emotional stability. If a vacation is necessary, take one.” 

The business plan guided the investing activities of Mr. Mittal, a retired engineer and self-described workaholic.  In the judge’s view, this was an organized and businesslike approach to investing, though ultimately leading to losses of almost $70,000 over two taxation years.

The combination of a well-documented plan and carefully tracked activities contributed to the judge’s ruling that there was a clear intention to conduct business activity, despite the lack of success.  Together with the favourable findings on the other factors, Mr. Mittal was entitled to his deductions.

Practice points

  1. Understanding the five factors will help a taxpayer decide whether it is worth the cost and aggravation to appeal an assessment.
  2. The act of good recordkeeping can be strong evidence of a taxpayer’s intentions, on top of the obvious benefit of quantifying claims.
  3. The implication of successfully claiming a deduction would likely be that trading gains would be fully taxable, rather than one-half treatment of capital gains.  Accordingly, would-be claimants should obtain tax advice before taking a position, as this could have lifelong repercussions.

Holographic Wills

At issue

The purpose of a Will is to dispose of one’s property at death.  

All provinces have rules governing the formality of Will execution.  Within such rules, witnesses serve the function of providing independent confirmation of the validity of the execution process. That said, a witness may not be necessary in all cases.  

A holographic Will does not require any witness.  At a minimum, such a document must be entirely in a person’s handwriting and be signed.  Some provinces require a date, while other provinces do not.  As well, a province may limit holograph Wills to specific circumstances or individuals, for example only for those in military service.

Regardless which form the document takes, it must be clear it is intended to function as a Will in disposing of property at death.  

Estate of Cecil George Harris, d. June 8, 1948

This is the classic case that students learn about in their first Wills course at law school.

Cecil George Harris was a farmer in Rosetown, Saskatchewan who became pinned under his tractor.  Alone and realizing the severity of his injuries, he used his pocket knife to scrape some words into the painted fender: “In case I die in this mess, I leave all to the wife. Cecil Geo Harris.”

Though he was found alive, Mr. Harris succumbed to his injuries in hospital.  Days later when a friend towed the tractor back to the barn, he noticed the inscription and removed the bumper.  It was offered into court as a holographic Will, and eventually accepted as valid.

The bumper and pocket knife remained ‘on file’ in the local Courthouse for almost 50 years, and are now on display at the University of Saskatchewan Law Library.

Popowich Estate, 2012 ABQB 665

This is a recent and sad case where a court was called upon to determine whether a suicide note constituted a holographic Will.  

The deceased woman SLP had been diagnosed with a bipolar condition in her adult life, and subsequently suffered from anxiety, fear, depression and overall sadness.  She was married, and had executed a formal Will in late 2009 dividing her estate equally between her husband and her mother.  In July 2010, SLP had been missing for a couple of days before being found deceased.  Police determined that she had committed suicide.  

A 9-page handwritten letter was found with the body.  Addressed to her mother, SLP expressed how she felt “stuck in a circle of pain”, but otherwise showed her continuing affection for both her mother and husband.  In it, she also wrote,“Take my money and do things for yourself,” which the mother argued was a testamentary statement. 

In court, the letter was found to have indeed met all the technical requirements for being a valid Will, including that SLP had testamentary capacity.  However, the judge ruled that there was no indication of an actual or implied revocation of the formal Will.  Rather, SLP had left her mother the “gift of trying to provide comfort in an excruciatingly painful situation.” 

Practice points

  1. In urgent situations, a holographic Will may be the only way to record one’s testamentary wishes.  In less pressing circumstances, the process of preparing a formal Will allows for a more considered, comprehensive review of one’s affairs.
  2. The requirements for execution of holographic Wills vary from province to province.  As well, even if a document is validly executed in the current province, it may not be enforced as expected if the testator lives in a different province at death.
  3. Disappointed beneficiaries may be more inclined to challenge a holographic Will, as compared to one prepared by a lawyer.  A competent professional can advise on content and oversee execution, so that the testator’s wishes are correctly reflected in the document and in the ultimate result.