Insurance Journal – Page 22

Tax treatment of rebates paid by an advisor

At issue

In some provinces, licensed insurance advisors are permitted to pay a portion of earned commission to the purchaser of a life policy. If an advisor chooses to use this device, there can be tax implications for both advisor and client – and possibly even for parties extending beyond that immediate relationship.

Here are a couple of Canada Revenue Agency rulings and a Tax Court case on the issue.

CRA 2008-0271381E5 – Commission Rebates

The CRA was asked whether a rebate payment served to reduce an advisor’s commission, or if it was instead a deductible expense.

In general, where the advisor has the absolute right to the commission without restriction, the total amount of the commission would be included in income. However, the rebate would generally be a deductible expense so long as it fulfills the Income Tax Act requirements of being incurred for the purpose of earning income and being reasonable.

The recipient of such a payment will be treated as having received an amount that is income from property, the property being the life insurance policy. In fact there is a specific income inclusion section in the ITA for inducements received from someone (ie., an advisor) who has made the payment in the course of earning income.

CRA 2010-0359401C6 – Rebate Paid by an Advisor to a Policyholder

At the 2010 Conference for Advanced Life Underwriting program, the CRA was asked again about this issue. The Agency representatives referred back to the above ruling, reaffirming its position regarding the payor advisor and payee policyholder.

An additional leg of the question inquired whether the payment would reduce the policy’s adjusted cost basis. In response, the representative noted that an election is available for similar payments in respect of capital property. Life insurance is not however capital property, and there is no corresponding provision in the ITA section dealing with the ACB of a life insurance policy.

Lapalme v. R. 2011 TCC 396

A corporation purchased life insurance coverage on each of four brothers who were its shareholders and directors. Shortly thereafter, each received a cheque in his personal name from the advisor’s insurance-licensed corporation, which each claimed as a non-taxable gift. The amounts approximately equaled the respective first year policy premiums.

The court upheld the CRA assessment of a shareholder benefit having been conferred on each of the brothers. Further, it allowed the assessment despite being outside the normal assessment period, finding there to have been misrepresentation in filing the personal returns. Penalties were also upheld, attributable to a finding of gross negligence.

The case did not address what the tax implications may have been to the advisor, who was not present at the hearing.

Practice points

Obviously, verify your provincial rules on the legality of rebating.
Keep in mind the implications and complications if it is contemplated that the payment will be made to someone other than the policyholder.
With respect to advising the client, be aware of CRA’s position as stated in the first cited ruling above that “clients should be notified of the CRA’s position that the rebate received must be included in their income.”

Advisor commission on own life insurance

At issue

An oft touted perk of being a life agent is the presumed entitlement to receive tax-free commissions on one’s own life insurance.

Look this up in the Income Tax Act, however, and you won’t find it. That’s because it is based on a Canada Revenue Agency administrative position. And as two agents discovered when they pressed their respective exemption claims before the courts a couple of years back, CRA is not the law.

In the wake of these judicial determinations, the danger for the rest of the advisor population was somewhat put in limbo, not knowing whether the CRA would retract or otherwise not be able to apply this administrative practice in future. A subsequent CRA technical letter clarified the agency’s continuing position.

Li v. R., 2009 TCC 530

The appellant was employed as a commissioned salesperson with a life insurance company. She appealed an income tax assessment that disallowed numerous deductions claimed as employment expenses, including commissions on own life insurance.

The Judge held that there are no provisions in section 8 (re: employment deductions) of the Income Tax Act that allow a deduction for commissions on own insurance. No mention is made of CRA administrative practice.

Bilodeau v. R., 2009 TCC 315

The appellant, a life broker, appealed from assessments disallowing $43,115 of claimed deductions against commission income. The commissions arose out of two universal life policies held by the broker on his life and his wife’s life. A significant portion of commissions were attributable to excess premium deposits.

With respect to an agent’s own coverage, the broker relied primarily on paragraph 27 of Interpretation Bulletin IT-470R and CRA’s longstanding administrative practice. While the judge acknowledged that Interpretation Bulletins may reflect the opinion of the Minister of National Revenue, he made it clear that they are not binding on the Minister, the taxpayer or the courts. To the point, those opinions are not a substitute for the ITA.

It was held that it is irrelevant whether the policies were acquired for personal reasons or to obtain a tax-free investment returns. The intended purpose of the insurance did not change the fact that the commission was taxable.

CRA 2010-0388111M4 F – Commissions – Life insurance salesperson

Following the Bilodeau decision, the CRA was asked whether it would continue to apply its past administrative practice. The agency responded that the practice would indeed continue, but that insurance policies held for investment or business purposes would not qualify for the exemption, nor had they in the past for that matter.

Practice points

It may be advisable for an advisor to hold pure personal risk policies separately from policies held for other purposes. Though that recent CRA letter does not explicitly bar combined-use policies, such an arrangement could present challenges in isolating the commission entitled to the preferred treatment, with the potential that all of it will be taxable.
By the way, the CRA administrative position has never applied to accumulation products such as segregated funds.

Revoking a spouse beneficiary on separation

At issue

The breakdown of a marriage is seldom a pleasant or simple process to work through. One potentially problematic aspect of this is how to deal with the revocation of life insurance and RRSP/RRIF/pension beneficiary designations. Despite expressed intentions and commitments in a separation agreement, additional positive steps may be necessary to give effect to a purported change.

Here is a recent trial court decision where an ex-spouse remained on record as life insurance beneficiary, and a couple of appeal court decisions that provide further context.

Love v. Love, 2011 SKQB 176

The separation agreement made reference to the husband’s pension, but made no mention of the group life insurance on which the wife was the named beneficiary. Following separation, the husband sent an email to his employer’s human resource department requesting the necessary paper work “to change the beneficiary on my pension etc. (from my former wife to my son).” After his death, the incomplete form was found in his files.

The court held that an email could suffice as a “declaration” to change a beneficiary under the Saskatchewan Insurance Act. On the facts however, neither the reference to the policy (“etc.”) nor the new beneficiary were sufficiently clear, particularly as there were actually three sons.

Richardson Estate v. Mew, 2009 ONCA 403

The Ontario Court of Appeal provides a useful summary of cases involving the interaction of separation agreements and beneficiary designations, and enunciates some principles for analyzing the cases:

“A former spouse is entitled to proceeds of a life insurance policy if his or her designation as beneficiary has not changed. This result follows even where there is a separation agreement in which the parties exchange mutual releases and renounce all rights and claims in the other’s estate. General expressions of the sort contained in releases do not deprive a beneficiary of rights under an insurance policy because loss of status as a beneficiary is accomplished only by compliance with the legislation. The general language used in waivers and releases does not amount to a declaration within the meaning of the Insurance Act.”

Martindale Estate v. Martindale, 1998 CanLII 4561 (BCCA)

The British Columbia Court of Appeal held that, on the facts in evidence, it would be a breach of the separation agreement for the ex-husband to claim insurance proceeds from the death of his ex-wife. Instead, he received the proceeds only as trustee of a constructive trust for the benefit of the intended beneficiaries.

In the words of the Court, “it would be against good conscience for the appellants to keep this money because Mr. Martindale had, by the separation agreement, surrendered any right he might have had to the property of the deceased.”

Practice points

Separating spouses and their lawyers should be sure to direct their minds and their drafting to explicitly address life insurance and RRSP/RRIF/pension beneficiaries in the separation agreement.
The Martindale result should be viewed as the exception to the general approach expressed in the Richardson case. To achieve greater certainty, separated spouses should change beneficiaries using each respective institution’s forms and procedures.