Creditors/Insolvency/Bankruptcy – Page 2

Creditor insurance and the CDA credit

At issue

Lending institutions often offer group creditor life insurance to their borrowing clients. A key concern for a private corporation is whether any or all of the insurance proceeds would result in a credit to its capital dividend account (CDA), facilitating follow-on tax-free dividends to surviving shareholders.

Until recently, the longstanding position of the Canada Revenue Agency (CRA) has been that a CDA credit arises only when the subject private corporation is the named beneficiary on the policy. This issue was considered before the Federal Court of Appeal (FCA) in late 2010, leading to some clarifying CRA technical letters earlier this year.

R. v. Innovative Installation Inc. 2010 FCA 285

Innovative had a business loan from a bank, with its principal covered under group creditor life insurance held by the bank as policyholder. On the principal’s death, insurance proceeds paid to the bank were applied to discharge the debt, with the remainder deposited to Innovative’s bank account.

The FCA upheld the trial judge’s finding that, although the insurer had paid the proceeds to the bank as was required by the group insurance policy, Innovative constructively received those proceeds when the bank applied them to discharge the debt. The company was thus entitled to a CDA credit equal to the gross insurance proceeds of $160,000.

CRA 2011-0399771C6 – CDA, Innovative Installation case

At the 2011 CLHIA roundtable the CRA was asked to consider whether constructive receipt would similarly apply in the following situation.

Pursuant to a shareholder agreement, life insurance policies are held by an inter vivos trust under which holding companies ACo, BCo and CCo are non-discretionary beneficiaries. On A’s death, the proceeds of the policy on A’s life are initially paid to the trust, then on to A’s holding company ACo in satisfaction of the purchase price of ACo’s shares of Opco by BCo and CCo. Are BCo and CCo entitled to CDA credits for their respective proportions of the proceeds?

In CRA’s opinion, the Innovative Installation decision is limited to situations involving group creditor life insurance, which is not the case in the scenario presented.

CRA 2011-0401991E5 – CDA and life insurance proceeds

In this French language letter, the CRA repeated the finding in Innovative Installation as being applicable in the case of group creditor insurance. The writer stated that the agency accepted this position, and accordingly paragraph 6 of Interpretation Bulletin IT-430R3 would need to be modified to reflect this revised administrative approach.

Practice points

Note that the CDA credit in Innovative Installation was for the full amount of the proceeds, as opposed to the net-of-debt amount. For comparison, if a private corporation owns and is beneficiary of a policy, the credit is calculated as the gross proceeds less adjusted cost basis of the policy to the corporation.
Cost and tax issues aside, it remains the case that insurance owned by a borrower is obviously more portable than insurance attached to a lender. This could be especially important in later refinancing discussions if insurability becomes an issue.

Safeguarding RRSPs against creditors

Is my RRSP protected from creditors? Clients are keen to know how bankruptcy affects this key savings vehicle.

Whether it’s nervous clients reviewing their depleted nest eggs, or troubled clients readjusting to a job loss, this is one question financial advisors have probably been asked fairly often in recent times.
The easiest answer is: Indeed—in the case of bankruptcy—except for deposits made within the 12 months leading up to the bankruptcy.

And isn’t it rather fortuitous that the federal bankruptcy amendments, exempting RRSP/RRIF assets from seizure in a bankruptcy, came into force just about a year ago, July 7, 2008, right around the time financial markets began to show us quite forcefully what had been brewing within the economy.

Short of bankruptcy, creditor protection would depend on the type of plan being held, whether it is lifetime or estate protection at issue, and what province or territory the client currently resides in.

Insurance-based plans

For insurance-based plans, protection is available against lifetime creditors if one or a combination of certain family members—spouse, child, grandchild or parent—is named a beneficiary. In the common-law jurisdictions, it’’s determined by the relationship of the beneficiary to the annuitant; whereas in Quebec it is the relationship to the owner. The distinction is irrelevant in the case of RRSP/RRIFs since the annuitant and owner are one and the same.

Insurance-based plans also allow protection against estate creditors if any beneficiary is named, family or otherwise. In either case, insurance-based plans are not automatically protected, but rather obtain protection if the owner has taken the active step of naming appropriate beneficiaries.

Lifetime protection, generally

British Columbia, Alberta, Saskatchewan, Manitoba and Newfoundland allow for lifetime creditor protection through their respective judgment enforcements legislation. No beneficiary designation is required; however, in B.C. deposits within 12 months of a claim remain exposed.

The Prince Edward Island law protects only where a family beneficiary—spouse, child, grandchild or parent—is named.
There’s no legislation enabling lifetime protection for residents of Ontario, Quebec, New Brunswick, Nova Scotia, Yukon, Northwest Territories or Nunavut.

Estate creditor protection

In B.C. and PEI, legislation is in place to assure RRSP/RRIF assets bypass estate creditors, so long as any beneficiary is designated (other than the estate of course).

Case law informs the protection in the remaining jurisdictions. In the 2004 Perring case (Amherst Crane Rentals Limited v. Perring), the Ontario Court of Appeal confirmed that non-insurance RRSP/RRIFs flow directly to a named beneficiary, out of the reach of estate creditors. The relevant phrasing in the Ontario law is the same or similar to legislation elsewhere. While not a certainty, this case would therefore likely have strong influence in those other jurisdictions — Alberta, Saskatchewan, New Brunswick, Nova Scotia, Newfoundland and Labrador, Yukon, Northwest Territories and Nunavut.

The 1997 Clark decision (Clark Estate v. Clark) from the Manitoba Court of Appeal held that RRSP proceeds had to be paid back by a named beneficiary to an insolvent estate, until creditor claims were satisfied. While this has not been directly overruled, it has also not been followed on occasion, so that leaves some uncertainty in Manitoba.

The Supreme Court of Canada ruled in the Thibault decision in 2004 (Bank of Nova Scotia v. Thibault) that a particular RRSP did not constitute an annuity for Quebec purposes, and therefore was available to estate creditors. While Quebec intended to remedy the legislation, the consensus from the legal community is that it falls short, and therefore it remains that RRSPs likely are exposed to creditors.

TFSA creditor protection

Insurance-based TFSAs are likely to be treated the same way as insurance-based RRSPs.
For non-insurance plans, provincial or territorial laws have been amended (or will be in the near future) to allow beneficiary designations. Once in place (some have had to be re-drafted), protection against estate creditors will likely be the same as with RRSPs. Even so, the local law should be confirmed before relying on financial institution forms.

One thing is certain though, no province or territory has granted lifetime protection to TFSAs.

Certain conditions and classes of creditors may override technical compliance with the rules, even for insurance-based plans.
If a creditor is able to show a fraudulent conveyance or preference, impugned transactions may be reversible. It depends on the province or territory whether intent is a necessary component of the action, or if prejudice to the claimant is sufficient.

It’s possible that matrimonial property, support orders and dependants’ relief claims could impress a trust upon RRSP/RRIF assets. In addition, CRA has been successful in actions taken against registered plans.

Where any of these complications are present, legal advice should be sought out before making any moves.

TABLE: Expected creditor exposure

The chart below summarizes expected treatment.

Is my RRSP protected from creditors?

Given the events of the past year, it’s probably a question that comes up fairly often now for financial advisors, and there’s no simple answer. Whether your clients are asking you out of nervousness for their nest egg, their jobs or both, it’s an extremely topical issue.

Last year’s amendments to the federal bankruptcy law gave RRSP/RRIFs a similar level of protection to their registered pension plan cousins. Short of bankruptcy, however, the question needs to be framed in terms of the type of plan being held, whether it is lifetime or estate protection at issue and concurrently what province or territory one resides in.

Expected creditor exposure

The chart below summarizes expected treatment.

Why is the creditor claiming?

Certain conditions and classes of creditors may override technical compliance with the rules, even for insurance-based plans. If a creditor can show a fraudulent conveyance or preference, impugned transactions may be reversible. It depends on the province or territory whether intent is a necessary component of the action, or if prejudice to the claimant is sufficient,.

It is also possible that matrimonial property, support orders and dependants’ relief claims could impress a trust upon RRSP/RRIF assets. As well, CRA has been successful in actions taken against registered plans.

Where any of these complications are present, legal advice should be sought out before making any moves.