Insurance – Page 9 – Doug Carroll

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.

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.

Tax talk on the dock – 5 planning points for an investing skeptic

I had the opportunity to catch up with an old friend by a dock earlier in the summer.

He is a true entrepreneur who took a calculated risk, established a successful business, sold to a multinational, had a brief retirement (at age 40) and a few years later is looking for the next challenge.

With those buyout funds in hand, he observed the recent economic turmoil with much skepticism about market investing. Actually he was a skeptic well back in time, and those funds never left the safety of his bank account. Even so, he knows he can’t remain on the sidelines forever.

So as summer comes to a close, here is what we threw about, apart from the horseshoes and mosquito swatter.

Run a business, if you are so inclined

My friend firmly believes that true wealth is built through active business management. And given his track record, I can’t disagree that a well-run enterprise can net impressive results – emphasizing the requirement to be well-run.

In actuality, he is something of a zealot when he extols the virtues of running a business, and more specifically the benefits of running a business through a small business corporation. He is living proof of the value of the small business rate, spousal income splitting and the lifetime capital gains exemption. Heck, he almost bubbles over in recalling the joys of a well orchestrated salary-dividend mix.

However, running a business is more than merely a financial decision, whether tax-driven or otherwise. In many ways, it’s a lifestyle choice, and has to be undertaken with that aspect clearly in focus.

Kill the mortgage

There is perhaps no more clearly predictable rate of return on applied money than to eliminate a big debt like a mortgage. Somewhat ironically, that kind of arithmetic certainty dovetails well with the more nebulously measured emotional comfort of being mortgage-free. Hey, it’s your home.

In his case, he had already achieved this prior to the business buyout.

That’s not to say that he was pursuing mortgage retirement to the exclusion of retirement savings. Rather, he placed more proportional emphasis on the mortgage than any raw calculus might explain.

Now being free of that debt burden, he is committed to becoming more knowledgeable and effective in fashioning his retirement income plan.

Getting 20% upfront on your RESPs

As people within the financial service sector, sometimes we forget that those outside the field have things on their mind other than the nuances we see much more regularly.

For instance, my friend was not even aware of the 20% Canada Education Savings Grant he was receiving on his RESP contributions. Thus, he was only contributing paltry amounts well below the $2,500 limit upon which the current year’s entitlement would be maxed out.

On the positive side, now that it is possible to pick up past years’ unused room, he will be able to get up to $1,000 CESG annually by putting in $5,000 for each of the kids until he catches up. Yes, he’s the same skeptic about market investments, but that’s a whopping tax/support benefit left on the table if that CESG is not unclaimed.

It remains to be seen whether he is inclined to make any further use of the RESP tax sheltering room beyond the CESG entitlement thresholds.

We differ on life insurance

While we are roughly on the same page that life insurance is a top priority matter for income replacement purposes, beyond that we diverge a bit.

He waffles on what to do with current life insurance, given the lack of an income replacement need. In not so many words, he defines that need in terms of whether his family would suffer a drop in lifestyle should he be removed from the equation. In that context, I agree that he does not need to replace income.

That said, terminal taxes and final debts loom, distant though they may be in the future. A tax-free death benefit may make sense to service that eventuality. Past premium payments are water under the bridge, and future premiums continue to be priced based on an earlier age.

A consideration of the internal rate of return of continuing premium payments may prove fruitful. That’s the kind of analysis an entrepreneurial business mind can appreciate.

Do the Wills

Actually they have done their Wills, but that was well before the business came to together and was later harvested.

The tax benefits of testamentary trusts may have been a passing topic in those earlier estate planning discussions, but now the benefits are very real – for the couple, the kids, and who knows who or what may come up in summers ahead.