Interestingly, ITA doesn’t say that Life insurance is tax-free, and it’s due to the reason that ITA is an act of inclusion and lists everything that’s taxable.
If you are incorporated and planning to buy life insurance, then it would be beneficial to weigh out that either it should be bought personally or through your corporation.
Suppose you are in the 48% top tax bracket in AB. To invest $100 personally, you must earn $192. If you make the same investment through your corporation, then you only need to earn $112. This is because of the reason that corporation tax is lower for active income. When you purchase a corporately owned life insurance policy or make any other investments from your corporation, you could buy more!
Based-on tax integration theory, income earned by a corporation and distributed to its shareholder should attract no more or no less tax than if the income had been earned directly. Death benefits paid to a corporation creates CDA credit, where the corporation is the owner and also the beneficiary of a life insurance policy.
The actual credit to the CDA is equal to the death benefit paid less the adjusted cost basis of the life insurance policy. Lower ACB is desirable when death benefit is accessed through CDA. If the cash value has to be accessed, then it’s more beneficial to have higher ACB
Its important to know that Critical illness or disability insurance do not create a CDA credit.
A negative balance won’t reduce the overall positive balance of CDA, but CDA negative balance in one category will affect the CDA to be paid from other category
Buy/sell- It’s very important to add appropriate CDA clauses when drafting a shareholder agreement. How the insurance proceeds will be distributed in case of death of a partner and who would benefit from CDA should be clearly mentioned in the agreement.
CDA is a notional account within a private corporation which gets credited during three scenarios.
- Capital gains/losses realized by corporation
- Life insurance death benefit
- To transfer funds within related corporations
Let’s have a look at the following examples to further simplify this:
- If a CCPC disposes of a building having ACB $500,000 and selling price $600,000 then there will be $100,000 capital gains. $50,000 of the gain is taxed at the passive income rate, and the other $50,000 would create a credit to the CDA account.
- A corporation owns a life insurance policy with death benefit of $1 million and ACB is $50,000. When this death benefit of $1 million is paid to the corporation, it would create a CDA credit of $9,50,000. This way, surviving shareholders or estate would be able to obtain $950,000 tax-free from the corporation.
- Corporation realizes capital gains of $100,000 and $50,000 will create a CDA credit. Subsequently, the corporation has a loss of $40,000 so $20,000 will be a notional negative balance. Corporation receives insurance proceeds with $200,000 which provide $200,000 CDA credit. So CDA balance would be $50,000-$20,000+$200,000 = $230,000
Prior to a dividend payout from the CDA, the corporation must file a form T2054, along with a detailed schedule showing the computation of the CDA and a certified copy of the corporate resolution authorizing the information described in Regulation 2101 of the Act. The over-election of a capital dividend is subject to a 60% penalty to a minimum of $500.
Net cost of pure insurance
The NCPI is meant to represent the “cost” of the insurance coverage under the policy. The NCPI increases each year because mortality risks increase with age. The Income Tax regulations govern the calculation of NCPI and differ according to the date the policy was issued. For policies issued after 2016, the NCPI will generally be lower, which reflects improved mortality experience over recent decades.
It is calculated by multiplying the net amount at risk for the year by mortality rates based on the CIA 1986-1992 table for G3(policies issues after 2016).
The net amount at risk for the year is the death benefit less the greater of (i) cash surrender value of the policy; and (ii) net premium reserve of the policy as of the end of the calendar year.
Adjusted cost basis –
An adjusted cost basis (ACB) of an interest in a life insurance policy is the base value from which accrued income and policy gains are measured. The higher ACB is generally more beneficial when determining the amount subject to taxation due to disposition of a policy. However, a lower ACB is preferred in a corporate owned policy for the purpose of CDA (Capital dividend account). A credit to the capital dividend account is created which is equal to death benefit minus ACB.
ACB = Cumulative premiums – NCPI – Policy Loans + Policy Loan Payments.
The following factors will increase the ACB of a policy:
- Premiums paid
- Policy gains from dividends or policy loans
- The interest paid on the policy loan
- Policy loan repayments.
These factors will decrease the ACB of a policy:
- Proceeds of disposition including policy loans
- Net cost of pure insurance
The ACB remains positive for a longer period of time. This is beneficial for policy loans and dispositions but not for the calculation of the CDA.
Are insurance premiums deductible?
Insurance premiums are generally not a deductible expense since they are capital in nature. However, in certain circumstances, a deduction for the lesser of the NCPI and premium is allowed.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.