Tax and Estate Planning Group

Hello everyone, and welcome to another podcast brought to you by Canada Life's Tax and Estate Planning Group. My name's Steven McLeod and I'm joined here with my colleague, Marco D'Aversa. And today, we're talking about the insured annuities and corporate insured annuities strategy, also known as back-to-backs. Now, these strategies have been forgotten about in the last few years, but the stars are starting to align so that they're starting to look a lot more attractive again because of our current higher interest rate environment. Now, we're recording this podcast in July of 2023, and as everyone knows, we're in a significantly higher interest rate environment compared to what we've seen in the last few years.

And this has allowed insurance companies to sharpen their pencils on the pricing for the two products that we use in this strategy. And that's one a lifetime annuity, and two, that's a universal life level cost of insurance, permanent life insurance policy. And on that note, I'd like to highlight that Canada Life recently lowered our rates on UL Level COI policies back in the month of May, and you can check out those lower rates on concourse. So Marco, back-to-backs or back to insured annuities, so they're looking more attractive again. Can you please tell our listeners at a high level how this strategy works and why would it be appealing?

Okay, thank you, Steve. Yeah, so specifically today we're going to be talking about two separate strategies, although they're very similar. We're going to be talking about the insured and unity strategy, which is undertaken at the individual basis. And then we're also going to be talking about the corporate insured and annuity strategies, which is done at the corporate level. Both strategies are somewhat similar as they provide guaranteed income for life. They preserve the value of your estate through a life insurance contract and also minimize taxes. Now, each of these two strategies uses basically the cashflow from an annuity to supplement your retirement income and pay the premium on a life insurance policy that provides a death benefit to replace the capital used to purchase the annuity. And as you mentioned, Steven, both these strategies use a combination of two separate products, one being a life annuity that ensures that you don't outlive your assets and a life insurance policy, which ensures that the capital that you've built out over the years transfers tax efficiently to the next generation.

Now, each strategy has its own unique benefits and product requirements. Now, we'll take a closer look and talk about first the insured and annuity strategy again, which is done on the individual level. And then we'll look at the corporate insured annuity strategy, which is done at the corporate level. But before talking about these two strategies, it's a good idea with any type of strategy that you look at some of the consideration and risks involved with strategy. So maybe I'll pass it back to you, Steven, to talk a bit about the considerations that you need to consider when looking at these two annuity strategies.

Great. So I'll look at the main ones. The first one would be on implementation. And that's you definitely want to get the insurance coverage secured before purchasing the annuity. You certainly wouldn't want to get the annuity and then not qualify for the insurance. There might be some tax costs if you need to sell investments to buy the annuity. The strategy is very inflexible and very difficult, if not next to impossible to unwind. Once implemented as you are purchasing an annuity. And apart from the income stream from the annuity, there's very no liquidity associated with the strategy. So because of this, the strategy likely isn't very appealing to younger or pre-retirement age clients because of the opportunity cost of purchasing the annuity with potentially a significant chunk of investment capital.

So this sweet spot for this strategy is probably early 60s to early 70s, talking more about the client profile, we're looking for someone with good health so they can qualify for standard ratings on the insurance policy. The client would be concerned about outliving their assets and making sure that they have income for their entire life. The strategy can be done on a single or joint basis. You definitely want to get the insurance and the annuity matching up from that perspective, business owners can do it. So Marco, as you said, it could be done corporately as well. So Marco, why don't we start by taking a closer look at the personal version of the strategy, the insured annuity.

Thanks, Steven. So the insured annuity again, uses cashflow from a life annuity to both supplement your retirement income and pay the premium on a life insurance policy that provides a death benefit to a name beneficiary, which typically would be a child to potentially avoid probate tax and certain jurisdictions, which I'll talk a bit about later in the podcast. But at this point, we're going to be talking about how the insured annuity strategy works both while you're living and then at death. Well, the first thing that you would do to implement this strategy is you would have to purchase an annuity contract. As Steven mentioned earlier, this may require you to liquidate certain investments. And of course, whenever you're liquidating investments, there could be significant tax implications depending on what you're invested in. So it's crucial that the clients seek the proper tax advice from your own tax counsel to quantify these tax implications before undertaking liquidation to fund the purchase of the life annuity.

So once you have the liquid funds, the non-registered funds personally, you would purchase a prescribed life annuity contract on your life. And basically, this prescribed life annuity would provide an income stream to yourself, which would be a combination of tax-free capital and taxable interest. And basically, you would use a portion of this income stream from the annuity to pay for a permanent life insurance policy on your life with the amount of coverage equal to the capital that you used to purchase the annuity so that you're able to replace that capital upon your death. Now, the annuity payment itself, as I mentioned earlier, does include a component that is a taxable interest component, which would be subject to tax at the personal level on your personal return.

And basically, any remaining portion of the annuity after paying this tax could be used to supplement your retirement income. And then upon death, the death benefit payout would go to your named beneficiaries, which typically would be the next generation, your kids, and the annuity would basically stop. Now, one thing I just wanted to clarify is the taxation of the annuity product itself. I mentioned prescribed annuity, so we should talk a bit about prescribed annuities and non-prescribed annuities. Basically, for purposes of this podcast, we are talking about non-registered annuity. Namely, we're using non-registered funds to purchase annuity. And from a taxation perspective, the annuity's taxation will be a function of whether or not the annuity is a prescribed annuity or non-prescribed annuity. Now, whether you have a prescribed annuity or non-prescribed annuity, the payments that you receive are a combination of tax-free capital and taxable interest.

Now, with prescribed annuities, the taxable interest component is level throughout the contract. For non-prescribed annuities, the taxable interest component basically accrues over the life of the contract. So generally, the taxable interest component is higher in early years and then gradually decreases over the life of the contract. So if we were to step back and look at these two types of annuities, prescribed versus non-prescribed, prescribed would generally be preferred from a tax perspective because it does provide an element of tax deferral in that you have a level taxable interest throughout the life, and the amount of taxable interest in the beginning of the contract is generally lower than it would be for a non-prescribed annuity. So you have the deferral. Moreover, since the taxable portion is level throughout the contract, it makes it easier for planning purposes to plan for the underlying taxes you'll be paying on an annual basis.

However, for annuity contract to meet the definition of a prescribed annuity, it has to meet certain conditions. And one of the conditions is that the purchaser must be an individual or a specified trust. As such, when we're dealing with an insured annuity strategy, which again is done at the individual basis, we have the opportunity to use a prescribed annuity which has favorable tax treatment. However, you'll notice when we talk about our second strategy being the corporate insured annuity strategy, we are not able to use a prescribed annuity. Instead, we use a non-prescribed annuity which has less favorable tax treatment. So that sort of explains the first strategy, the insured annuity strategy. Maybe I'll pass it back to you, Steven, to talk a bit about the life insurance contract you would put in place for this first type of strategy.

Sure, Marco. And I'd add to, because we're looking at maximizing your net cashflow from the strategy, we probably won't put a large guarantee period on the annuity. So we might want to kind of look at the pricing and just see what type of guarantee period would not impact the maximum cashflow that we can get from the annuity. So that could be probably no more than 10, likely 5. Going to the life insurance policy, again, we do want to maximize the net cashflow from this strategy. So that's being the amount that could be paid to the client after taking the annuity cash flow and paying the life insurance premium. So what we want to do is buy the most amount of permanent coverage at the lowest cost, which as noted earlier, leads us a Canada Life to using a minimum funded universal life insurance policy with a level cost of insurance. So Marco, when we're talking about cashflow in today's pricing environment, again, being July 2023, what kind of results could say a 65-year-old male, non-smoker, standard risk expect using an alternative investment as a frame of reference?

Oh, thanks, Steven, that's a good question. I actually ran an example using those parameters, again, a 65-year-old male, non-smoker, standard risk using a $1 million prescribed annuity and a $1 million minimum funded UL policy level cost of insurance. And based on those results, the rate of return required for a GIC to generate the equivalent after tax cashflow would be approximately 5.58%. As such, we can see that this could be an attractive strategy for certain clients because again, 5.58% is higher than probably the going GIC rate currently. And again, it's pretty attractive. However, that said, as you mentioned for it may not be for everybody, this strategy is very inflexible and it actually probably can't be unwound. So it's something you definitely want to keep in mind if you're looking at this type of strategy for one of your clients. So to recap, the benefits of this first strategy, the insured annuity strategy is one, it does provide a guaranteed income for life with the life annuity that you're purchasing.

It does have preferential tax treatment, again, because you are using a prescribed annuity. Thirdly, since you're purchasing a permanent life insurance policy, you do get immediate protection and the life insurance policy allows you to transfer wealth to the next generation on a tax efficient basis. And lastly, the other consideration is that assuming you name a beneficiary other than your estate, for example, you name your kids, it may potentially eliminate any type of estate administrative fee or probate tax on death depending on your province of residency. So that wraps up the discussion on the first strategy being the insured annuity strategy. So now maybe we'll just jump into the corporate insured annuity strategy. Now, the corporate insured annuity strategy, again, very similar to the insured annuity strategy, but it's done at the corporate level. So with this strategy, you use cashflow from a corporate owned life annuity to both supplement the shareholder's retirement income and pay the premium on a corporate owned life insurance policy.

And of course, the death benefit on this policy basically is intended to replace the funds that the corporation uses to purchase the annuity. So again, we'll look at this from perspective of while the shareholder is living and then at the death of the shareholder. So while the shareholder is living, the first step would be for the corporation to purchase a life annuity corporately. And of course, if the corporation has all of its funds invested in various investments, then there might have to be some type of liquidation of part or all of your investments. And just like at the individual example, you have to consider the tax implications to the corporation of disposing of those investments. And it's important for the client to seek their own tax advice to quantify these tax implications to the corporation. So once the corporation owns this life annuity on the shareholder's life, the corporation would use a portion of the annuity payment or the income stream from the corporate annuity to fund a corporate owned life insurance policy on the shareholder's life.

Again, the amount of coverage would be equal to the amount that the corporation used to purchase the annuity. And any remaining portion of an income stream from the annuity would first be used to pay any taxes that arise from the annuity stream. And then secondly, any remaining balance could be distributed to the shareholder to fund their retirement income. Of course, to distribute those funds out of the corporation to the shareholder, it would generally be a taxable distribution. Typically, you would do it as a taxable dividend because it has a more favorable tax result than a salary, for example. And as such, any remaining income stream could be distributed to the shareholder as a taxable dividend to supplement their retirement income. Now, as I mentioned earlier, the corporate annuity that is purchased under this strategy would be a non-prescribed annuity. So the annuity payments would still be a combination of tax-free and taxable interest.

However, the taxable interest component wouldn't be level like it is for prescribed annuities, but instead would accrue over the life of the contract. So it should also be noted that the taxable portion of the annuity is taxable in the corporation as passive income. And generally across Canada, passive income is taxed at roughly a 50% average tax rate tax rate. Now, upon death, the death benefit from the life insurance policy would be paid out to the corporation as the corporation is the owner and a beneficiary of the policy. Moreover, the death benefit payout would credit the corporation's capital dividend account. As we know, the capital dividend account on death is credited for an amount equal to the death benefit payout, less the adjusted cost basis of the policy. At this point in time, the corporation could distribute the death benefit payout to the estate or any surviving shareholder, and it would first exhaust any CDA balance to pay it out as a tax-free capital dividend.

And any remainder, to the extent there's not enough capital dividend account balance would come out as a taxable dividend to the shareholder. Now, one other benefit of this strategy that should be noted is that it may potentially minimize taxes on death for the shareholder. In particular, we know that on death you're deemed to dispose of your capital assets at fair market value, and one of those assets would include the shares of your corporation. Now, the fair market value of corporate shares is generally driven by the underlying fair market value of the assets within the corporation. Now, when it comes to a corporately owned life insurance policy on the shareholder's life, it's the policy's cash surrender value that is used for determining the fair market value of the deceased shares for tax purposes. And since we're talking typically about a life insurance product that is a minimum funded UL policy in order to minimize the premium for the strategy, typically these types of life insurance products would have a nominal amount of cash value as such, resulting in a nominal impact on share value at death.

Now, if we were to look at the corporate annuity, and assuming there is no guarantee period on the corporate annuity because again, we're trying to maximize the income stream from the annuity, it could be argued that for such an annuity with no guarantee period, that it would have nominal value at death. And as such would also contribute nominal value to the deceased shares at death. So in summary, the combination of both the annuity without guarantee and a life insurance policy, i.e, minimum funded UL, both contributed a nominal amount of to the shareholders' share value at death. This may provide substantial tax savings to the shareholder in comparison to other type of corporate investments that are held in the corporation. So that wraps up my summary of the corporate insured annuity strategy. Maybe at this point in time, I'll pass it back to Steven to talk a bit about the type of life insurance product that you would put in place for this type of strategy.

Sure, Marco. So again, we typically want to maximize the net cash flow from the strategy, which leads us to, again, typically using a minimum funded universal life policy with a level cost of insurance. But in the corporate context, it might also be worth looking at another type of UL policy that has an annually increase in cost of insurance, or also known as YRT type of cost of insurance with a level death benefit to possibly achieve a better CDA profile compared to the UL COI policy. So this type of annually increasing cost of insurance UL policy would have cash value though, unlike having a minimum funded UL COI policy. However, as if the life insured reaches their life expectancy, this amount of cash value in the policy would decline relatively quickly.

So just moving on to summarize the benefits of the corporate insured annuity strategy, well, again, the benefits are very similar to the personal version of the strategy. There's guaranteed income for life, the client gets insurance protection through the policy or state preservation depending on how you view it. Again, there's the CDA component to the strategy, to the corporate strategy, which really speaks to and highlights the tax efficiency of being able to get the corporate assets out of the corporation to the shareholder, even the estate, surviving spouse or heirs in a very tax efficient way. And then the reduction of share value, which can reduce the taxes at death compared to if the corporation held traditional types of corporate investments. And it's really important to underscore how, I guess, significant those two benefits are. So for example, if you have a corporation that has, I'll just pick a nice round number, a million dollars of GICs, if the shareholder passes away and with the corporation owning GICs of that amount, they might have a capital gains tax liability of approximately $250,000.

And then on top of that, there'll be a tax cost on getting those assets out of the corporation to a surviving spouse or surviving errors or the estate. But when you look at the strategy, just using the combination of the life insurance policy and the annuity, that tax bill can be reduced arguably to nil. And then there's the tax efficiency of getting the death benefit out of the corporation using the CDA. So that's very two powerful benefits with the corporate insured annuity strategy just like to underscore. And there are variations on the back-to-back strategy as well. So we talked about the personal insured annuity, we talked about the corporate insured annuity, but you can, I guess, slice and dice the insured annuity strategy differently. So for example, there is something called the hybrid insured annuity, and that's where the client say has personal non-registered assets and also investment assets in the corporation.

And they can do, I guess, a combination of the personal and the corporate insured annuity by using the personal non-registered money to purchase an annuity and get the benefits of the prescribed annuity. So just having that level tax taxable amount every year, and then using the corporate money to buy a corporate on life insurance policy to get the benefit of the CDA and reducing shared value as well. There's other types of variations of the strategy, which might involve using different types of insurance policies. Earlier, I mentioned using an annually increasing cost of insurance for the corporate version of the strategy. But you know, could also consider using a par policy with enhanced coverage option as the dividend option. And this can give some potential for liquidity to this strategy using the par policies, cash value.

And maybe after 20 years or so, depending on the type of policy structure and the performance of the policy, there may not be a contractual premium anymore after say 20 years. Or perhaps the policy has the potential to go offset, which would really enhance the net cash flow of the strategy because then there wouldn't be an insurance cost to the strategy. So definitely some different variations that you could do when you're looking at the strategy. Well, Marco, let's end it here, unless you have anything more you'd like to add.

No, I think that's a good summary, Steve. Thanks.

All right. So with that, we'll end it here. And I'd just like to remind everyone that this podcast and other tax and estate planning resources, including two articles on insured annuities, are on our tax and estate planning website at tepg.salesstrategies.ca. So once again, thanks everyone for listening and take care.

This material is for information purposes only and should not be construed as providing legal or tax advice. Reasonable efforts have been made to ensure its accuracy, but errors and omissions are possible. All comments related to taxation are general in nature and are based on current Canadian tax legislation and interpretations for Canadian residents, which is subject to change. For individual circumstances, consult with your legal or tax professional. This information is provided by the Canada Life Assurance Company and is current as of July 2023.

Steven McLeod: Hi, everyone. Welcome to another podcast from Canada Life's Tax and Estate Planning Group. I'm your host, Steven McLeod, Director in the Tax and Estate Planning Group. Now, we've done a handful of podcasts and they've typically have been on a technical issue that we cover and provide some insight where we can, but today, we'll do something different and speak to Ryan Fraser. He's a comprehensive financial planner and insurance advisor based out of London, Ontario, whose practice focus is in the charitable giving space, and he also only works with like-minded clients.

Ryan also led a national cross industry team that developed national guidelines on the gifting of life insurance to charitable organizations in response to regulatory issues raised in BC in 2019. Ryan also has a book titled Driven by Purpose, which we'll talk about throughout this podcast as well. Ryan, welcome and thank you so much for joining me today.

Ryan Fraser: Thanks, Steven. It's great to be here. Thanks for having me.

Steven McLeod: Now before we get started, I would love it if you could tell me and our audience about you, your background and how your practice evolved into one that focuses on having charitable giving as part of a client's financial and estate plan.

Ryan Fraser: I always chuckle at that question because I fell into this area of practice accidentally, and one of the things I've learned over the years is almost everyone does. So many years ago before I became an advisor, I was working in the arts sector. I was teaching music for two different universities, and like many musicians in the 1990s who were making a full-time living at it, I think I worked seven gigs simultaneously, and one of them was actually as executive director for a small performing arts organization here in London, and that was really my first intro to the charitable side of things because I was essentially responsible for running a small charity.

It was an interesting time in the arts here in Ontario and in education in the late 1990s. The Harris government at the time, I'll just say was a little bit unfriendly to both, and our little arts organization ended up going under because it lost about 70% of its funding on two months notice, which made it really difficult to try and replace.

At the time, my wife was an elementary school teacher. I was teaching at university, I was running these arts organizations, and so I ended up retraining as a financial planner because it was one of the few industries that you could go into that having a diverse and unique background was an asset and not maybe a liability. I started my career, was very fortunate to have worked with a couple of amazing CFPs. I like to say I learned at their knee, as well as one of my earliest people who trained me is Candle Life's own, Lynn McMillan, our insurance wholesaler here in Southwestern Ontario and we were both at a different company at the time. So I had a really solid foundation.

Parallel to that going on, I had been suckered into start to put together a museum from scratch because of my background in the nonprofit world, and then the love of history, and we actually founded a place called the Secrets of Radar Museum, which is still running here in London, Ontario, just outside of the airport 20 some years later.

Really amazing experience to start a charity from a scratch just as 9/11 was happening. In fact, we filed our charitable registration papers the day before 9/11. So if you can imagine a military history themed museum as 9/11 just happened was a very interesting time to start a charity, but it was amazing experience.

So my earliest days as a financial planner were spent half in the charity world and half in the advisor world, and it was a terrific experience on both sides. Eventually, I went into management for the old London Life and spent about 10, 12 years there and a few years before that with another insurance company, and in 2016 decided to leave management to go back into my personal practice because I realized I was really enjoying working with people who had charitable interest in their financial and estate plans.

Along the way became very involved in a wonderful organization called Canadian Association of Gift Planners that was designed to bring together representatives from charity, financial insurance, accounting advisors, lawyers, and others with an interest in the sector and been deeply involved in that ever since.

Steven McLeod: Okay. So I'm glad you brought up the CAGP. So hopefully we'll talk a little bit about that later on. So you have quite a diverse background. After reading your book, I mean, you mentioned that you're a musician, but you're also an amateur astronomer, an outdoorsman, and a bird and wildlife photographer as well.

Ryan Fraser: Yeah, I have a really hard time fitting into a box. If underwriting was based on your life interests, I think I'd be an underwriting nightmare, for sure.

Steven McLeod: Right. So let's talk a little bit about charitable giving in your practice. So I assume at some point you had to motivate your clients into charitable giving and perhaps you still do. So how do you talk to or motivate a client about getting into charitable giving?

Ryan Fraser: Yeah, that's a great question, Steven. One of the things that I've learned is that you can divide people up into different groups, and I think this is true of advisors as well. There's a large number of clients that you're going to deal with that have little to no interest in charitable giving and probably never will. There's a portion of people who would be very interested but maybe need some handholding, some encouragement, some education to bring them along that path.

Then of course, there's a group of people who were into it right from the beginning, and I've been very fortunate in that the way my practice has developed, we've positioned ourselves for those people in that last group to really hunt us down and find us, and that's taken us probably 10 to 15 years of work and being involved in the sector, but there still is that component of people who are interested but maybe don't know enough, a little bit cautious, and those are the ones where we have to motivate and lead along, but a lot of that is really education.

I find one of the best ways to do that is to convince the client to get their hands dirty as a volunteer, to check out some of the behind the scenes tours that they might be able to get, to meet with people who are fundraisers at the organization or other stakeholders, and I find that really helps people get engaged.

Steven McLeod: Okay, and there are obviously tax benefits to giving to charity. For example, individuals get the donation tax credit, corporations get a tax deduction. So how much focus do you need to place on these benefits before getting a client to act? I'm wondering if you have any insight on the motivating factors for both the active giving and the amount of the gift. So put another way, is it mostly altruism and that's where you focus your discussion about the client or is it a balance between altruism and discussing the tax benefits that they might receive during their lifetime and on death?

Ryan Fraser: Yeah, great question. This is one I'm going to apologize in advance knowing you work for TEPG. So here's one of the big disconnects, and this is a disconnect that's been proved by a lot of research. There's a study done called 30 Years of Giving in Canada by Rideau Hall and Imagine Canada, and this one was done I think about 10 years ago. It was one of the first pieces of empirical research that really opened our eyes to the fact that advisors' discussions and clients' interest are sometimes really different.

So when they asked people, "Why do you give to charity?" it turns out that tax credits were the absolute bottom of the list. So I've actually got the study open here in front of me and it's really fascinating because it does vary a little bit by age, but only once we get to the tax credit part.

So it turns out the number one thing which was well into the mid 90% response is people had compassion towards those in need. The second most prominent reason for giving was personal belief in the cause, which hovers around 85% to 89%. Contribution back to one's community ranged from about 76%, and some older clients to 83%, and some younger clients having had something that personally affected you was around the 65% to 70% range. Being asked by a family member or friend, neighbor or colleague might be 30 to 50%. So I mean, think of that as somebody going, "Hey, I'm fundraising, would you buy this ticket? Would you do this? Would you donate?"

Religious obligations are very important for between about 30% and 50% of the population with the 30% being people younger than 65, the closer to 50% being those 75 plus, and at the very bottom of the list below all of that was tax credits. So for people under 65, only 23% of people said they actually cared about that. Between 65 and 75 in age, about a third of people, and 75 plus about 40% of people.

I think that's really stunning because as advisors, we're thinking about these things. We're making recommendations on them. So what I'd like to say is this. If you're just talking about tax credits, probably nobody's going to make a gift, and if they're doing it, it's probably not for the right reasons, but if somebody is charitable, if somebody wants to give something back or personal belief or compassion need, which is a huge percentage of why people give, then talking to them about tax credits will often change the timing and the method in which they give and can be very, very important to them and often allow them to give substantially more than they originally thought if you can show them what those savings are.

That is something that I think advisors really miss out on, and there's another study that Canadian Association of Gift Planners was part of a few years ago that looked at polling high net worth clients and financial advisors about how they each thought certain things were important. There were massive disconnects there that showed that advisors were often talking about the tax credit and thought that that was the primary motivator, and yet it turned out, again, only 25% or 30% of H ultra high net worth respondees said that was their motivator for giving.

So I think we need as an industry to wake up to the fact that when we have these conversations, it has to be around why somebody is giving and why they want to give first and the tax credits need to come second to encourage them to give more or give more efficiently or effectively.

Steven McLeod: Okay. That's really interesting. So tax credits are more about, say, structure around the gift, not so much the motivating factor or perhaps affecting the amount, but it sounds like it's more of structuring consideration than anything else.

Ryan Fraser: Absolutely, and I think where this is most reflective is 10, 15 years ago, there were a pile of tax scams dreamed up so that people could donate a small amount and then in reality claim a tax credit that's 10 or 15 times the amount, and there were a lot of repercussions. CRA really clamped down on that. We still see these things coming up and it's a big concern to those of us who spend a lot of time in this sector because it leaves a bad taste in everybody's mouths, and those gifts are not truly philanthropic in nature, right? That's about somebody trying to win on their taxes.

That has to be a red flag for the advisor and the client in a situation where the tax benefit is substantially beyond the actual amount that's ending up in charity. In fact, it has and will and can get charities to lose their charitable registration. So somebody who does one of those schemes is actually putting entire organization at risk as well as the person that they convinced to go along with it.

Steven McLeod: Right, and those schemes, just for the honesty sake, are I guess would be the art donations was the big one and software donation too I think were big ones.

Ryan Fraser: Yeah, and it's had repercussions out for things like gifts of life insurance. So the same clause that deals with fair market valuations and adjusted cost bases to try and deal with some of these scams and shut them down, unfortunately has caused some really interesting rules around the gifts of life insurance to charity. So you have to be very careful if you have a policy. Normally, we can do something called a fair market valuation. I know many of your listeners would be familiar with. That can't happen under certain circumstances depending on the age of the policy and whether or not the policy was originally intended to be donated to charity.

Steven McLeod: Right. Three years if you intended to donate, then it's cost base or, sorry.

Ryan Fraser: 10 years.

Steven McLeod: Three years from purchase is cost base or 10 years if you intended to donate looking at-

Ryan Fraser: Yeah, and it's tricky too because CRA's position is still somewhat unclear on things like client had a term policy, they converted to a permanent policy and then donate it. Well, is the acquisition date under the ITA the original purchase date of the term policy or is it the new date?

Steven McLeod: Right. So I'm going to get back to your book now. Now, you have a chapter in there that highlights a finding that there's a correlation between clients who give to charity while growing their net worth really well in relative terms compared to the rest of population. So what do you think accounts for that correlation, and is it not the case that these are just wealthy people who have more money than they need and therefore they can give more and presumably save more as well?

Ryan Fraser: Yeah. That's a study that came out of Dr. Russell James from Texas Tech University, and Dr. James is one of the few people in the world who actually do hardcore research on charitable giving and estate planning and financial decision making. Much of his research outside of this particular study actually puts people in functional MRI machines and looks at how the brain is making decisions in terms of gifting, which is a whole other fascinating discussion, but that particular study was interesting because they actually controlled for the levels of wealth and a number of other factors.

So what was fascinating about the finding is it's not just people getting richer because they've already got assets. It turned out that people of more modest means who were giving ended up better than their peers. My feeling on this, Russ' study was, I'll call it scientifically worded to not jump to conclusions, but my particular feeling from working in the space for a long time is people who give away money tend to be a certain personality and tend to have a certain outlook on life that is generally quite positive.

They're not miserable human beings, and so I think without trying to sound new age or hippie-ish here, but sometimes if you flow good intent out, good intent flows back. The example I used in the book is if you had a choice of doing business with a business owner who is giving back to the community and involved in philanthropic versus one that you know is greedy and going to nickel and dime, who are you going to choose to put your business with?

Well, for most people, that answer's pretty obvious, and I think that's part of the impact, but I also think that people who are community-focused end up wealthier because business flows back. I think that's a large part of what's going on there in that study. I think there's a little bit more to it as well that we can't quite define yet because the research isn't there, but I think that's a really good life lesson for all of us.

If we only think about ourselves, at some point we can only grow so wealthy, but if we start thinking about other people, the goodwill that is gained from that comes back to enrich us I've often said five times or 10 times more than what we gave away. I think that's a great lesson for every financial advisor of every kind to remember in our own practices.

Steven McLeod: Right, and they might be more inclined just to be savers as well, I assume, because they need something to give, obviously.

Ryan Fraser: Yeah. Our client base is, if I could put one title in all of them, they're chronic savers. Everybody in our industry focuses on high net worth and business owner and high-end professional doctors, whatever, but there's an entire marketplace of people with very few gatekeepers whose, if you go back to the Thomas Stanley book from 20 years ago, The Millionaire Next Door, their basic formula in life is they saved as much as they could and kept their spending down. At some point, thanks to compound interest and time value of money, wake up in their mid to later years going, "Geez, I'm fairly well off."

I really love working with those clients. I like to say that the clients that I love, they want to keep people's lights on. They don't want their name in the lights. For me, that's where our practice is focused and it's just a joy to work. They're just lovely, lovely human beings, every single person we work with.

There isn't anyone in our practice that we dread get in the phone call or the interaction with. It's just we have a genuine love of everyone we're working with, and that's just a remarkable and special place to be as an advisor.

Steven McLeod: So let's bring life insurance into the discussion now. So I know from your book, life insurance has a role in your practice for facilitating charitable giving. Could you tell us how you talk to clients about charitable giving using life insurance, and what's your go-to strategy or strategies when implementing a charitable plan for clients? So are these policies, are they charity owned, are they owned by the clients that have the charity as a beneficiary? What's your, I guess, preferred strategy or is it just completely fact dependent?

Ryan Fraser: I like to say we're agnostic as a financial planning organization. So going into engagement with a client, we really don't know what the answer is going to be. We start differently than most financial planners and that there's a number of values, exercises, and discussions around philanthropy and wealth and giving, and that comes from my teaching days. I was doing a lot of cognitive psychology work and I've carried that over to the financial practice. So we get a good handle on what the client's needs and wants and values and intents are, and we use that to drive the planning process.

That said, in the last five to 10 years, we have much more frequently been suggesting to clients the use of life insurance in particular, in fact, anything with a name beneficiary. So as I know many of your listeners are aware of back, and I forget the exact year, 2014, 2015, CRA switched over to the concept of graduated rate estates. When GREs came out, it was great initially for charities because they loosened up a lot of the rules that led us use charitable tax receipts at death, and that could be a whole hour long podcast on that. I won't get into the technical side, but one of the criteria came out originally was that in order to use a charitable receipt in the year of death or being able to carry back, the money had to make it to the charity within a 36-month window as indicated by the will or the beneficiary designation that you weren't allowed to substitute assets.

That change had some interesting repercussions. First of all, 36 months seems like a lot, but for more complicated estates, that was going to be a big problem in CAGP and CALU and a few others advocated very strongly to extend that. So now, it's been moved out to 60 months, thankfully, but even then on higher net worth estates may or may not be enough time. So if you were going to donate an asset from the estate, you have to liquidate it and then get the money over to charity and you got to wait to get your clearance certificates and everything else, and that takes time.

The other thing that started happening is if people left residual requests and their will for percentage of their assets. Under the old rules, the estate trustee or executor could file the tax return right away just making the assumption that was there. Under the new ones, you can't do that till it's actually dispersed.

Well, if you leave 20% of your estate to charity, might take you through four years to get everything settled out, and let's say you had a million dollar estate, 200,000 goes to charity. Charity issues a taxable receipt. In Ontario, that would save you about a hundred thousand dollars. Well, now, there's a hundred thousand dollars to distribute of which another 20,000 goes to charity. Charity issues a taxable receipt, saves you about 10,000. Now, there's 10,000. So we get into these loops and they're ugly, they're time consuming, and they become costly, and you might go three, four, five, six times till it's not worth it anymore.

So if you have something like life insurance with a designation where you put the charity as the beneficiary, for the most part, any life insurance policy, it's hard to conceive of a situation other than a suspicious death or a very recent policy where investigation is needed, where the money wouldn't get to charity within a matter of, say, three or four weeks. So that means that we can guarantee the charitable tax receipt is there right away, provided that that's a situation where the donor owned the policy and named the charity as a beneficiary.

So we have been encouraging clients for the last five, six years to make their gifts as much in that way as we can. So the two areas that's impact is anything which falls under life insurance, so insurance version of GIC is segregated funds, traditional life insurance, annuity beneficiaries. All that has those benefits that isn't available anywhere else to ensure it's going to get there. The only other spot where that works is to make someone the beneficiary of a TFSA or an RSP, but those are usually going to be declining balances in our later years. So leaning towards insurance, if it's appropriate to the situation and cost effective, that's great.

Now, the other way, of course, that we can give to charity is that we can donate a policy to charity in our lifetime or right from the get-go, in which case the client receives the tax receipt immediately and no tax receipt at death, but the charity, of course, receives the proceeds at death. That can be very effective in a number of ways. First of all, if you have a policy with low cash value that's been around a long time, it might qualify for fair market valuation, and the value of those gifts could be tremendous relative to just letting a policy lapse, for example.

So that could be where we would make some recommendations going, "Hey, you've got this asset. Maybe you don't need the insurance anymore for your own estate purposes. Let's talk about donating that to charity," or, of course, we could set up a brand new one with charity, and all of those work depending on the circumstances. So it really comes down to what's the overall situation of the client and then what method if we decide insurance is viable do we want to go with.

Steven McLeod: I really like how you painted that picture of an estate basically having certainty when using life insurance to donate because once the charity gets the death benefit, it's done. You don't get into a circular issue, where if the will does, say, a charity gets the residual or the 20% of whatever's left in the estate, then you get into that circular problem. Actually, I've never appreciated that practical problem. So I guess that's another benefit of using life insurance is just to get the gift done with and then you can deal with the rest of the estate.

Ryan Fraser: The key thing that's really important for people to remember is that if we're gifting a policy to the charity in our lifetimes, the right structure for the client may be very different than the right structure for the charity. You have to remember that the charity becomes the client, and so it is vitally important that if we're suggesting this to a client, that we structure a charitable gift of life insurance properly. If your client owns the policy and is just sending the death proceeds over, it doesn't really matter from the charity's point of view how it's structured, whatever. They just care about the money's going to show at the end and they can issue a receipt. It's simple.

Where our industry needs to do better is on the donation of a policy to charity in the client's lifetime. So just before the pandemic hit, there was a big kerfuffle out of BC where the BC regulator identified some issues around gifts of policies that got into regulatory areas around stranger own life insurance and viatical settlements. The initial response from the regulator basically shut down all gifts of life insurance by BC residents or BC charities, and it was quite traumatic to the industry.

The regulator stepped back from that position, thankfully bit, and that actually, I'll just give a shout out, very thankful to some of the work done by Canada Life, particularly Jeff Kitchen, the Regulatory Affairs VP, who I reached out to raise the issue and the insurers were pretty good at helping us work through that, but one of the recommendations that came out of that is that the industry should develop best practice guidelines.

So my pandemic project in those early months was working with a cross Canada group and cross-industry group from representatives from a number of insurers, as well as charities, lawyers who specialize in charitable area, and a number of insurance advisors. So through the Canadian Association of Gift Planners now, we have an amazing set of documents that came out of our working group to give guidelines to advisors, to charities, to donors, and to insurers on the right way to do gifts of insurance to charity.

I would say it's probably one of the things I'm most proud of in my entire career. I feel like we've made a really significant impact, and I know a number of charities have adopted those guidelines. A number of insurers now are looking at those guidelines and using them, and I think it's going to make a really significant impact going forward. You can get those through the Canadian Association of Gift Planners websites. It's publicly available resource.

I think if you are going to make a recommendation to donate a policy to charity going forward, many of the charities in Canada now will ask that the advisor review those guidelines and review the package that's there. So it's a pretty amazing impact, and I will say that that whole process started with a call that I made to Jeff Macoun who introduced me to Jeff Kitchen, who then opened up the doors to some other people in the industry. So huge kudos there to Canada Life for helping to get that project started, and together, we've made a really significant impact on the sector.

Steven McLeod: Yeah. Kudos to you too for doing what you do for the charitable industry. Sounds like a very valuable contribution. So getting back to life insurance, I'm curious how you illustrate life insurance for a client, if you're showing them about buying, I guess, a new policy to use for charitable giving. Are you a spreadsheet guy or do you just speak to clients on a more conceptual basis?

Ryan Fraser: Yeah. I personally am a big spreadsheet guy. One of my life lessons early on in this business is most of my clients are not. Some of them are, but most of them are not. So I am using the spreadsheets. I've used a number of different planning tools. On the charitable planting side right now, my go-to is Snap Projections, which is spreadsheet based, and they've done a really good job of integrating life insurance for charitable giving purposes, but I'm not beholden to any one particular planning software because they all leapfrog each other at different times, so I've used pretty much all of them.

From the client's point of view, when we're doing our planning work, what we try to do as a narrative, so I find that 85%, 90% of clients, spreadsheets don't tell them what they need. Instead, what we need to be doing is telling the story of why we're making this recommendation.

So we've done the spreadsheets and we tell them we have the spreadsheets and they're welcome to see how the math works out, and we'll often pull bits and pieces like what's the internal rate of return like on this. So we've had to developed a few things where the white label software packages don't necessarily give all the details we want, but what I've learned as most important is to talk about why we're making the recommendation, what is the impact, what does it ensure that we do, and a lot of that actually now is talking about the graduated rate of estates because we find a lot of the people we work with have recently been an executor maybe for their parents, maybe for a friend, maybe for their spouse.

If we're making insurance recommendation, the number one selling feature is often, "Look, the charitable tax receipt can be gotten right away if we're using insurance versus waiting around going through the process, dealing with the GRE issues, having some of those risks." One of our largest clients right now, that was the case. There's a huge problem liquidity in their estate. Unfortunately, the way that their lawyer worded the charitable gifts, because there was a spousal trust, none of the gifts to charity were eligible for tax receipt.

For the moment, we're triaging that with a 15 million dollar insurance policy that will ensure liquidity is there, the gift will go to charity, and that will reduce here in Ontario about seven and a half million dollars of taxes on the estate to make sure that the estate stays liquid. Very elegant solution for this particular individual.

The discussion really wasn't on the numbers per se, it was really on the, "Oh, my goodness, we've just discovered this disaster because of how the will is worded combined with what the charitable giving rules are that was missed by the lawyer who had done the will 10 years ago," and now we've got them going back to another lawyer who's a little bit more versed to be able to fix this problem and insurance will continue to be a component, but it's allowed us to stop gap a very complex estate for a two or three year-period until the client is rewriting the will.

Now that we have the insurance, there's lots of ways that we can use that in his corporation, outside of his corporation, all kinds of different ways that we can use it. So the flexibility of the insurance here is really key.

Steven McLeod: Yeah, that's a great story. It really underscores that charitable giving isn't necessarily a slam dunk when you're trying to achieve tax savings in someone's estate plan. The structuring is so important. I remember last year or maybe it was a couple years ago, I did an article on how to do charitable giving when you have corporate on life insurance and just paying a dividend from the corporation up to the estate doesn't actually allow the estate to .... Sorry. If the estate gave the gift at that level, it doesn't actually allow the estate to apply the charitable tax credit back to the charitable return. So it's very technical and it's very tricky and it's definitely a place where you want to get your people who are very experienced and have technical knowledge in this involved.

Ryan Fraser: Oh, yeah, and it's crazy. I moderated a Canada-wide webinar last January with CALU and with a lawyer from BC who was part of the original BC kerfuffle that we talked about. There was this case, I think it was the Odette case, that came up with massive charitable gift, and because things weren't done properly on a technical level, it couldn't be used. So it is real important, and I can't emphasize this enough. If you're hearing this podcast and you're like, "Wow, I'd like to be in that space," you're going to need to learn a lot and you're going to need to make sure that you get yourself in contact with, if you've got access to great people at TEPG, the Canada Life, you want to make sure you have people who understand the technical side of it and that you don't just think you can dabble in this without getting a good solid education.

Find the people who know the space, who understand what's going on, who understand both the technical but also the charity side of things. A great resource for that, I was a faculty member for an industry designation called the MFA-P, Master Financial Advisor Philanthropy designation. There was a joint effort between CAGP, Spire Philanthropy, and the Knowledge Bureau, and that is a great starting spot if you want to learn how charities operate, how they think, how they learn, and get some basic education. As well, Canadian Association of Gift Planners has all kinds of educational content and resources available. It's incredible organization to become a member of, but there's a gift planning fundamentals course specifically for advisors now that our Vice President of Education, Paul Nazareth, delivers and does an amazing job. Those are the things and places to go if you're interested in this, to learn more, and to make sure that you're lifting everyone as opposed to maybe inadvertently doing something that could be damaging to you, your client or a charity.

Steven McLeod: Okay, that's great advice. So all those resources are on the CAGP website, I assume.

Ryan Fraser: Yes, they are. Another website to check out is willpower.ca. This is a national initiative by CAGP to encourage Canadians to give more. If you're a CAGP member, you're automatically included on that. You can have an advisor page. They have a Find An Advisor section, Find An Estate Lawyer, and a ton of resources. Those resources are free to anyone across Canada. So even if you're not part of CAGP but you want to send your client to a good source to see some information, there's some estate calculators, there's some information videos, different things that are part of it. It also help connect them to different charities across the country as well.

Steven McLeod: Okay. So here's my last question about life insurance for you, Ryan. I'm just curious if you had any insight on whether charities even like life insurance as a funding source. I know you said earlier that all charities like being, say, a beneficiary of a death benefit. They just receive the cash on death of the life insured, but how in terms of owning a policy?

Ryan Fraser: Yeah. So I would say that's a love-hate relationship. Every charity will be happy to accept a gift of life insurance. Can be hugely beneficial for them, but historically, charities have not always had a great experience with our industry and gifts of insurance for a couple of reasons. Commonly what I see most often, and we actually have a service where we'll go into a charity and audit their life insurance program to see the existing policies that they own, and we've seen lots of things.

So for example, a term to 100 policy seems like a great idea for a donor, for a charitable gift, fixed costs. We're not caring about cash value because the charity's going to get death benefit, but if that donor was 40, that could be a 60-year payment window, and if the donor disappears in their mid 70s, there's no cash value, there's no safety net in that policy, for example, for charity.

We run into things where policies were on premium vacation. Interest rates dropped way down for a long time up until the last few months. Some of those are no longer sustainable. Now, they have to go back to a donor who's maybe 80, who started this policy when they were 40 and say, "Hey, we have to get some money to pay this again." So those are the kinds of things that drive charities nuts.

That's where going back to our recommendations, our guidelines that were created, in those guidelines, we've tried to give advisors descriptions of types of policy structures that are going to make a charity very happy to accept and will minimize the future risk. So for example, in there we recommend limited pay policies quite strongly, particularly the younger the donor is. We recommend policies that can have a cash value as an exit plan. So you'll be able to see through there the suggestions and guidelines. So the idea here is that going forward, we want to remove those headaches.

The other thing that I'm really happy to see since we've come up with the guidelines, because we had a section there for insurers, we will talk to the insurers that were at the table for the development of those guidelines about some of the pain points the charities had behind the scenes, the after sales and service. So a common example we'd run into is a large charity like, say, a hospital foundation or a university will have somebody in their structure who's authorized to talk to the insurance company, but when they call into a call center, the call center say, "Oh, we have to speak to your president or your chief financial officer," which in the context of a small business makes sense, but in the context of a charity, that person could be 17 layers removed with no idea what they'd be talking about. So are we going to have them on a call center call?

So I've been really impressed to see with some of the work in the background from the insurers like Candle Life who were part of that project with us looking at the backend and trying to make that much easier for charity. So that's a huge win I think that's coming forward. So I think what we'll see is between the GRE changes that we've been talking about, putting more emphasis on insurance with our new guidelines to help make sure that things work smoothly for everyone, and new products that are being developed across the industry now in response to that. I think we're going into what I hope will be a golden age for charities where they'll be super happy to accept a gift of insurance

Steven McLeod: Right, and as Canada Life, as we've launched a new participating life insurance product that's designed to minimize some of those pain points, that's very encouraging to hear. So maybe getting into the last question here. I've referenced your book, Driven by Purpose. a few times. Do you think this would be helpful for advisors to read because I know it's written more for the client point of view? So do you think it would be helpful for advisors to read, and if so, where can they buy that book?

Ryan Fraser: Yeah, absolutely. The book is available as an ebook on all major ebook platforms, Amazon, Kobo. You name it, it's there. It's also available in hard copy through Amazon, but I would suggest that you go through the book's website, www.drivenbypurpose.ca. You'll get a better quality and probably shipped out to you faster than Amazon in our experience. The book was designed, you're right, mainly for the end user, the potential donor.

So what we have done with the book is it's been designed to be an easy pickup, put down read for those folks. So we've had a number of advisors purchase the books for their client as a way to start the conversation. Not every chapter is about charitable giving, but it's woven throughout. We find if we hit people over the head with they hammer a little too much, they stop paying attention, but it's a general book on financial and estate and charitable planning and how it can all be integrated. It's drawn over real life scenarios and it's done in a storytelling format. Most chapters are only at most four or five pages long.

We also have sold a huge number of copies to charities who will hand them out as donor gifts or if they have a donor who's thinking about it. What's been really cool is we get the feedback of finding out, "Oh, well this motivated somebody to turn around and make this gift."

So the other thing that we'll do with it as well is we'll do webinars and presentations around the book as client events, donor events, things along those lines. The idea is to get people thinking and talking, but also not getting bogged down in the technical and the tax side, which we do talk about, but more on the human interest side and what's the impact that it's made, and to get people to understand the full range of things you can do.

I always like to say, when it comes to charitable giving, there are hundreds and hundreds of ways that you can make a gift, but we want to give people some tangible examples and enough examples whether they'll see something that'll resonate with them, whereas if we just chose one or two things and one do it, but with a book with 32 short stories, it's a very different kind of conversation.

I think where we're really proud, Karen Miller, who's the publisher of the book who worked on a lot of the Daryl Diamond retirement books, she's just a legend in the industry and we're so happy with how the book has been received and then getting these stories back of how it's motivated people to actually take action.

Steven McLeod: On that note, we'll wrap up. So thank you, Ryan, again for joining me today and sharing your experience and insights. I'll give you the last word if you want to share with the audience any last thoughts or parting words.

Ryan Fraser: Well, I just want to say thank you for taking the time to listen to me ramble on today. I hope everyone has gotten something out of it. If I can leave you with one really important thought, if you're interested in this space, look up CAGP. The website address is cagp-acpdp.org. We're a national organizations, so it's our name in French and in English on both sides, but Canadian Association of Gift Planners. There's so many resources there. It is an amazing group of collegial professionals.

If you want to be serious in this space, you must, must, must become a member, and with it, your life will be enriched professionally and personally way working with these different charitable people across the country, both in our own professions but in related professions and within the charitable sector.

I know for me, I've been involved in almost 20 years. I'm currently chair of the education committee. I cannot tell you what a profound impact that organization has had on me professionally within my practice, but also in bringing deep meaning to the work that we do every day. So if you get one thing from here, please reach out and become one of our colleagues and you'll just find it's a great opportunity to stuff your mind and empower yourself in this space.

Steven McLeod: Thank you, Ryan, and with that, we'll wrap up and I'll just remind everyone, so this podcast and other tax and estate planning related resources, including articles are on our tax and state planning website at tepg.salesstrategies.ca. I should also mention that we also have a updated charitable giving tool on Concourse. So you can bring in insurance illustrations and being able to illustrate them as a charity owned policy or as a policy that's owned individually that uses the death benefit for the donation. Once again, we've also launched a new participating life insurance policy that is really designed for the charitable giving industry, and that's definitely something that we'd like to highlight as well. So once again, thanks everyone for listening and take care.

Speaker 3: This material is for information purposes only and should not be construed as providing legal or tax advice. Reasonable efforts have been made to ensure its accuracy, but errors and omissions are possible. All comments related to taxation are general in nature and are based on current Canadian tax legislation and interpretations for Canadian residents, which is subject to change. For individual circumstances, consult with your legal or tax professional. This information is provided by the Canada Life Assurance Company and is current as of March 2023.

Steven McLeod:

Hi, everyone. I'm Steven McLeod and welcome to another podcast from Canada Life's Tax and Estate Planning Group. I'm here with my colleague and co-host Marco D'Aversa, who's joining us over the phone. Hi, Marco, how are you doing?

Marco D'Aversa:

I'm doing very well, Steven. How are you?

Steven McLeod:

Excellent, thank you. Today we're going to discuss a popular topic in the world of leveraging and corporate owned life insurance, and that's the differences between taking a collateral loan personally or having the corporate policyowner take the loan and then paying the loan proceeds out to the shareholder as a dividend. I think most of our listeners probably know that if a loan just goes to the shareholder, it's received tax free, and if it goes to the corporation, well it's received tax-free by the corporation as well, but then the corporation has to pay that out as a dividend and that dividend is taxable. So depending on the shareholder’s marginal tax rate, there could be a tax cost of around 45% on that dividend. So that's basically taken off the amount in the shareholder's hands. So the loan to shareholder is an attractive option from that pure after tax income perspective.

But there are a lot of tax issues involved with shareholder borrowing, and I think what we'll show you today is that there are a number of tax benefits or benefits from a tax perspective of having that loan go to the corporation and then paid out as a dividend. Now, I also want to stress that we're only talking about the tax issues in this podcast today. We're not going to talk about the financial issues and financial risks associated with collateral loans because indeed collateral loans do involve risk. They involve using a life insurance policy as security. So the policy's at risk, the interest rates on collateral loans are variable. So as interest rates go up, the caring costs on these loans go up as well.

Collateral loans are not guaranteed, so their availability is not guaranteed. There are several insurance lenders in the market right now, but 20 years down the road. We certainly don't know what that looks like. So a clients should definitely not buy a life insurance policy just for the sole reason of getting a collateral loan sometime in the future. And while we're talking about considerations, I should also mention that Canada Life does not provide tax, legal or accounting advice, and this content is intended for discussion purposes only. So Marco, with that, let's get discussing the topic at hand. Taxable benefits, taxable shareholder benefits are a big issue with loans to shareholders. So could you start us off with this topic and then we'll go from there?

Marco D'Aversa:

Yeah. Thank you, Steven. As you alluded to, whenever you have a corporate owned policy and you assigned it to a lender for security for a loan, the loan can be made directly to the corporation or directly to the shareholder. Now, when the loan is made directly to the shareholder, there are additional tax risks and considerations that need to be addressed, two of which are: 1) the guarantee fee issue, and, 2) the loan repayment at death. Now, both of these tax risks could lead to taxable shareholder benefit unless proper structuring of the loan arrangement is done in advance of putting it in place. So we'll discuss both of these risks in the podcast, but let's first talk a bit about guarantee fees. Now, whenever you use a corporate asset, for example, a corporate policy for personal purposes, for example, to secure a personal loan, this may result in a taxable shareholder benefit.

That said, CRA has stated in the past that in the situation where the shareholder pays a reasonable fee to the corporation as consideration for the granting of the guarantee, the guarantee would not in and itself give rise to the benefit. So as such, it is the general view that as long as you pay a reasonable guarantee fee annually to the corporation for the personal use of that corporate asset, that will minimize this taxable shareholder benefit risk. Now, generally the fee is calculated as a small percentage of the outstanding loan balance. So what that means is that the guarantee fee starts off as a low amount because the loan is initially small, but it could become significant in later years as the loan balance increases. So for example, this particularly would be the case if you're capitalizing interest in your situation, the loan balance would grow significantly and it could result in a significant guarantee fee down the road.

What that means is that you also have to assess the shareholder's ability to pay this guarantee fee down the road when that loan balance becomes a significant in later years. Now, in practice, I've seen annual guarantee fees range from one to 2% of the outstanding loan balance. However, the method of determining the annual guarantee fee is not really well established, and as such, it is very important that the client work closely with their own tax professional to establish a reasonable fee based on their particular situation. So Steven, that's all I really have to say in respect to guarantee fees. I'm not sure if you have anything else to add, but if not, maybe I'll pass it back to you to talk a bit about the Golini case, I believe.

Steven McLeod:

Yeah, no, I'll certainly get to the Golini case. I just maybe would add one thing about the guarantee fees. When the shareholder pays them to the corporation, it's actually income to the corporation too, and it's treated as passive income in the corporation. And I think, passive income in a corporation is taxed at a high rate, so approximately 50% in most provinces. So there's that. And then when you talk about how much a guarantee fee should be, like I know you can hire actuaries that will do a detailed analysis on what a guarantee fee should be. I've also heard that looking at a bank letter credit is a good kind of a guide post on what the amount of a guarantee fee should be. And I think the type of letter credit that you'd be looking at is a standby letter credit from a bank. And I did a little bit of research this morning before the podcast, so I know they're around two and a half percent these days. So that's kind of a bit of an indication on what a guarantee fee could be. Yeah, so those are kind of the two cents that add to that.

But like you said, moving on to the Golini case, that is a case that I would say that adds some uncertainty to the arrangement of shareholder benefits. So Marco talked about paying a guarantee fee to the corporation to deal with the possibility of a taxable shareholder benefit. But this Golini case, it's kind of interesting in that it casts a little bit of a doubt on whether or not a guarantee fee is kind of the silver bullet for dealing with the taxable shareholder benefit issue. In the Golini case, it's from 2016, it's a tax court to Canada case. It's facts, I'll kind of go through them quickly, but they're a bit dissimilar to what we are talking about today, but in the same breath, they're kind of similar as well.

So basically what we have is the taxpayer, Golini, has a holding company that’s incorporated in Canada, and this holding company gets a si$6M loan from an offshore lender. Takes this $6M, buys an annuity from an offshore insurer, uses the income stream from the annuity to buy a life insurance policy, also from an offshore insurer. So the taxpayer’s holding company here that's buying these insurance products, it assigns those, the annuity and life insurance policy to a Canadian lender, not a commercial lender, but let's just call it CanCo, a Canadian lender. And the Canadian lender extends a $6M loan to the taxpayer personally, and then the taxpayer sends that $6M back into his holding company and the holding company pays off the loan to the offshore lender. So we basically have money going in a circle, and at the end of the day, what we have then is a loan outstanding to the shareholder from this CanCo.

The loan is a limited recourse loan. So basically that means if the security given for the loan is bad, the lender cannot go after the borrower personally for it. So its only recourse is the annuity and the life insurance policy. And also what we have is a receivable. So when the shareholder taxpayer put that $6M into his company, he established a mechanism that where he could take $6M out tax free whenever that company has $6M to give out. So the tax court found that there was a shareholder benefit. Just to kind of say it mildly, the whole arrangement kind of smelled. So basically, I mean, this is kind of your classic series of transactions where steps two through eight would not happen if step one did not happen.

The tax court found a large shareholder benefit, and the benefit was basically the amount of money put into the life insurance policy, so $6M minus any guarantee fee that the taxpayer paid. So the taxpayer paid $600,000 of guarantee fees throughout the arrangement before the reassessment. So basically the court found a 5.4Mtaxable shareholder benefit. So it's a little bit ... and I just want to stress that this arrangement is very different than what we're talking about here. What we're talking about here is a life insurance policy that kind of stands on its own from a financial and economic commercial point of view. I mean, it's not linked to any other transactions or its performance isn't linked to any sort of rate on a loan. The loan that we're talking about here is from a commercial lender. Its interest rate is subject to market forces. So in our case, we're talking about two independent financial products. In this Golini case, we're talking about offshore products that are basically tied to each other.

So that's one, and two, I guess why we would talk about it here is that really just the way that the taxable shareholder benefit was calculated is a little bit surprising. I mean, I would've thought that if a court looked at a shareholder borrowing type of arrangement, that if they were to find a taxable shareholder benefit, maybe they would've looked at, "Okay, well maybe the shareholder should have been paying in a guarantee fee, maybe could have been a benefit." But in this case, the court said, "Nope, we're going to look at the premiums for the insurance minus the guarantee fee."

So it's just kind of underscores that there is some uncertainty here. If there are bad facts in front of a court, the court might want to kind of throw the book at the taxpayer, which apparently happened in this Golini case. So just want to underscore that the guarantee fee is intended to deal with a shareholder benefit issue, a taxable shareholder benefit issue. But there is a bit of uncertainty out there around that right now because of this Golini case. So with that, I will kind of end on the guarantee fee issue, and Marco, I will send it back over to you to talk about interest deductibility.

Marco D'Aversa:

Thanks, Steven. So yeah, with respect to interest deductibility, whether the loan is made to the shareholder directly or to the corporation for the interest on the loan to be deductible for tax purposes, the general rule is that the loan needs to be used by the borrower to earn an income from a business or property. Now, in the case of a shareholder borrowing case, this test wouldn't be met because typically the loan is used to fund the shareholder's lifestyle needs, for example, at retirement. So in the case of shareholder borrowings, typically you don't get any type of deduction for interest expense. However, there is an opportunity for potentially obtaining the interest deduction in the context of corporate borrowing, even where the loan proceeds are ultimately used by the shareholder for lifestyle needs, say in retirement, for example. In the case where a corporation, for example, borrows from the bank against its corporate policy and pays a dividend to the shareholder to fund their retirement, there may still be an opportunity to deduct the interest for tax purposes.

In particular, the CRA's administrative position states that interest on a loan used to pay a dividend is deductible, where the borrowed money replaces the accumulated profits for the retained earnings of the corporation that have been used and retained in the corporation for business or investment purposes. So if we think of our typical corporate clients, they're either going to be an active business or they're going to be maybe an investment holds call, if you look at their financial statements and they have significant retained earnings that have been deployed in various investments in the case of investment holds going back into the business, then there is an argument that could be made that any money borrowed to pay out a dividend to the shareholder would meet this accumulated profits administrative position and the interest would be deductible.

Therefore, in conclusion, there is an opportunity to get an interest reduction with corporate borrowing that otherwise would not be available in the case of shareholder borrowing. That's all I really have to say in terms of interest deductibility. Steven, maybe I'll pass it back to you to talk a bit about capital gains tax on death and how personal borrowing versus corporate borrowing impacts that.

Steven McLeod:

Thanks, Marco. Right, so capital gains at death. So where do we start here? So if I think as everyone appreciates when you pass away or when you die, you're deemed to dispose of your capital property at fair market value for tax purposes. So if you're a owner of a company, you own shares of this company, let's say it has a cash by life insurance policy in it, while there's a rule in the income tax act that deems that when you're looking at valuing those shares and that company has a cash value life insurance policy, is that you're looking at the cash value of the life insurance policy for determining the fair market value of those shares for tax purposes. So just to use an example, let's take kind of two extreme examples. Say a corporation has a life insurance policy that has a cash value of $1, and that's all the corporation owns.

Well, when that shareholder passes away, he or she is deemed to dispose of those shares for tax purposes for $1. So the death benefit could be a $1M, but still for tax purposes, those shares are worth a dollar. So there might be a dollar capital gain on those shares. On the other hand, if the corporation owns a life insurance policy that has $1M of cash value, and let's just say it has $1M of death benefit too, so just again, an extreme example. So for tax purposes on the death of the shareholder, those shares are worth a million dollars for tax purposes. So it's not necessarily a bad thing this rule because I mean, if you think about, well, if you put money into something else like your regular traditional types of corporate investments, then the value of those will definitely impact the value of share.

So this is just kind of the rule for life insurance, and I have to say at least it's the cash value, not the death benefit that impacts the fair market value of the shares at death. So I think that's actually a good rule. Now, when we're talking in the collateral loan context, when we're talking about a loan to the corporation or a loan to the shareholder, there's a big difference on how that will impact shareholders' capital gains that death. Now we're always dealing with a cash valuelife insurance policy in these situations because the cash value is security for these loans. So if we're talking about collateral loans, they're going to have high cash value, which could impact the capital gains. Now a loan to a corporation is a liability of that corporation and that liability of the corporation will reduce the value of the shareholder's shares for tax purposes and just for general valuation purposes.

So again, when you have the loan going to the corporation, you can think of a balance sheet assets minus liabilityand equity. So that liability will basically reduces the effect of the assets on the value of the shareholder shares, and therefore it would reduce their capital gains or the potential capital gains tax liability at death. Now, if you contrast that to if the loan went directly to the shareholder, the loan therefore is not a liability of the corporation. It's a liability of the shareholder, and that will have zero impact on the value of the shares at death.

So it will not reduce the value of the corporation and therefore reduce the value of the shareholder's shares at death, which could potentially reduce their tax liability at death as well. So again, this is a benefit of having the loan go to the corporation and then paid out. It's a dividend to the shareholder because that loan to the corporation is a liability of the corporation and it will reduce the value of the shareholder's shares for tax purposes at death, which could lead to a lower tax bill at death as well. So hopefully that made sense and I'll pass it over to Marco and we can talk a little bit more about shareholder benefits.

Marco D'Aversa:

Thank you, Steve. So we talked about the one thing that impacts potential shareholder benefits. So that's the guarantee fee, and as long as there's a reasonable guarantee fee, that should mitigate that exposure. There's also a taxable benefit risk at the backend when the loan is repaid. And that's what I'll be talking about right now. Basically in the case of shareholder borrowing, if the shareholder's personal loan is repaid directly from the death benefit proceeds of a corporately owned policy, then a shareholder benefit equal to the amount of the loan will arise. For this reason, the repayment process should be structured so that the personal loan is not repaid directly from the corporate policy. And the steps required to do this can become complex and it does defer, depending on the lender. As such as a general rule of thumb, it's best practice to address the loan repayment issue and the requirements at the beginning of the loan arrangement.

In general, what happens to mitigate this risk is that on death the bank needs to either accept the payment of the loan from another source of personal funds, or maybe they agree to release the policy as security, for example, by signing personal security in its place so that the corporation could receive all the death benefit from the insurer and subsequently pay out a capital dividend to the estate so that the estate could pay off the loan and thereby avoid any taxable shareholder benefit issues. Now, as I noted with shareholder borrowing, the corporation would normally use its capital dividend account credit generated from the life insurance proceeds to pay a capital dividend to the estate, so it could pay off the personal loan and avoid the taxable shareholder benefit issue. However, in the case of a corporate borrowing case, the corporation does not need to use its CDA to facilitate the repayment of the loan.

In particular, it could just pay back the loan directly because it is an outstanding loan to the corporation, and the corporation receives the full death benefit from the insurance. The insurance company that it could use be used to pay the loan off without using any of the CDA. So as a result in many of the corporate borrowing cases that you would typically work on, there would be something called excess CDA leftover for distributing other non-insurance assets from the corporation to the shareholder's heirs on a tax-free capital dividend basis, thereby saving significant amount of tax. This excess CDA is basically calculated as the CDA otherwise calculated for life insurance proceeds less the death benefit left over after the loan is paid off. So that's a significant advantage when it comes to corporate borrowing that's not available for a shareholder borrowing situation. So Steven, I think that's all I really have to add on the taxable shareholder benefits. I'm not sure if you have anything else to add, or maybe if you just want to wrap up the presentation with some closing remarks.

Steven McLeod:

Yeah, I think I echo what you said in terms of the excess CDA is a significant advantage of the loan to corporation as opposed to the loan to shareholder. It's hard to understate how big of a benefit that would be. So with that, we will close. I should mention before we close though, that if you did want to illustrate either shareholder borrowing or corporate borrowing with a dividend to shareholder, our corporate asset efficiency tool, which you can find that on Concourse, does both. And if it does show shareholder borrowing, there is lots of disclaimer language and consideration language that will help out as well. We also have an article on our website, tepgsalestrategies.ca in the article section that's called Backend Leveraging: Loan to Shareholder v. Loan to Corporation.

And that article goes through a lot of the issues that we talked about today and even a couple more. And just to close, kind of like I said at the beginning, the shareholder borrowing does look like a very attractive option just based on the after-tax portion being more than the corporate borrowing. But there are some significant benefits and simplicity that corporate borrowing has over shareholder borrowing.

• Marco went over the shareholder benefit issue and paying guarantee fees and how guarantee fees can add up to quite actually a significant amount. So that's a big consideration with shareholder borrowing. There's some uncertainty from case law on how to deal with the taxable shareholder benefit issue.
• Corporate borrowing can get interest deductibility in the right circumstances.
• Corporate borrowing also reduces share value at death, so that could potentially reduce the capital gains tax at death.
• There's a lot more complexity in repaying a loan that goes to the shareholder, as Marco explained, in terms of having to make sure that the corporate owned life insurance policy death benefit doesn't directly pay off the loan or else that could be a shareholder benefit.
• And also there's the excess CDA issue that Marco went through as well that's involved in corporate borrowing and not so much on the shareholder borrowing.

We'll close on those points. And Marco, if you have any parting comments for the audience, I'll leave it to you.

Marco D'Aversa:

Yes, Steve. The only thing I would add is that whether you borrow corporately or at the shareholder level, there are risks involved with any type of borrowing. So it's important to ensure that the client's own tax advisors, whether it's your accountant or legal counsels involved in any of these types of transactions, and just as important to include Canada Life's wholesaling team as support for your leveraging cases.

Steven McLeod:

And thank you to the audience for joining us for this podcast. You can find more podcasts as well as other information on our TEPG website, and that's tepgsalestrategies.ca.

Speaker 3:

As important considerations, please note that Canada Life does not provide tax, legal or accounting advice. All comments related to taxation are general in nature and are based on current Canadian tax legislation and interpretations for Canadian residents, which is subject to change. For individual circumstances, consult with your legal or tax professional.

Steven McLeod:

Hi everyone, and welcome to another podcast from Canada Life Tax and Estate Planning Group. My name is Steven McLeod. I'm the director in the Tax Estate Planning Group and I'm very pleased to be joined today with our guests, Michael Pilz from Equitable Bank, also known as EQ Bank. Mike, thanks for joining us today. And, why don't you give our listeners just a little bit of a background about yourself, your role at Equitable Bank, and also some of Equitable Bank's, I guess, role in the insurance lending space.

Michael Pilz:

First off, thank you very much for having me, Steven. I am the head of National Sales for the insurance lending at Equitable Bank. I've been at Equitable Bank for almost four years now. In terms of a little bit of my background, while I am technically a banker, I am here at this role, given my background in insurance. I've been an insurance wholesaler for many years previous to this role, also on the investment side. So, just have a really solid understanding of the world in which you and your clients operate. And, that really comes through in how myself and the rest of our team work with advisors when it comes to insurance lending opportunities.

Steven McLeod:

Great. And in the insurance lending space, Equitable Bank has a back-end leveraging product.

Michael Pilz:

Exactly.

Steven McLeod:

And a front-end leverage.

Michael Pilz:

So, in terms of the insurance lending space, it has been an evolution. Certainly, we'll focus in on the IFA product that we have offering for the bulk of this conversation, but it's been an evolution. As I mentioned, we've been in this space for four years. The initial foray was with what we call our CSV Flex product. Really, just designed for more traditional back-end leveraging scenarios, is a CSV-based lending product. We did launch another product, and do have another product called CSV Max, once again is a CSV-based lending product. So, that was the product shelf for the first three years. And as of the beginning of this year did launch, and quite successfully so, knock on wood, a very unique and compelling IFA solution.

Steven McLeod:

Excellent. So before getting into that IFA product, I think maybe for our listeners we'll describe what the IFA is. So we've said IFA a number of times so far, so that means immediate financing arrangement. What it is, is a front-end leveraging insurance strategy. So, it's a strategy for business owners and investors. And it basically lets them acquire permanent life insurance, but also have their capital stay invested in their business or invested in their investments. So in a nutshell, the mechanics of how the strategy works is that the business owner, like I said, it could apply to business owner and investor, but let's just go with the business owner. They take cash flow from their business, they use that cash flow and put it directly into the life insurance policy to pay premiums. And then, they take that life insurance policy, and it will have cash value, and that cash value will be used as collateral for bank loans.

So they'll assign the policy to a bank, take a bank loan, and then take those loan proceeds and reinvest it back in their business. So that way, they're basically whole from a standpoint of the capital that they use in their business. Now, they'll do that every year for about 10 years until that policy is fully funded, and generally, they will be paying interest costs on that loan every year. But at the same time, that interest is tax deductible because the idea is that the loan proceeds will be used for a business or investment purpose. And because assigning the life insurance policy as collateral for the loan, and the loan is used for a business purpose, they will also get the collateral life insurance deduction as well. So basically, they'll have two tax deductions that will create tax savings that will offset some of the costs that they'll have in paying interest.

So, it's a very tax efficient strategy. It's a great way to keep capital invested in the business. In the earlier years of doing this strategy, there's really not much out-of-pocket costs because it's all interest, and the loans are quite low in the early years until the policy's fully funded. But, one thing with this strategy as well, is that because in the earlier years the cash value of the policy isn't enough security to get a loan that's equal to a hundred percent of the premiums that you put into the policy, you might have to put up, or the policy owner would have to put up additional collateral as security to get that full amount of the loan that's equal to the premium. And, that's probably best described as a sticking point with the strategy, particularly to the sense that some policy owners won't get a loan that's equal to a hundred percent of the premium, they'll just lend on cash value.

But, a really nice feature with the strategy is to be able to get to a hundred percent of the premium to get back-filled by the loan from the IFA lender. So like I said, putting up that additional collateral is a sticking point with this strategy, but Equitable Bank has an IFA product that they launched this year that actually deals with that sticking point of the strategy. So Mike, why don't you take us through your new IFA product and basically, how it works in terms of what products you're looking for to use to be able to take advantage of this no collateral IFA, DL size, interest rates, set up fees. What an advisor can expect when they come and see you, et cetera. So, take it away.

Michael Pilz:

Happy to jump in. So to your point, and just to reiterate, yes, the overall goal with the IFA is to allow borrowers to one, fund a large insurance need, i.e., a large premium, while at the same time borrowing back that same premium dollars for ongoing business needs, generally speaking. To your point, and this relates to what I had mentioned earlier about Equitable Bank being a challenger bank and wanting to come to market with unique offerings. In our research in the IFA market, we obviously identified some of the sticking points, pain points, speed bumps if you will. And one of the big ones is around the need with other bank lenders to post additional collateral. For us at Equitable Bank, we do not require, and in fact, do not take additional collateral.

So what that means is, we have developed a certain comfort level with a certain amount of unsecured risk, if you will. Now, there is a limit to what that is, and that number is 30%. So, we can have a certain comfort level with up to 30% unsecured risk. So, what does that mean and what does that translate into? It very much translates into, in order for us to know that the policy will allow for a hundred percent of the premium being lent back to the borrower, that the underlying CSV must be at least 70% or more of that associated premium amount, because 100 minus 70 is 30%, hence that's our 30% unsecured appetite.

Now, how do you get a policy to have very rich CSV from the get-go, and you would well be aware, and I think it's great, that you want to use a wealth product as opposed to a state product because invariably, it will have higher CSV values from the get-go. As well as, my recommendation would be to make very liberal use of, if not maximizing or looking to maximize the use of ADO. Because, Canada Life's Wealth product in conjunction with the ADO will certainly allow, in most, if not all cases, be a very unique case where it wouldn't do so, for you to achieve that minimum 70% and actually go well in excess of that.

Steven McLeod:

And, if I could maybe jump in. So, you mentioned our Wealth product. So, just to maybe put specifics around that. So, at Canada Life we have an early cash value participating whole life policy. So, that's our Wealth Achiever Plus for the MGA & National Accounts channel, or the Wealth Select for our Direct and Advisor Solutions channel. So, that's our early cash value product that fits in very well with the 70% minimum that you're looking for your IFA lending product. We also have the Estate Achiever Plus or the Estate Select participating whole life that has higher longer-term values. So, we have the early cash value which lends itself well for this IFA lending product from Equitable Bank.

Michael Pilz:

To circle back to other questions you had asked me to address in terms of set-up fees and minimums. So when it comes to Equitable Bank and our current IFA offering, we do have minimum annual premiums in order to be considered for the IFA. So currently, we require a policy to have an annual premium of at least $50,000. I will say, there is very much a desire and we're very much going to be going in this direction. Timing of which is not set in stone as of yet, but very likely to be increasing that minimum annual premium up to a hundred thousand. But currently, it is a 50,000 minimum annual premium. In terms of set-up costs, we do have a application fee. That application fee is currently pegged at 25 basis points relative to the single-year premium, so 25 basis points if you will.

If it's a hundred thousand dollar annual premium, the application fee is $250. If it's a million dollar annual premium, the application fee is $2500, the $50,000, $125. And then, that would be the only application fee associated with set-up. We do not require involvement of lawyers, so there should not be any legal fees. If by chance there are, though in the 200-plus IFA applications that we have received, and the over a hundred that are currently in force, there's never been a need for legal. So, just to throw that out there.

In terms of the ongoing annual review, other companies refer to it as an annual review, and they might have a set fee charged with that. We refer to the annual review, if you will, as a credit limit increase, and we do have a credit limit increase fee associated with that. And at that stage, and currently, it's just a flat $250. And that is only charged well and truly, in future years when the client is looking to borrow back another premium.

As you mentioned Steven, the general goal of an IFA at set-up is that the borrower will borrow back the 10 premiums they're looking to pay into the policy, or the 20 if you will. But we know anecdotally that oftentimes, many borrowers will, maybe borrow back the first six or seven years of the premium, and then choose to just pay the remaining three out of pocket, and that's a hundred percent okay with us. While we definitely would like them to engage with us year-after-year and continue to borrow more and more money, they're very much in the driver's seat. One of the things we always try and do and frankly be at Equitable Bank is, really focus on the needs of the customer, and provide them with maximum flexibility.

Steven McLeod:

Okay. So while we're talking about costs, why don't we talk about interest rates on your loans. So, you do take an unsecured portion, so I'm assuming there's some give and take around costs?

Michael Pilz:

Yes, great question. So, in terms of how we operate in terms of the rates. So, when we engage, and this will lead into latter parts of the conversation, when it comes to pricing out a deal in the interest rate, because that's certainly of interest obviously to anyone looking to set up an IFA, we have on our side various rate bands. And at initial set-up or say, initial discussion, we will be able to work with the advisor just in the very earliest stages, look at the policy structure, ensure that the CSV is at 70%. So great structure, we can get to a hundred percent of the premium back. And what we will also do, is run it through our rate calculator and tell you, "This is what your starting rate is."

So as mentioned, we have a number of rate bands. And our general guidance is, the starting rate, and key in on the word, starting rate. The starting rate might be prime plus 50, prime plus one, or prime plus one and a half percent. Now, how do we calculate that rate? And the key inputs are... There's a number of inputs, but the key inputs are frankly, size of the loan and how secure is it. And now, we technically price out the deal on a year-over-year basis. So at initial set-up, if it's a hundred thousand dollar premium and the underlying CSV is, say, 72%, in the rate calculator, we're going to say the size of the loan's a hundred thousand and it's 72% secured. Now, that might come out at the prime plus one, or prime plus one and a half band. And the reason for that is because we're not fully securing the loan, so we are effectively behind the scenes blending a secured rate and an unsecured rate.

Now as time goes on, say the subsequent year, that loan will be calculated as a $200,000 loan that's now, maybe 78% secured. That might not be enough to, say, drop from prime plus one to prime plus 50, but as that plays out and the years go on, that is very much the indication and what clients can expect. You might start at a higher rate band than say, another lender will quote you, but you need to keep in mind that the process with the other lender is requiring excess collateral, and they're fully securing the loan. So, it's really just a unique offering, and I'm very comfortable with our offering with that. A lot of people seem to understand it. A lot of people like it because, as mentioned, we have been very busy since the beginning of the year in entering the IFA space.

Steven McLeod:

Yeah. No, I can imagine. So, if a policy owner or if a client is using the Wealth product, so after maybe four, five, six years, that loan will be fully secured. And I think, one thing to bear in mind is that, in the first few years, while there is maybe a higher interest rate and there's an unsecured portion that would lead to that higher interest rate, is that the loan is smaller relative to later years.

Michael Pilz:

Exactly.

Steven McLeod:

So, the interest costs are going to be lower anyway. So, the impact of that higher rate is going to be quite negligible I would say.

Michael Pilz:

Exactly. Yeah. It's just to keep reiterating for people, right? Because generally, we are not the only lender in this space. A lot of the big banks will quote, say, a rate closer to prime. But once again, that's a rate based on a fully secured loan. And once again, I'll take the opportunity to say that, many of the other banks have much higher minimums in order to even look at a deal. Even once we move to a hundred thousand dollars, that will still be a relatively low entry point relative to, as I mentioned, the other banks that operate in this space.

Steven McLeod:

So, let's talk about the margin ratio that Equitable Bank will take on the cash value of a participating life insurance policy. So, when you're looking at what portion of your loan is secured or unsecured, are you looking at 90% of the CSV as considered the secured portion or a hundred percent of the CSV? What does Equitable Bank do?

Michael Pilz:

Okay. So for us, with the IFA, and we're looking at how much is secured, we very much just look at the in force illustration or the software illustration, because many times the policy's not necessarily in force. And, we are happy to use the projected year-end CSV value at the current dividend scale interest rate. So, if the illustration, once again, just says a hundred thousand premium, year-end CSV is going to be $72,548. We will look at that as though it's 72.548% secured, and then would look to top up to get to a hundred percent as, my math is not going to be the greatest, but about 25% unsecured lending.

Steven McLeod:

Okay. Now what about capitalizing interest? Does Equitable Bank do that?

Michael Pilz:

So, currently with our IFA we do not allow for capitalization of interest. We do require the borrower to service the interest on the borrowed funds on a monthly basis.

Steven McLeod:

Now what about time from application to approval? What kind of timeframes can an advisor expect from approaching Equitable Bank to actually getting the loan funded?

Michael Pilz:

For sure, that's a great question, and I'll hedge my bets by saying every case is unique. And so, the number I'm going to throw to you is based on spending time with myself or the rest of the sales team, really lining up our ducks and ensuring what I'll call, a complete application package. Which generally, will require a lot of back and forth early, what I call field underwriting. Just lining up our ducks in terms of what type of information do we well and truly require? And it has to do with their, what kind of supporting financials do we want to see in order to financially underwrite and get to approval on the deal?

But my general timeline, and then we peg ourselves too in terms of service level agreements is, from time of a formal application, a complete application being received, which is the application documents in complete or minimal financials to handle the financial underwriting, is that we want to get to approval within four weeks. Now, within that four-week timeframe, I'm allowing for one back and forth, or request for more information from the underwriting side, because we really try and not ask for everything under the sun. We really try and focus in on what it is we need to get the deal done. And so, I would expect four weeks from time of formal application until formal approval. And then, that's a stage at which we will either... There's two ways we can do the approval. One, if the policy is already in place, we will just send out a proper approval package.

If the policy is not in place because you're really looking to line up the approval on the lending side before placing the policy, we will offer a conditional approval, which will essentially tell the advisor and i.e., the end client here, "You're approved. Go put that policy in place, send us the proof it's in place, and then we will issue the actual approval documents." And those approval documents, the key things in there are the assignment form, that's when we'll ask for banking information. Client will complete that, send it back in to us. So generally speaking, from time of approval until time money is in their bank account, that should be handled within two weeks or so. So realistically, say from time of application until time money's in the client's bank account, move it from four to six weeks.

Steven McLeod:

So in terms of your Equitable Bank's geographical footprint, is it a national program that's available across Canada?

Michael Pilz:

Yep, for sure. So Equitable Bank is as mentioned, a Canadian Schedule One Bank, national in scope. And on the insurance lending side, we have definitely been growing and have built out our sales team. We do have national coverage. In terms of actual boots on the ground, the majority of our sales team is located in Toronto, so cover different geographic regions remotely, but that'll certainly likely change. Out East, we have Geoffrey Mark Tivey, who's actually based out of Halifax, so he's boots on the ground there. Covering Quebec, we have a lady by the name of Christelle Nguidjoi. She is bilingual. Obviously, fantastic solution for Quebec. And then covering Ontario, we have Delano Ferguson, and then Points West, Danielle Pears.

In terms of contact information, I think the easiest way to direct people on this podcast is just to go to the Equitable Bank website. Look under the insurance lending tab, scroll to the bottom of the page and you'll find all of our names, pictures, and contact information. Or certainly, look any of us up on LinkedIn. I may be the easiest last name Pilz, P-I-L-Z. Find me, and reach out to me there and we'll definitely connect, get you in touch with the right people.

Steven McLeod:

Thank you, Mike for all that information. That was very helpful in getting an idea of what your new IFA product is. And thank you for your contact information as well. But, I should also remind all the listeners that Canada Life has an extensive wholesaling, a group across Canada, and they all have the contact information for Equitable Bank as well. So, if you have an IFA case and you want to take advantage of Equitable Banks, no additional collateral IFA loan product, by all means you can get in touch with Equitable Bank directly, or you can do it through our advanced case consultants, regional sales, marketing consultants, or wealth and tax planning consultants. They all have contact information for Equitable Bank. And with that, Mike, thank you very much for joining us. It was a pleasure having you on.

Michael Pilz:

Thank you as well, Steven. And, thank you to the wider Canada Life sales team. We work very well with them and really appreciate the partnership.

Steven McLeod:

So with that, we'll close. Thanks everyone for listening, and we'll talk to you again on our next Tax and Estate Planning Group podcast. Thank you. As important considerations, please note that Canada Life does not provide tax, legal or accounting advice. All comments related to taxation are general in nature and are based on current Canadian tax legislation and interpretations for Canadian residents, which is subject to change.

For individual circumstances, consult with your legal or tax professional. The immediate financing arrangement is a strategy that involves using a life insurance policy as collateral for a loan. Collateral loans involve risk. They should only be considered by sophisticated policy owners with high-risk tolerance and access to professional advice from a lawyer and accountant.

The terms and future availability of collateral loans cannot be guaranteed. The loan or line of credit must be negotiated between the policy owner and the lender. And, it is subject to the lender's financial underwriting and other requirements. The policy owner should have enough income and capital to cover the interest and loan repayment as well as the insurance premium.

Steven McLeod:

Hi, my name's Steven McLeod and welcome to another Tax and Estate Planning Group podcast, where we cover technical and tax and estate planning topics that matter the most to you. I also want to note before we get started, that this discussion is solely for informational purposes for insurance advisors and their clients' tax and legal advisors, and that [Can LA 00:00:26] doesn't provide tax, legal or accounting advice. I'm here with my colleague and co-host Marco D'Aversa, who's joining us over the phone. Hi Marco, are you ready to discuss trust and life insurance today?

Marco D'Aversa:

Thank you Steve, I'm looking forward to this podcast.

Steven McLeod:

Right, so I'll give a bit of an outline of the topics we'll cover. And then I'll hand it over to Marco to get us started. But first we're going to cover what is a trust? Why use a trust? And give some examples as well in those contexts. And then we're going to get more in depth on trust and life insurance. So I guess the ins and outs of a trust owning a life insurance policy. And then we'll get into a trust receiving a death benefit. And then we'll finish on some details about some issues that the Canada Revenue Agency has raised about life insurance in the context used with spousal trust and alter ego and joint partner trust. So with that outline, we'll just get going. So Marco, why don't you take us through what a trust is?

Marco D'Aversa:

Sure. Thank you Steven. A trust is basically a form of property ownership that splits legal title from beneficial title. A trust property is basically provided by a seller. The trustees of the trust have the legal title to the trust property, and the trust beneficiaries have the beneficial title to the property. Now as you can imagine, a trust could get complex and typically it is governed by a written trust agreement that outlines the duties and powers of the trustees and the beneficiaries entitlement to the trust property. Moreover, it should be noted that trusts are governed by provincial law and rules that vary by province and as such it's important to have a lawyer involved in the planning and drafting of any agreement that creates the trust.

Marco D'Aversa:

Now basically, there are two types of trusts. There's something called an inter vivos trust, and there's something called the testamentary trust. Now a trust can be established either while a settler is living, which results in an inter vivos trust, or upon his or her death, which basically results in a testamentary trust. Now previously, testamentary trusts were taxed using graduated tax rates, and that allowed for significant planning opportunities as part of your state planning, where it wasn't uncommon for wealthy individuals to set up multiple trusts at death. So multiple testamentary trusts that each got their own graduated tax rates. Now starting in 2016, it's only graduated rate estates or GREs and qualified disability trusts that are the only two types of trusts that basically benefit from graduated tax rates. All other trusts are taxed using the highest marginal tax rate applicable to individuals. So for example, in Ontario it would be 53.53%.

Marco D'Aversa:

However, there is a rule that allows income of the trust to be distributed and allocated and taxed in the hands of the beneficiaries. Income of a trust basically that is paid or payable to a beneficiary is generally deductible in computing the taxable income of the trust, and is included in the income of the beneficiary. Therefore a trust may function as a conduit for tax purposes. Given the high rate of tax in a trust that otherwise doesn't get the graduated rate, it's not uncommon to see all the income of the trust allocated and distributed to its beneficiaries and taxed at the beneficiaries level.

Marco D'Aversa:

Now trusts are commonly used for estate planning arrangements, for wealthy individuals. I.e. To direct maybe the distribution of the estate in a manner and time as they consider appropriate. Trusts are also used to administrate a property on behalf of minors or others that are not regarded as capable of administrating their own affairs. And in the business space, you also see trusts commonly used for tax planning for business owners. And for example, in the case of an estate freeze. But with that said, maybe I'll pass it back to you Steve, and you could maybe expand on the common uses of trusts?

Steven McLeod:

Sure yeah. I just want to make a couple of points too before getting to that, is that one really neat thing about the taxation of trust is that when a trust allocates its income out to a beneficiary, it can actually retain its character as the type of income. So if a trust received a dividend, it can allocate the dividend out to a beneficiary and that income will be taxed as dividend income in the hands of the beneficiary. So we'll have access to the dividend tax credit. So we'll have a bit of more favorable tax treatment. So it's kind of neat how the income can retain its character. I think that's the other thing too, and Marco you hit the nail on the head with that, is that a trust is a form of property ownership. It's not an entity in and of itself like a corporation is. So it's just really a form of property ownership. Now for tax purposes, it is an entity on its own. It's, treated that way as a fiction, but really all it is a form of property ownership.

Steven McLeod:

So getting into why using a trust, Marco you already touched on a lot of those, or a couple of them anyways, like control is probably the main one I would say. So if you think about, you want to give your wealth to a family member, but perhaps that family member is a minor. Perhaps they lack capacity, perhaps they have an addiction or maybe they're a young adult and they shouldn't have significant amounts of money in their bank account or portfolio, whatever the case may be. Or perhaps they're spendthrift, or perhaps... You might have a client that foresees matrimonial issues, and you don't want your family member to get a significant amount of money that can go into a matrimonial home and maybe become matrimonial property.

Steven McLeod:

So you want to have that kind of control over your wealth. And that's really what a trust excels at, is giving the settler or whoever donates property to the trust or gift property to the trust, control over that asset. So that's the main one. Flexibility, a lot of types of trust are discretionary trusts. So that basically means the trustee has a lot of discretion on his or her ability, or their ability if there's more than one trustee, to really allocate an asset out to perhaps one beneficiary to the exclusion of others. So creditor protection is another reason to use a trust. There are some limitations though, if there's a credit on your heels, you can't really give property to a trust to get it out of your hands and get it out of the purview of that creditor. But with enough planning in advance, that is a way of doing some creditor protection planning.

Steven McLeod:

Probate planning, assets of a trust does not go through the estate, therefore it does not go through probate. There's other types of trust too, that are used specifically for probate planning. So you might have heard of an alter ego trust or joint a partner trust. So those types of trust are really unique because you can actually put assets into those types of trust on a rollover basis, which is unique. Because typically assets going into a trust are deemed to be disposed of at fair market value for tax purposes. But you can use those alter ego trusts or joint partner trusts for probate planning. Disability planning is another big one. Probably a lot of advisors have heard of Henson trust, they're of commonplace planning in say Ontario and BC, for basically limiting the amount of assets that a disabled beneficiary has access to. So it doesn't compromise their ability to receive government benefits.

Steven McLeod:

And then lastly, tax planning is a huge one. Tax planning, the flexibility provides the trustees the discretion to be able to give income out to a beneficiary, to the exclusion of others. Which gives a little bit of, in some circumstances, that gives the ability to do some income splitting. Of course, that ability has been curtailed significantly with the introduction of TOSI. But there is multiplying the capital gains exemption, that's one way of doing it.

Steven McLeod:

So going back to the business owner context, if a trust owns common shares of the business, it sells those to a purchaser, it realizes a capital gain. It can allocate that taxable capital gain out to the beneficiaries who can use their capital gains exemption if the shares qualify for that. So that's a way of doing tax planning with trust. So we covered off what a trust is, we covered off why using a trust. Now let's get into trust and life insurance. So we're going to cover off two topics on this. So trust owning a life insurance policy, and then trust receiving a death benefit. So Marco, why don't you discuss for our audience a trust owning a life insurance policy and the ins and outs of that?

Marco D'Aversa:

Yeah, thank you, Steve. That was a great discussion of the uses of trust. And you could see from your discussion that there are a lot of advantages of using the trust and a lot of uses of it for estate planning and tax planning. However, in this next section, as Steven has alluded to, we're going to talk specifically about trusts owning life insurance policies. And at a high level, it works really well. Life insurance policies owned in a trust, and there are a couple of reasons for that. And Steve alluded to them earlier, and I'll just expand on them. Firstly, as Steve mentioned, most trusts have something called a deemed disposition of capital property every 21 years, unless certain action is taken. For example, the property is rolled out to a capital beneficiary.

Marco D'Aversa:

However, this 21 year deemed disposition rule does not apply to a life insurance policy. So what that means is that there's no need to transfer out a life insurance policy out of a trust in its 21st year. And as such, trustees can control a policy in a trust for a very long period of time, which leads to potential tax planning opportunities with life insurance policies held in a trust. The second advantage I wanted to align is that a trust can roll out, on a tax free basis, capital property to a capital beneficiary in satisfaction of a capital beneficiary's interest in a trust under certain conditions. And at high level, these conditions are one that the beneficiaries resident of Canada for tax purposes, and the trust is not tainted by this certain attribution role.

Marco D'Aversa:

And it should be noted, and it's very important to note, that a life insurance policy for purposes of this provision for the rollout is considered a capital property. Meaning that a life insurance policy can't roll out tax free from a trust to a capital beneficiary. Now it should be noted that, for other sections of the income tax act, a life insurance policy is not considered a capital property. But for this purpose of the rollout, it is considered capital property. It's important to note however, that as Steven mentioned earlier, that a transfer of property into a trust is a taxable event. And in particular, a transfer of an existing life insurance policy into a trust is a taxable event. Now that said, whenever a trust owns a life insurance policy, you would generally want to ensure that the trust is both the policy owner and the beneficiary of the policy. Failing to name the trust as the beneficiary of a policy that it owns, could result in adverse tax implications.

Marco D'Aversa:

For example, if a trust beneficiary, or other non arms like person is named as a beneficiary of a trust owned policy, then a potential subsection 105 sub one benefit could arise. And this is similar to subsection 15 sub one that applies to a corporate owned policy with a shareholder named as beneficiaries. Now, CRA has in the past confirmed that there will be no benefit under subsection 105 sub one of the income tax act to the beneficiaries of the trust when the trust owns the policy and is a beneficiary of the policy. So the rule of thumb is that if a policy owned by the trust, it should also be named as the beneficiary of the policy.

Marco D'Aversa:

So what happens when a trust receives a death benefit under a life insurance policy? Well not surprisingly, a as a policy beneficiary, the trust would receive that death benefit on a tax free basis. And furthermore, when they distribute those funds to the beneficiaries, according to its terms, it also goes out to the beneficiaries on a tax free basis. As you can see, there are advantages of holding life insurance in a trust. And maybe next I'll spend a few minutes talking about common examples of where you would see a life insurance policy held in a trust, and I'll go through three examples.

Marco D'Aversa:

The first opportunity may arise on the sale of a business. For example, in situations where a trust owns shares in a business directly, I.e. as a result of an estate freeze, where it owns the gross shares or the common shares, it is not uncommon upon sale for a trust to retain a portion of the net proceeds from sale. Now to the extent that these funds are retained in the trust, there may be an opportunity to use such funds to purchase a policy. Another example, a trust may also own a life insurance policy as a cash gain alternative. Now we know if a parent owns a policy on a child's life, they could transfer that policy to a child on a rollover basis. However, for the rollover to apply the child must be the definition of a child under the income tax act.

Marco D'Aversa:

Now, a niece or nephew generally does not meet the definition of a child. And as such, you cannot generally rely on the tax free intergenerational rollover rule for a policy on a nephew. However, by using a trust to own a life insurance policy on your niece or nephew's life, and by having that said niece or nephew as a capital beneficiary of the trust, you can own the policy and the trust. And then when the time makes sense, you could transfer the policy out of the trust to that niece or nephew on a tax free basis. As such accomplishing a cash gain alternative.

Marco D'Aversa:

Now, the third example I wanted to talk about deals with US persons. Now US persons that are resident in Canada, or US persons generally would be subject to an estate tax upon their death. Now an opportunity exists where you use your own life insurance policy to structure your affairs, using a trust in order to avoid this potential US estate tax. In particular, an irrevocable life insurance trust is sometimes used to own a life insurance on the life of a US person for US estate planning purposes. And if structured properly, the death benefit would be paid to this irrevocable life insurance trust. And it wouldn't be included in the estate of the deceased US person. Again, as always clients should obtain the proper US tax advice prior to undertaking such US planning.

Marco D'Aversa:

So the above three examples are just a few examples where life insurance works well within a trust. And maybe now I'll pass it back to you Steve, and maybe you could maybe talk a bit about insurance trusts?

Steven McLeod:

Sure Marco, thank you. So insurance trust is, I guess a type of trust that is settled upon the receipt of life insurance proceeds. And when would you use life insurance trust? Well at the exact same times that you would use just a regular trust, as explained above. And really, it's about control. So going back to that list of situations where you might want to have or maintain control over a significant amount of funds. So if we're dealing with a minor, using a trust is a great idea there.Iin a lot of provinces, you have to go to court to get a guardian of property appointed, which a lot of costs and delay in doing that. So having a trust set up beforehand is a really great alternative. There could be capacity issues with the beneficiary. Again, addiction, young adults, spend thrift, matrimonial issues. I know there's very common situations where you'd want to maintain control and use a life insurance trust.

Steven McLeod:

So how do you set them up? Well really, there's probably three ways, I guess. One way, one very simple way, is just using our forms. So if you look at our life insurance application or beneficiary change form, there's an opportunity to designate a trustee in the application. And what that does really is, it really sets up a very simple type of life insurance trust. And the terms of that trust are actually basically in two sentences that are on the application. And it's basically this, is that the trustee may invest the trust funds prudently and use the funds and any investment returns for the education, support or other benefit of the minor. When the beneficiary reaches the age of majority, the trust will end and the trustee must transfer any remaining trust assets to the beneficiary.

Steven McLeod:

So that's essentially the terms of the trust and they're quite broad. And of course there's lots of interpretation in case law about some of those terms, some of those phrases in that term. But it's a very simple trust, and that is a life insurance trust. Just bear in mind that it will end when the beneficiary reaches the age majority. So it's a fairly rudimentary type. So that's the first way to set up a life insurance trust. The two other ways are setting one up through your will, so through your will, you can designate a life insurance trust through your will, and the terms of the trust are set up in the will as well. And they could be much more detailed than what I just read out, that's in our application.

Steven McLeod:

So for example, it can provide a lump sum when the beneficiary reaches the age of 25, and then perhaps more at 30, and then perhaps more at 35. Or it can have other sort of conditions attached. So there is just a lot more room to get a detailed trust through a will, or alternatively through a standalone insurance declaration. So that's the other way you can set up a life insurance trust. So basically, the process is very similar to through a will. You can make the designation through the declaration and the terms of the trust can be set out in the declaration as well. So basically, generally there's three ways, using our forms, wills, our standalone declaration. And one thing to keep in mind, and this is very important is how you notify Canada Life, or perhaps any other insurance carrier you're using, that an insurance trust has been set up, and that will receive the death benefit.

Steven McLeod:

Because really what you don't want to do is name the trustee of the insurance trust in the application, without much more detail or just specifying that there is this existing trust with the set terms that are outside of this document. Because if you don't, basically the risk is that you set up a new trust. A new trust that has very basic terms based on provincial legislation and case law. And not the detailed terms that you otherwise would've in the insurance trust setup, say in your will or in a standalone declaration. So you want to be very careful. And we do have an article on our website called Trust in Life Insurance. And it does have some instructions or guidelines on a way that you can inform Canada Life, that there is an insurance trust.

Steven McLeod:

And lastly, what we'll touch on today is an issue that the Canada revenue agency has raised about a spousal trust owning life insurance policies. And this issue likely extends as well to alter ego trust and joint partner trust, for reasons that I'll briefly describe. So the benefit with the spousal trust is that it's similar to an alter ego trust or joint partner trust in the sense that it can receive assets on a rollover basis from a spouse. So for example, if I had property, I could set up a spousal trust that benefits my spouse, and I can transfer that property to the spousal trust and there's no deemed disposition for tax purposes.

Steven McLeod:

So that is unique, because if I transferred to kind of a regular inter vivos trust, there would be a deemed disposition. So there are some rules though around spousal trust, or some restrictions, and a big one is that no other person may receive or otherwise obtain the use of any of the income or capital of the trust during the surviving spouse's lifetime. And so that applies to spousal trust. When we're talking about alter ego trust or joint partner trust, there's a very similar restriction in the sense that only the settler can obtain the use of the income or capital of the trust. Or in the case of joint partner trust, only the settler and the settler's partner or spouse rather can obtain the use or income or capital of the trust. So there is that restriction. And so the CRA has come out a number of years ago and said that, in the case of a spousal trust, it would be tainted if the terms of the trust include the obligation or power to fund a life insurance policy on the life of the surviving spouse.

Steven McLeod:

So what a tainted spousal trust means is that if it would be basically compromised in its ability to receive assets on a rollover basis. So that would basically defeat the planning of, or the point of, using a spousal trust if you don't get that rollover. So if the terms of the trust have that type of language, it could be tainted. And really what the rationale is, the rationale that the CRA would have in putting this type of restriction on a spousal trust is that it thinks that a spousal trust payment of a life insurance premium would represent someone other than the surviving spouse using the trust property during the spouse's lifetime. So I guess it just considers that if a spousal trust received the death benefit, that would happen after the spouse's lifetime. And therefore the other beneficiaries of the trust who would receive the assets after the spouse dies, would in fact get the benefit of it and not the spouse.

Steven McLeod:

So that's kind of where we're at with spousal trusts at the moment. But there are I guess, some planning measures that can be taken to address these concerns. We do go through some of these alternatives, we have another article on our Canada Life website titled Spousal Trust and Life Insurance. So it does go through this issue and offer some planning alternatives. One is just using our premiums payable 'til first death product, or participating whole life product. So basically that would basically have contractual premiums go to zero on the death of the first spouse, in the context of a joint last to die policy. So in that case, there's no more premiums. So that would basically satisfy the Canada Revenue Agency's concerns. So that's just another planning alternative, and there are others as well. And some of those are outlined in an article that we have on our TPG website, titled Spousal Trust and Life Insurance, that gets into a couple more other alternatives that are a little bit more detailed.

Steven McLeod:

In this podcast, I did reference two tax and estate planning articles. One was Trust and Life Insurance, and the other one was Spousal Trust and Life Insurance.

Marco D'Aversa:

Yes Steve, and the one thing I did want to highlight is that, we do have a Canada Life Tax and Estate Planning group at tepg.salesstrategies.ca, where you can learn more about our team and there's various resources, including articles, presentations, and podcasts. And I think that's probably a wrap Steve. So maybe I'll thank the audience for listening, and stay tuned for our next podcast.

Steven McLeod:

Thanks Marco.

Marco D'Aversa:

Thanks.

Hello, and welcome to Canada Life's tax and estate planning group's podcast. My name is Nick Fabiano, Director of the Tax and Estate Planning group at Canada Life. And I'll be your host today. Joining me for today's podcast is Stephen MacLeod, also Director of the Tax and Estate Planning group at Canada Life. Stephen, how are you today?

I'm good, Nick. Thank you very much. Great to be here for part two of our podcast series on transferring life insurance policies.

It's great to have you join us for part 2 in our series on policy transfers. In this podcast, Stephen and I will be discussing the tax issues and considerations regarding life insurance policy transfers involving shareholders and their corporations. Stephen, before we get into the specifics, perhaps you can start us off with the general overview of the tax issues surrounding policy transfers.

All right. Thanks, Nick. So in the corporate context, one thing that I would really like to stress off the top of this podcast is that when we're looking at transfers, there's always two sides of the coin. So there's the tax consequences to the policy owner transferring the life insurance policy. But there's also the tax consequences to the recipient of the life insurance policy as well. And we'll see that that's particularly important when we're transferring a policy from a corporation to a shareholder.

Now, that might be a little bit different than what we're used to in the individual context. And that's what we covered in part one of this podcast series, our transfers in the individual context where we're mostly just concerned about the individual transferring-- the owner transferring the policies. But in the corporate context, always remember that there's always two sides to the coin. So there's a transfer in the transferee. And even in some cases when we're transferring between sister companies-- and we'll talk about this-- is that there might be consequences not just to the transfer and transferee but also to the shareholder of those two companies. So definitely a lot more moving parts going on in the corporate context.

And I'll say, too, when we're talking about transfers in this particular context, there are always-- I guess the context that we're focusing on is the owner manager corporate structure. So these are basically family owned businesses. So these aren't widely held businesses. So these are definitely your owner manager type context.

And in this context, these are non arm's length transfers. And non arm's length transfers of life insurance policies are governed under a particular section of the Income Tax Act. And the proceeds of the disposition in the insurance context, to use that language-- it's always the greater of the fair market value of the consideration given for the policy, the policy CSV, and the policy's ACB. So CSV, the Cash Surrender Value of the policy, and the ACB is the Adjusted Cost Basis.

So the greater of those three amounts are going to be your deemed proceeds for tax purposes. So that amount in excess of the policy's adjusted cost basis would produce a policy gain if there is an excess over the ACB. So when we're talking about transferring from the owner, that's what we're looking at is whether or not there's a policy gain or not.

And inside a corporation-- so if there's a corporate policy owner transferring a policy and we're looking at whether or not that produces the policy gain, if it does, then that income in the corporation's hands, so to speak, is treated as passive income. And passive income inside a corporation is taxed at high rates, closer to 50% or more in some provinces-- a lot of provinces, actually, slightly over 50%-- the majority of which is a refundable tax that gets refunded to the company when it pays a taxable dividend. But that policy gain is treated as passive income. It's not treated as a capital gain.

So capital gain, of course-- half of it is included in income. Half of it is tax free. That's not the case with the policy gain. The full amount is income. Inside a corporation, it's treated as passive income. In the hands of an individual policy owner, that triggers a policy gain.

Again, that's treated as regular income. So it's not treated as capital gain. And of course, there's no such thing as a policy loss in the life insurance context. It's a policy gain treated as regular income or passive income in a corporation.

So with that background, let's start and look at the tax consequences of transferring a policy from an individual shareholder to their corporation. So Nick, can you take us through that scenario? Sure thing, Stephen. Thank you. So the first scenario we're going to look at, as you mentioned, is when an individual shareholder transfers their personal policy to their wholly owned corporation.

Now, in light of you having just provided an overview the rules, I think the best way to look at this scenario is to jump straight into a simple example. So let's see we have an individual shareholder with the personally held policy having cash surrender value of $1,000 and ACB of $100. And let's also assume the shareholder transfers the policy to the corporation for no consideration. We know we have a disposition for tax purposes. And therefore, we need to determine if the shareholder has a policy gain on the transfer. Our starting point is to figure out what the deemed proceeds will be. In order to do this, we need to look at the greatest of three amounts, as you previously mentioned, which in this case are fair market value consideration received of $0, cash surrender value of the $1,000, and ACB of $100. So in this example, the greatest amount is the cash surrender value of $1,000 and this will form the deemed proceeds. The next step is to determine the actual policy gain, which is simply the deemed proceeds of 1,000 less ACB of $100. Therefore, the individual shareholder will have a policy gain of $900. The final point to remember is that the deemed proceeds amount of $1000 will also form the starting point of the corporation's new ACB in the policy.

Now, it's easy to see that the tax outcome to the individual shareholder will depend on the extent of fair market value consideration they receive for the policy. If we simply change the previous example and assume the policy had a fair market value based on a valuation of $2,000 and the individual shareholder decides to take back $2,000 is consideration, well now we can see that the shareholder will have deemed proceeds of $2,000 since the greater of the three amounts will now be equal to the fair market value consideration received. And there's going to be a taxable policy gain now of $1,900, being the deemed proceeds of 2,000 less ACB of $100. Furthermore, the corporation will now have a starting ACB in the policy of 2,000.

So we can see how the outcomes to both the shareholder and the corporation can change simply based on the extent of fair market value consideration received on the transfer. Now, I mentioned in the revised example that, based on evaluation, the policy had a fair market value of $2,000. Stephen, perhaps you can provide some general insights on a policy's fair market value and its importance in transfer situations.

For sure. So the fair market value of a life insurance policy is important, Nick. You just described how it's important in a situation where you could be transferring a policy to a corporation and you can take back consideration from the corporation equal to the fair market value of the policy. So it's important to actually get the fair market value of the policy right because, for example, if you take back more consideration from the corporation that's in excess of the fair market value of the policy, that would result in a taxable shareholder benefit.

And as we talk about another situation where we're transferring a policy from a corporation to a shareholder, that's an asset coming out of the corporation to a shareholder. So we want to know-- we want to know the specific value of that because that will determine how we tax report that transaction for the shareholder. So getting the valuation of a life insurance policy is quite important, actually, in a lot of these contexts.

And I should just clarify, too. Canada Life does not do valuations of life insurance policies. There are a number of-- there's a handful of firms, I should say-- across Canada that with actuarial consultants who do valuations of life insurance policies for a fee. So there is that. But basically what we want is we want to be able to substantiate how we tax report these transactions. And getting a valuation for that purpose is very important.

Now, when we talk about the, what is the valuation of a life insurance policy, like I said, Canada Life does not do that. Actuarials do. But just as some guidelines just to go by, probably the cash surrender value of a life insurance policy would be, for example, the floor of what that valuation could be. And then it could go up from there. And from my understanding, a big determinant on what could influence the valuation of life insurance policy is the health status of the life insured.

So for example, just to take an extreme example, if someone has a terminal illness and they don't have long to live, then the value of that life insurance policy is probably getting closer to the death benefit of a policy. So it can go quite high. And of course, that would drive some of the tax consequences if that policy was ever transferred to or from or between corporations. So again, framework and value of policy-- it's very important, something that policy owners, if they are transferring a policy, should probably get from an actuarial consultant.

So with that, Nick, now why would someone actually want to transfer their individually owned policy to their corporation? So you described the tax consequences of doing that. So why would they actually want to do that in the first place?

Well, Stephen, there could be numerous reasons why this might happen, but mainly it would be for business or estate planning purposes. And certainly, prior to 2016 we were seeing a lot more of this type of transfer. And I'll get to why that was in a moment. But in the present time, I think one of the most common reasons, that I see anyway, is to have the corporation pay for the premiums.

And why that is because life insurance premiums are not generally deductible. Therefore, using corporate dollars that are generally taxed at a lower corporate rate to pay insurance costs is a significant incentive for business owners to transfer personal policy to their corporation. In other words, it's generally more expensive from a tax perspective for an individual to receive a salary or a dividend from his or her corp and use the after tax amounts to pay for the premium than it is for the corporation to pay the same premium with the after tax corporate dollars.

Now, having said that, though, I think often it would be shortsighted for cheaper after tax dollars to be the sole reason to transfer personal policy to your corporation without looking at some of the other facts that come along with that. So for example, consider whether the policy will now be exposed to creditors of the corporation. The provincially legislated creditor protection when naming a certain family member as a beneficiary is going to be lost when policies are transferred to a corporation.

A second thing you might want to look at is, are the shares of this company likely to be sold in the future? And if so, we could have a situation where the same policy now needs to be transferred back out, again giving rise to all these potential tax issues that we're discussing. Another item is, how will the capital gains exemption be impacted? Any cash value buildup within these policies is considered passive asset and could impact the share's eligibility for the capital gains exemption. So as you can see, there's numerous factors to consider when contemplating moving a personally owned policy into a corporation. Now, I did also want to just circle back to what I mentioned earlier regarding policy transfers from individual shareholders to their corporation prior to 2016. As some of the listeners may know, prior to the March 21, 2016 federal budget, these types of transfers are actually quite prevalent. And this was due to how the rules worked prior to being amended.

So prior to the 2016 federal budget, when a policy was transferred by an individual shareholder to their corporation, the tax rules deemed the proceeds to simply be equal to the cash value of the policy, regardless if the individual shareholder took back fair market value consideration from the corporation that was greater than the cash value. So you could have situations where the fair market value of policy was determined through a valuation to be greater than the cash value. And therefore, the shareholder would transfer the policy and take back consideration equal to that fair value, but only be taxed on a policy gain that was determined using the cash value as a deemed proceeds. So in other words, the excess fair market value over the cash value was essentially taken out of the corporation without paying any tax. Now, along comes 2016 federal budget. And they amended the rules so that this type of planning could no longer happen going forward. And as we've already stated, the rules now deem the proceeds to be the greatest of three amounts, fair market value consideration received being one of those three amounts. But interestingly enough, the 2016 amendments also contained rules that would end up retroactively impacting transfers that did take place prior to the 2016 federal budget. And that certainly has to be kept in mind. Stephen, maybe you could perhaps walk the listeners through the impact of those retroactive changes.

Sure, Nick. So these retroactive changes apply in situations where there is a transfer from a shareholder to a corporation after 1999 and before March 22, 2016. So if there was a transfer between those two dates and fair market and consideration was taken back from the corporation that exceeded the greater of the ACB and CSV of the policy, then there are two components that could basically decrease the amount of CDA that the corporation would be entitled to upon receiving a death benefit from the policy, so upon the death of the life insured.

And let's just go over those two. The first one is what we call a fixed grind on the CDA calculation. And what that is that there-- this is basically a permanent weight on the CDA credit. And basically, what is that?

So the amount of that fixed grind would be the consideration taken back from the corporation minus the greater of the ACB and CSV of the policy at that time. So the difference between those two amounts will always weigh down on-- will always decrease the amount of CDA that the corporation would generate as a result of receiving a death benefit from that policy. So that's the first one. And that one does not go away.

And the second one is something-- it's quite complicated to describe in a podcast. We do have an article on it that describes in a bit more detail, but it's not so much of a fixed amount that decreases the CDA credit. It's an amount that will decrease over time, but it's really aimed at a situation where the ACB of the policy is lower after it was transferred from the shareholder to the corporation.

So in that situation where the ACB of the policy actually decreases, there's another type of grind on the CDA. And just for the sake of this conversation, I'll leave it at that. But we do have materials that get into that in a little bit more detail. But just know that if there is a policy transfer after '99 before March 22, 2016, there's the potential for two adjustments to CDA if the shareholder took back consideration from the corporation.

Great. So enough about that. We talked quite a bit about transferring a policy from a shareholder to a corporation. So let's just turn that around. How about the other way around, about transferring a policy from a corporation to a shareholder? Definitely a very popular question that we get. Nick, you want to take us through that?

Sure thing, Stephen. And yeah, you're right. It is a common transfer scenario that we see quite a bit of, and certainly with similar issues to address that we just talked about in the previous scenario. So again, and at the risk of maybe repeating some stuff that's been already said, again we start off looking at this and saying, well, it's a transfer and there is a disposition for tax purposes. And because it is a disposition between related parties, we have certain rules that guide us.

And the rules are going to apply much as they did in the first case. They're going to apply to the corporation in determining what the deemed proceeds are. And that the deemed proceeds is going to be the greatest of the three amounts we keep talking about, being fair market value of consideration received, cash surrender value, and the ACB the policy. And the corporation will have a policy gain to the extent that the deemed proceeds is greater than the ACB.

Now, when we look at the shareholder receiving the policy, this is where it gets a little bit interesting. So the rules also tell us that the shareholder is going to receive a policy with starting ACB equal to that same deemed proceeds. But there's potentially this other significant issue that you alluded to in your opening comments, Stephen, which is around shareholder benefits. And the reason why that is because the shareholder is receiving a corporate asset and therefore will need to pay fair market value for that asset. Otherwise, we have a taxable shareholder benefit issue. And the amount of that benefit is going to be equal to the difference between what the fair market value of the policy is and what was actually paid to the corporation for that policy.

So to the extent that there is a shareholder benefit, there's a couple of things that you need to keep in mind. The first is that the shareholder benefit is fully taxable to the shareholder, but there's no corresponding deduction to the corporation. And second, either the full or a portion of that taxable shareholder benefit amount is added to the new ACB of the policy to the shareholder up to the fair market value of the policy.

And I think the best way to really understand these issues is if we just walked through a simple example. So, say you have a corporation that owns a policy that has fair value of 2,000, cash surrender value of 1,000, and ACB of $500. The corporation transfers the policy to the shareholder, but the shareholder decides to pay no consideration for it. Well, when we look at what the deemed proceeds are to the corporation, we know that it didn't receive any consideration. So that's zero. We know that the cash value is 1,000. And we know that the ACB's 500.

So in this case, the cash value of 1,000 ends up being the greatest of those three amounts. And it forms are deemed proceeds. This, in turn, causes the corporation to realize a $500 policy gain, the $1,000 deemed proceeds less the ACB of 500.

Now, when we look, though, at the impact to the shareholder, it's quite evident there's going to-- they will have a taxable shareholder benefit because they received a corporate asset that had a fair value of 2,000, but recall they decided to pay no consideration for it. So the taxable shareholder benefit in this case is going to be 2,000, which is the difference between the fair market value and what was actually paid.

And also, the ACB of the policy to the shareholder-- while it starts off at about $1,000, which was the deemed proceeds amount, there is going to be an adjustment upward to that by the taxable shareholder benefit amount but only up to the fair market value of the policy. So in this case only 1,000 of the 2,000 taxable shareholder benefit amounts will need to be added to the starting ACB in order to hit that fair market value of $2,000. So we can see that the initial results of the corporation's shareholder-- they would actually be the same regardless if this was an individual shareholder or corporate shareholder. And obviously, it's wise to avoid or at the very least try to manage the shareholder benefit issues if possible. And maybe with that, Stephen, I'll ask you to discuss ways that there are in terms of managing shareholder benefit issues in these cases.

Sure, Nick. One are the main reasons or main ways of managing the shareholder benefit issue is to have the transfer be characterized as a dividend rather than a shareholder benefit. So as you're saying a shareholder benefit is taxable, the inclusion income is just treated as regular income. And dividends are taxed at a slightly more favorable rate than regular income. So there might be some tax savings if the transfer is instead characterized as a dividend.

So what does that mean? Well, a corporation can pay dividends in cash, or it can pay a dividend in property. The dividend in property is a dividend in kind. So what we want to do is pay that or transfer that policy out as a dividend in kind.

And to do that, it kind of goes back to what we were saying about getting a valuation. So we would need a valuation of the policy and then pay out the dividend-- pay out the policy as a dividend in kind. And then that amount, being the fair market value of the policy that we know from the valuation, would be the income inclusion to the shareholder in that situation. So you could get some tax savings doing it that way. So that's the corporation transferring the policy to an individual shareholder.

Same thing applies with a corporate shareholder. So if we have a holding company and the holding company owns an operating company and let's just say the operating company owns the life insurance policy, well, if the operating company just transferred that policy to the holding company, we can actually get into that taxable shareholder benefit issue in this context as well. You often don't see shareholder benefit issues in the corporate context simply because corporations can transfer assets between themselves or to a shareholder that's a corporate shareholder as a tax-free inter-corporate dividend. And that's exactly how we would want to treat a transfer of a policy from a subsidiary to a parent company or to a shareholder company, as well as that we wanted to have that treated as a tax-free inter-corporate dividend as well.

So to do that, again, you'd have to pay the policy out as a dividend in kind. And that's simply done in the same exact same way that we described in the context of transferring the policy to an individual shareholder, is that you'd want-- is that you'd want to declare a dividend on the shares that are owned by the corporate shareholder. And then the payment is done by transferring the policy.

And if the companies are connected-- and like I said earlier, in this context, we're talking about what we're talking about these transfers between companies. It's in the context of the owner manager. So these are companies that are held within perhaps a family. And in that situation, the corporations are most likely connected. Of course, this is something that you want the client's tax professionals to confirm, but dividends between connected corporations are tax free. So then if the policy is paid as a dividend in kind, going from a subsidiary or an operating company to a wholly owned holding company, there would be a tax-free inter-corporate dividend in that situation.

I just want to just be clear, though. So when a dividend in kind is paid, there's no consideration for that. So when we're going through-- so when we're looking at, OK, what are the proceeds to the corporate policy owner that's transferring the policy, we're looking at the highest of the ACB, CSV, and fair market value given for the transfer or fair market value consideration given for the transfer. There is no consideration with a dividend in kind.

Now, I just want to juxtapose that situation to another type of transaction that a lot of tax professionals will do to get that tax for inter-corporate treatment. A lot of tax professionals will characterize transfers of assets between companies as payment of a share redemption-- or the payment of the price of a share redemption. So it's fairly common these days for companies to do share redemptions to get assets on a tax-free basis from one company to another because the tax treatment of a share redemption is a deemed dividend. And like I said, dividends between connected companies can be tax free.

But I would just-- I would just very much caution people or perhaps new tax professionals listening to this. When you transfer a policy as a payment for redemption price, that redemption price becomes the consideration for the transfer. So that could increase the deemed proceeds, which could produce a policy gain for the corporate policy owner transferring the policy.

And the same thing goes if you want to characterize an inter-corporate transaction through debt, so characterizing it as a receivable. That becomes the consideration as well. So just be very mindful of that, if redemptions and receivables-- they could push up the deemed proceeds because that could be the consideration for the transfer. So transfers by dividend in kind are definitely the safest way to go between when you're talking about inter-corporate transfers.

We probably want to get into-- I'll end on this one last situation, and that's transfers between sister companies. So what's a sister company? It's two companies that are owned directly by a shareholder. So it's not a parent subsidiary situation where there's a holding company and operating company type of thing. So it's basically two companies that aren't owned. They don't have inter-company shareholdings, but they're just owned by one-- oftentimes it's an individual.

So a lot of times assets will be transferred between sister companies before a company is sold. So an individual shareholder will want to use their capital gains exemption. And to do that, you basically want to purify the company and get all the passive assets out of it so you satisfy the tests that the shareholder can-- so that they can use their capital gains exemption.

So when you do that, you want to have assets go to a sister company at fair market value-- or for fair market value consideration, or else you could create a tax issue for the shareholder individually. So there's an indirect payment anti-avoidance provision. It's fairly broadly worded. 56-2 if anyone wants to visit that section of the Income Tax Act, but it could basically create tax issues for the individual shareholder unless the assets go between the companies for fair market value consideration.

And often when that happens, it's often done as a result of a type of single-wing butterfly transaction where there are shares that are being transferred over for assets and they're redeemed. And basically that redemption gets you back into that situation where I described where the payment of redemption price using an asset that includes a life insurance policy could be the considered, or would be considered, consideration for the transfer of that policy, and therefore could push up the deemed proceeds of disposition and create a policy gain.

So when you transfer that policy over to a sister company, just be concerned. If a policy is in a policy gain situation, if the fair market value of the policy kind of exceeds the ACB of the policy, you're almost in a no win situation when you're transferring it over. It's either you push up the deemed proceeds by having it go over for fair market value consideration. Or if you don't do that, you could create a tax issue individual shareholder owning the two companies.

So that's an issue just to bear in mind, kind of a nuanced issue. But Nick, you have the last word today. There's one last situation in the corporate context that we haven't talked about yet. And that's amalgamations and wind ups. Would you be able to give us a high level overview of the tax consequences of that scenario?

Yeah. Sure thing, Stephen. And I think it is important to note that sometimes policy transfers are necessitated because of corporate restructuring transactions like amalgamations or wind ups. So for example, you may have a corporation that owns a policy and that corporation is either going to be amalgamated with another corporation or wound up into a parent corporation. Now, in both these cases, there will be no disposition of the policy for tax purposes. And a tax-deferred transfer is generally allowed. But on the other hand, though, there is one important difference. And that's where corporation is wound up in any other circumstances other than into a parent corp. The tax consequences there could be quite different.

So for example, if you have a corporation that is owned by one or more individual shareholders and it is being wound up or dissolved, the corporation is deemed to receive proceeds equal to fair value of the policy. And to the extent that fair value exceeds ACB, the corporation will, in fact, have a taxable policy gain. Also, the ACB of that policy to the shareholder will now start off equal to the fair market value immediately before the wind up. So you do have a taxable event and the individual having a starting position in the ACB of that policy all driven by the fair market value of that policy.

The other thing I would mention is that the individual shareholder would actually have a taxable dividend now equal to the fair market value of the policy as well. And that's as a result of having received the policy on wind up of then distribution from the corporation. So it is a quite different scenario than the previous wind up scenario where the corporation is just simply wound up into a parent one. This one here is quite different. It has different tax results. So it's important to be aware of the type of restructuring transaction in order to understand the potential tax concerns and issues.

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With that, we've covered quite a bit in this podcast regarding policy transfers and the numerous issues that can arise and that need to be addressed. And I'd like to point out that we have a number of great written resources regarding policy transfers on our website at PEPG.salesstrategies.ca under the Articles and Brochures Resource section of our site. So please visit the website for more information. And as a final takeaway before we end off our podcast, I just wanted to remind our listeners that the rules regarding policy transfers are complex. And it's always best to get professional tax and legal advice when dealing with policy transfers so that, not only that all the issues are addressed but any alternative planning that might be available is evaluated based on the particular circumstances. So on behalf of Stephen and myself, thank you for listening to our podcast. And we hope you found it useful.

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Hi and welcome to the Canada Life Tax and Estate Planning Group Podcast. My name is Stephen McLeod. I'm your host for today and a member of the Tax and Estate Planning Group here at Canada Life. I'm joined by my colleague and co-host, Marco D'Aversa.

How are you doing, Marco?

I'm doing great, Steve. I'm glad to be joining you today in our latest podcast.

Excellent. And in this podcast, we're going to talk about a very popular topic, and that's the tax consequences of transferring a life insurance policy. Now, this podcast is part one of two. And in this podcast, we're going to talk about transfers in the individual context and in the trust context. So individual, we're going to talk about the non-arm's length and arms length transfers, some of the more common situations with non-arm's length transfers, and also the tax consequences of transferring a policy to a trust and from a trust to a beneficiary.

And then in part two, we're going to talk about transfers in the corporate context. So transferring to a company, from a company to a shareholder, and then between companies as well. So the tax consequences of those. So very popular topic. And with that, Marco, I think we should get into it. So why don't you take us through the tax rules that apply to the arm's length transfers and non arm's length transfers and maybe describe the differences between those two as well?

Sure. Thank you, Steve. And yeah, so let's get right into it. So non-arm's length transfers are basically transactions between related parties. And for non-arm's length transfers, they are governed under subsection 148(7) of the Income Tax Act. And it should also be noted that this provision also covers gifts, distributions from a corporation, and transfers by operation of law.

More specifically for non-arm's length transfers, the proceeds of disposition to the transferor are deemed to equal the greater of, one, the consideration received on the transfer, two, the adjusted cost basis of the policy at the time of transfer, and three, the cash surrender value of the policy at the time of transfer. Now, this greater of these three amounts also becomes the adjusted cost basis to the transferee or the recipient of the policy. To the extent the deemed proceeds of disposition is greater than the adjusted cost basis, then the transferor has a policy gain for tax purposes.

In the case of arm's length transfers, the transferor's proceeds of disposition and the transferee's ACB is generally equal to the agreed upon sales price or consideration paid for the policy. Again, a policy gain will result to the transferor to the extent that the proceeds of disposition exceeds the adjusted cost base of the policy.

It should be noted, Steve, that there are two common situations where there is an arm's length transfer but the tax result is different than I mentioned above. Namely, when there's a gift of a policy to a charity and secondly when there's a transfer of policy from an employer to an employee. So let me dive more deeply into these two situations.

In the case of a charitable donation of a policy, the tax consequences are as follows. Subsection 148(7) will apply as it covers gifts, as I mentioned before. As such, the donor's proceeds of disposition will be deemed to equal the greater of those three amounts I mentioned earlier. First the consideration received, which would generally be 0 in the case of a donation, to the adjusted cost basis of the policy at the time of the donation and, three, the cash surrender value of the policy at the time of donation. And again, a policy gain will result to the donor to the extent the deemed proceeds of disposition exceeds the adjusted cost basis.

Furthermore, the donor will receive a donation received from the charity equal to the fair market value of the policy. However, there is an anti-avoidance rule that must be considered that will deem the fair market value or the donation receipt equal to the adjusted cost basis of the policy at the time of donation. And the conditions for this anti-avoidance rule are as follows. One, where the policy was acquired less than three years before the donation was made or, two, less than 10 years before the donation was made and it's reasonable to conclude that one of the main reasons that the policy was acquired was to donate. Now, in the second scenario, in the case of transfers from an employer to an employee of a policy, again, this transfer is governed under subsection 148(7), as the transfer is generally considered a distribution from a corporation. As such, the employer is deemed to have proceeds of disposition equal to the greater of, again, those three amounts, one, the consideration received, two, the adjusted cost base of the policy, and three, the cash surrender value of the policy.

Again, a policy gain will result to the employer to the extent the proceeds of disposition exceeds the ACB. And from the employer's perspective, there will be a taxable benefit to the employee to the extent that the fair market value of the policy is greater than the consideration that the employee paid for the policy. This taxable benefit would be T4ed to the employee and would be subject to a tax in the employee's hands. Furthermore, the adjusted cost basis of the employee's interest in the policy would include this taxable benefit. Therefore, it'll eliminate any potential double taxation. So Stephen, I think this summarizes the non-arm's length and arm's length transfers. Maybe I'll pass it back to you just to expand on policy gains and the taxation thereof.

All right, thanks Marco. Right. So you mentioned a policy gain a couple instances there describing the tax consequences for non-arm's length and arm's length transfer. So a policy gain is basically income in the hands of the individual transferor when the proceeds of disposition or proceeds of the disposition I guess we say in the insurance context exceed the adjusted cost basis of the policy. So the difference between the proceeds, and that could be a deemed amount, as you discussed, Marco. So it could be the fair market value of that consideration, the CSV or ACB. So the higher of those three is the deemed proceeds in a lot of these transfers that we look at.

So if that amount exceeds the ACB of the policy, it's a policy gain. And a policy gain is in the hands of an individual. It's just treated as regular income. So it's not like a capital gain. It kind of sounds like a capital gain, but it's certainly not taxed like one. So a capital gain has a 50% inclusion rate. So half of a capital gain is treated as income. Definitely not the case with the policy gain. 100% of the policy gain is included in income.

We the insurer, we track a policy owner's policy gain and we'll issue a tax slip if there is one. And also there's no such thing as a policy loss. So in the capital gain, capital contacts with capital property, there's capital gains and capital losses. In insurance, there's just a policy gain. No such thing as a policy loss. And it's treated as regular income in the hands of an individual. So that's a kind of a policy gain in a nutshell.

And with that, I want to move on into talking about more of the common situations that we would see in non-arm's length situations. And so I'm going to start on talking about transfers between spouses. And then after that, Marco, you can touch on transferring between, say, parents and kids or grandparents and grandkids in that scenario.

But in the spousal context, so just like with any type of property, there is-- or with capital property, there is a rollover available for transfers of a life insurance policy between spouses and common law partners. There's also a spousal rollover to a former spouse if the transfer is arising from a settlement of rights stemming from a breakdown in marriage. So there is an automatic spousal rollover in that type of situation.

Both policy owner and the spouse or former spouse, as the case may be, have to be a resident of Canada to get the rollover. It is possible to elect out of the rollover if a policy owner wanted to trigger a policy gain. Maybe there's some non-capital losses that can be used. They could certainly trigger a policy gain and elect out of the rollover. Certainly more uncommon to do that. So there is that rollover to a spouse.

And I should clarify that also applies on life and on death. So if a policy owner was transferring or transferred a policy to their spouse via their will, so goes through the estate to a surviving spouse, there is a rollover in that context as well. But I should clarify, and it's kind of a big caveat with this, is that we're probably used to hearing about property being able to roll over to the spousal trust. And that's either an inter vivos spousal trust. So it's a trust set up during the spouse's lifetime or on death.

There could be a testamentary spousal trust. So if we're transferring a life insurance policy to a inter vivos or testamentary spousal trust, there is no rollover. So that's definitely one thing to bear in mind with your client's tax and estate planning is that if the idea is to put a bunch of assets over into a spousal trust, a life insurance policy could go, but it would not get rollover treatment, unfortunately.

So Marco, the spousal rollover, it's a common type of transaction that achieves a rollover. Like I said before, another one is that intergenerational rollover. Can you take us through this intergenerational rollover, kind of the why someone would like to use it and the tax consequences?

Yeah, for sure, Steve. And I'll refer to cascading, because that's a term commonly used for the intergenerational rollover. It's commonly referred to the cascading strategy. Now, the cascading strategy is a popular strategy used mainly by wealthy clients to transfer wealth to future generations taxed efficiently. And cascading works because of subsection 148 of the Income Tax Act. In particular, this provision allows for a tax free rollover of a life insurance policy where the policy is transferred to the policyholder's child for no consideration and where the life insured is a child of the policyholder or a child of the transferee.

Now, for purposes of this rule, the child would also include a grandchild, a great grandchild, a stepchild, an adopted child, a son or daughter-in-law, and a person who at any time when under 19 was wholly dependent for support and under custody control of the policyholder. So this provision is unique to the Income Tax Act, because Stephen, as you know, in general purposes, when you try to transfer property other than insurance from a parent to a child, it typically results in adverse tax implications to the transferor and potentially to the transferee.

However, with this provision, a taxpayer is able to transfer a policy on the life of a child to another child or to that same child on a rollover basis. And for that reason, the strategy is amazing for transferring wealth to future generations, works well with wealthy clients. It also allows for a tax efficient transfer of wealth and potential income stream to both the parent and the child. So maybe, Stephen, maybe I'll ask you to talk about some of the nuances with this cascading strategy.

Sure, Marco. A big nuance with the cascading strategy is that to get the intergenerational rollover, the child recipient of the policy has to receive it directly. So what does that mean? Well, it means either the policy owner has to transfer the policy directly to the transferee child or name of the child as a contingent owner in the contract. Now, unfortunately if the policy is, for example, if it's transferred to a trust that's set up for the benefit of the child, so it's indirectly received, that does not achieve the intergenerational rollover. The CRA actually interprets that section quite strictly. And basically you have to have that direct ownership of it.

Now, in the case of a minor, if a minor, for example, is named as a contingent owner of the policy, before we transfer it over, what we require is in-- and this is in provinces where like, for example, in Ontario and Alberta, a 16-year-old can contract to purchase life insurance. So for example, a 16-year-old and older can actually receive the policy. But in instances where the recipient is below that age, we'd actually require a court appointed guardian of property.

And where there's a court appointed guardian of property, that would accomplish the intergenerational rollover in that context, unlike the trust context where if a trustee received it, there would not be a rollover in that situation. So there's a court appointed guardian of property. You do achieve the rollover. Apart from that, the child has to receive that insurance policy directly to achieve the rollover.

Another, I guess, alternative to the intergenerational rollover, and if that is an issue with I guess having the policy go from the owner to the child and achieving that rollover is important, one ownership alternative is using a trust. And transfers to a trust are generally-- they generally can't be done on a rollover basis. So setting that type of ownership arrangement up within a trust at the onset is quite important if you want to achieve that rollover.

Now, transfers to a trust generally with anything cannot go on a rollover basis. There's three exceptions, really. There's a spousal trust, alter ego trust. So that's a trust set up for basically yourself. It's a probate planning tool, really. And then a joint partner trust. So assets can go to those three types of trusts generally on a rollover basis. That's not the case with life insurance, unfortunately.

So as I said earlier on in this podcast, a transfer to a spousal trust cannot occur on a rollover basis. The same thing applies to the other types. So like alter ego, joint partner. We're kind of used to hearing about assets going over these types of trust on a rollover basis. But again, that doesn't apply to life insurance. Whenever insurance is transferred to a trust, there is a disposition of that. And 147, Marco, will apply, as you indicated above. So the proceeds will be the greater of the fair market value of the consideration given the CSV and the ACB of the policy. In most cases, that will be at CSV in most cases with the permanent policy.

So Marco, that's how transfers to a trust occur. And that's the tax treatment of transfers to a trust. How about when policies are transferred from a trust to a beneficiary? How are those treated for tax purposes?

Yeah, so fortunately, transfers out of a trust of a life insurance policy do have a favorable treatment. Now, there is a provision in the Income Tax Act that allows capital property to be transferred out on a rollover basis from a trust to a capital beneficiary in satisfaction of their capital interest in the trust. For this rollover to apply, certain conditions have to be met. Mainly one, the beneficiary must be resident in Canada for tax purposes. And two, the trust must not be tainted by subsection 75(2) at the attribution rules under the Income Tax Act.

Now, for purposes of this provision, a life insurance policy held by a trust is considered to be capital property. And therefore, the rollover provision would apply as long as the conditions are met, which is not the case in other provisions in the Income Tax Act where a life insurance property is not considered a capital property. For example, for section 85 rollovers. But again, for this purpose of the rollover, it is capital property. And in a nutshell, a life insurance policy could be transferred out to a beneficiary on a rollover basis.

As such, a trust structure can be used as an alternative to a cascading strategy, as I talked about earlier, where you otherwise don't, for example, meet the conditions of the cascading rollover rules previously discussed. For example, where you have a policy on a niece or nephew and you're looking to transfer that policy to a niece or nephew, you can't do it under the cascading rules, because the niece or nephew doesn't meet the definition of a child.

However, if a policy could be acquired in a trust structure, it could be transferred out on a rollover basis from the trust to a niece or nephew as long as they're capital beneficiaries of that trust. So that's one example where a trust structure might be used. But there are also other situations where a life insurance might be owned by a trust. Maybe, Steve, I'll pass it back to you just maybe to talk about other situations where a trust could be used to own a life insurance policy.

Sure. And also build on your cascading example with a niece or nephew as they don't fit the definition of a child under the intergenerational rollover rules. But even if a policy owner wants to own a policy on their child and they might be in the situation where the child is a minor and they're kind of looking at, OK, well, if I do make this person or the child a contingent owner, but they could be a minor at that time. And if they don't want to go through the whole process of getting a court appointed guardian of property, then maybe starting out with a trust is actually a good alternative from the outset, because you can roll that property out to a beneficiary who's a resident in Canada on a rollover basis under the rules that you're referring to there, Marco. So that's one.

And then another common situation too is that US citizens owning life insurance, a very common tax planning method that they use is using something called an irrevocable life insurance trust to own the life insurance policy. And the type of planning that that's for is for US estate taxes. So if a US citizen owns, and this could be a US citizen in Canada, but if they own a life insurance policy on their life, that death benefit gets included in their estate for US estate tax purposes. So if instead something called, like I said, an ILIT life insurance trust owns that policy, that death benefit does not get included in their estate if it's set up properly and operated properly. So that's another common use of a trust owning life insurance. And then I guess I kind of close on the last point is that life insurance in trusts, I mean, if somebody wants to have a trust that's set up to create a type of legacy, it might exist past the trust 21st anniversary where there is a deemed disposition for tax purposes of all the capital property in the trust. A life insurance policy does not fall under that.

So it's actually a life insurance policy will not be deemed to be disposed of for tax purposes in a trust, which is unlike other types of, I guess, your traditional investments that a trust could own. So a life insurance is actually quite well suited for that type of arrangement where they're supposed to be assets in a trust for a fairly long time exceeding a 21 year period. So that's kind of the areas where a trust might be used in the life insurance context.

So with that, Marco, we certainly looked at a number of situations involving transfers and policies in the individual context. So we looked at non-arm's length transfers. And so we looked at some arm's length transfers and to situations where that might be more common in the charitable context and in the employer employee context as well. You might see that arm's length transfer. We looked at policy gains. We looked at transfers between spouses, spousal trusts. We looked at the tax consequences of intergenerational transfers, and we looked at the cascading rules as well. And then we spent some time on transfers to trusts and transfers from trusts.

And with that, that really does wrap up our first podcast on this topic. And like I said at the beginning of this podcast, we do have a part two to this where we're going to look at transfers in the corporate context. So to a corporation from a corporation and then between corporations as well. So hopefully you can join us for that.

And for more materials on these topics as well, we do have a number of technical materials that cover all the aspects of transferring life insurance policies in various contexts on our website at tepg.salesstrategies.ca. We do have a section on articles, and within that there's a topic on transferring life insurance that has a number of resources with this technical information. So with that, thank you for joining us and listening to this podcast.

Steven McLeod:

Hi, my name is Steven McLeod, and welcome to the very first Tax and Estate Planning Group Podcast. In this series of podcasts, we'll cover technical tax and estate planning topics that matter the most to you. We have a number of written resources available to you, but we want to introduce this new format that might cover technical topics in a more accessible way. I'm here with my colleague and co-host Marco D'Aversa, who's joining us over the phone. Hi, Marco. How are you?

Marco D'Aversa:

I'm very good, Steven. I'm very excited about this first podcast on Corporate Owned Life Insurance.

Steven McLeod:

Excellent. Thank you, Marco. A quick intro about me. I'm a lawyer with tax and estate planning background. I've been with Canada life for approximately 11 years. Five of those years, I've been in the field working with advisors on their large and complex case work. And in the past six years, I've been at head office in the tax and estate planning group, helping wholesalers and producing articles and presentations relating to life insurance and living benefits. Marco, can you tell us a little bit about yourself?

Marco D'Aversa:

Yeah. Thanks Stephen. I'm a charter professional accountant by background. I've been practicing taxation for the last 20 plus years. The last nine years I've been with Canada Life and for the first eight years of Canada Life, I was part of the wholesaling team supporting the advisors on large cases. And for the past year I've been with Steven as, as part of the tax and the estate planning group at head office.

Steven McLeod:

Excellent. Thanks Marco. So for this first podcast, we'll discuss Corporate Owned Life Insurance and some of the benefits and considerations that go with it. Marco, why don't you get us started?

Marco D'Aversa:

Sure. So, Steve, earlier you mentioned today's topic is Corporate Owned Life Insurance. And when you're structuring life insurance, there's generally two places that it's either held personally or corporately. And when you're dealing with a business client, that decision becomes crucial because you do have the option of owning a policy personally, or corporately. For today's topic, we're going to get into corporate and life insurance. We're going to talk about why people buy policies within their corporation. And then we'll talk about some of the considerations that you'll look into when deciding whether to put up policy corporately, or personally, and some of the pitfalls to watch out for. So maybe Steven, I'll leave it to you to talk a bit about, why Corporate Owned Life Insurance is used as an estate planning tool.

Steven McLeod:

Absolutely. So when we talk about Corporate Owned Life Insurance, it could really be for a couple of purposes. It could be for the corporation's purpose, or it could be for the individual shareholders purpose. Now from a corporation's point of view, they can have insurance or insurance needs because they might have a commercial loan and the bank requires life insurance on the shareholder, or there might be multiple shareholders and they might want to fund a buy-sell arrangement with life insurance, or there might be a key person in the company. And if that key person died, they might use life insurance to possibly smooth over the financial impact of that person's debt. So there are commercial reasons why a corporation might want life insurance, but there's also an opportunity for the individual to have life insurance owned corporately as welL for an insurance policy that satisfies their individual needs.

Steven McLeod:

For example, by virtue of having a successful business, they might have a capital gains tax liability on death, or they might want to provide financial protection for their family and use life insurance for that purpose, or they might have an insurance need, but they might also have money in their company that's really earmarked for their children or potentially their grandchildren, or we can talk a little bit about this later too, or maybe even a charity, but you can use a policy owned in the corporation can also satisfy those functions as well. So it's a great way as we'll discuss to basically transfer those assets onto the next generation in a very tax efficient way.

Steven McLeod:

And owning a corporate is also a great opportunity, and really for a couple reasons. One is the tax savings and Marco you'll talk a little bit about that. And also that's the tax savings of having the corporation owned and payed for the policy, but also just the tax savings on getting those assets out of the corporation by virtue of using the capital dividend account, which I'll get into a little bit later as well. So Marco, you want to discuss a little bit about the tax savings of having a company pay for a policy instead of the shareholder individually?

Marco D'Aversa:

And I think probably the easiest way to go through that is with an example. Generally, as we all know, life insurance premiums are typically not deductible. For that reason, when you're looking at the absolute cost of funding a policy, you want to look at pretax dollars to see how much you need, then net a certain amount after tax to pay the premium. And in the current thing in landscape, generally personal tax rates are higher than corporate tax, therefore on a pre-tax basis, there's savings using corporate dollars to pay for a premium versus using personal dollars. So using a simple example, let's assume client has a corporation. And the corporate tax rate within the corporation is at the active business rate at the small business rate of say 12%. And let's also assume the client has a personal tax rate of 50%. So if we compare owning the policy personally, versus owning the policy and the corporation, the results are as follows. If you own the policy personally, the corporation would have to earn roughly $20,000 in order to pay a salary to the individual.

Marco D'Aversa:

And that's $10,000 because individual's tax rate is roughly 50%. So $20,000 is needed. 10,000 goes to the CRA, you net 10,000, and that would fund a $10,000 premium. Now, if you wanted to fund the same level of premium corporately in order to generate $10,000 after tax within the corporation, assuming a tax rate of 12%, the corporation only has to earn roughly $11,364. They would pay roughly $1,364 in taxes and net 10,000 for the premium on the life insurance policy. So when you compare these scenarios, owning a policy personally, versus through the corporation, in this example, there's a net savings of roughly $8,600 between the two. So for that reason, Corporate Owned Life Insurance is very attractive. However, as you probably know, there's various other things we need to consider before going down that route.

Steven McLeod:

I just wanted to clarify. So that's active business income, correct? So if the corporation needs earn active business income, as opposed to passive income.

Marco D'Aversa:

That's right. So we're talking about a 12% rate. We're talking about active business income earned into corporation that's subject to the... Is eligible for the small business rate. That said, when you do structure the policy corporately, if you do that, you have to be aware of some pitfalls that sometimes are over overlooked. One of the main pitfalls is, having the owner and the benefits of the policy being different. As a general rule of thumb, what I tell most clients and advisors is that if you're going to own a policy quartelyly, the corporation should be both the owner and beneficiary of the policy. Failing to do that, for example, if you own the policy corporately, and name, for example, the shareholder's beneficiary, you fall into 15 sub one of the act, which is college's shareholder benefit that would arise. And without getting into a lot of detail, the net result of that, is that the premium would be a shareholder benefits for the shareholder and would be taxed ordinary rates by the shareholder and the corporation wouldn't be entitled to underlying reluctant. So it results in a double tax.

Steven McLeod:

Great. That's a great rule of thumb to keep in mind when you're structuring a corporate on life insurance policy is to have the corporate owner as the beneficiary, to avoid that shareholder benefit issue.

Marco D'Aversa:

Right. And another example, is a lot of times you might want to have one corporation on the policy and have a sister corporation be the beneficiary. Again, there are taxable benefits of provisions within the income tax act that could apply again, 15 sub one, and 246 sub one. So again, you have to be very careful when structuring a policy within a corporation. But that said, if it's structured properly, the advantages are quite significant, and one of the other advantages that is available, is something called the capital dividend account. And maybe I'll pass back to you Steven, to talk a bit about the capital dividend account.

Steven McLeod:

Thanks Marco. Like I said before, having a corporate owned life insurance policy is an opportunity. It's an opportunity for a couple reasons. One is, as you explained, Marco, a corporation earning active business income can pay the premium cost of a policy and shareholder can achieve significant tax savings by having the corporation pay the premium instead of the shareholder paying the premium with after tax personal dollars. The other opportunity is that with a corporate owned life insurance policy, when a corporation owns a policy, and he's the beneficiary, when the life insured dies and the corporation receives the death benefit, the death benefit minus the adjusted cost basis of the policy. And I'll talk a little bit about that later, credits the corporation's capital dividend account. And when a corporation has a credit to its capital dividend account, we'll just call it CDA for short, it can pay out a tax free capital dividend to its shareholders who are residents of Canada.

Steven McLeod:

So that's a very unique feature to life insurance and it's really a significant benefit as it allows the corporation to distribute an asset like a death benefit out tax free to its Canadian resident shareholders. Now, the amount that can be distributed out tax free is dependent upon the adjusted cost basis or ACB of the policy. So you can think about the ACB of the policy, similar to the ACB or adjusted cost base of other types of assets that a corporation might own. So what it pays for the asset that contributes to its adjusted cost base. So life insurance is similar. So the premium cost that the corporation will pay each year for a set amount of time gets added to the ACB of the policy, but the ACB can also get grounded down by something called the Net Cost of Pure Insurance, or NCPI for short.

Steven McLeod:

The NCPI, is basically a statutory estimate of the cost of insurance. Infact, it doesn't actually impact the actual pricing of the policy. And, it has nothing to do with what the client or the corporation in this case actually pays for the policy. It's just a statutory estimate of the cost of insurance that's in the income tax act. And every year, there's that estimate of the cost of insurance. And it grinds down the ACB of the policy. The premiums increase the ACB of the policy, and then the NCPI grinds down the ACB of the policy. So over time, what you can see is that the ACB of the policy could actually go to nil. Not in all cases, but in some cases it could, which would entail that the full death benefit received by the corporation can be paid out as a tax-free capital dividend.

Steven McLeod:

And that's very unique when you compare life insurance to other types of financial products that the corporation can own. So like traditional corporate investments, don't typically have that, unless you're looking at a capital gain where half of it can be added to a corporation CDA, but this is a very unique feature of life insurance, which basically allows it to get assets out all or substantially, or significant amount as a tax-free capital dividend. So, Marco, I mentioned this is a unique feature of life insurance. Would you be able to talk a little bit about how different that is, compared to other types of products or traditional corporate investments that the corporation may own?

Marco D'Aversa:

Yeah. Thanks, Steve. You're right. The CDA mechanism is one of the main advantages of life experience has over other types of typical corporate investments. But the other advantage just as important is the tax advantage growth within the life insurance policy. So, as we know, if you have a tax value product that's exempt, the growth within the policy is exempt from taxation. And when you own that policy within a corporation, again, the growth and the cash value is not considered to be passive income subject to passive the corporation. So if we step back and look at passive income in a corporation, the one thing to keep in mind and remember is, the rate of tax that you pay within a corporation on passive income, is different than the rate of tax you pay in a corporation for active business income.

Marco D'Aversa:

So in the previous example, we gave before going through the example of the tax savings of corporate versus personal, we talked about a corporation paying tax of 12% because of the small deduction. However, if that same corporation earns investment income, whether it's interest, income, rental income, or whatnot, that investment income would generally be taxed at the passive rate within the corporation that is roughly around 50% across the country. Here in Ontario, 50.17%. But again, it varies by province. So that means that for every dollar of investment income you earn in your corporation, 50% of it is going to the CRA for taxes. That said, there is something called the refundable dividend tax on hand mechanism that's in play, where a portion of that 50 cents on the dollar that you're paying and taxes goes into the refundable accoun that's refunded to the corporation upon payment of a taxable dividend.

Marco D'Aversa:

One of the main advantages of life insurance as I said, it's not subject to this 50% tax. Namely the cash value increase every year is not subject spending tax. Moreover, the other thing to keep in mind is that passive income in a corporation, once it reaches a threshold, it causes back your small business deduction limit. Now the small business deduction limit to a appropriation is $500,000 a year. However, once you earn more than $50,000 of passive income in a corporation, it grinds that $500,000 limit at a one to $5 ratio. So for example, if you have more than $150,000 of passive income, you get no small business deductions because your full $500,000 small business deduction limit is ground down to zero. Again, the insurance product on its own doesn't create passive income. So it doesn't result in a grind in your small business deduction limit.

Marco D'Aversa:

So that's another advantage of the life insurance versus a traditional investment within a corporation. So between the CDA that Steven talked about and the nature of the insurance product being exempt from taxation, as it relates to the growth of the cash value on a yearly basis, it does make the life insurance product hopefully held a lot more attractive than a traditional investment fee. So maybe I'll, I'll pass it back to you, Steve, and maybe we could circle back and talk about those situations where we do deviate between the beneficiary and the the policy holder being the same corporation. Earlier I mentioned that the rule of thumb as you want them to be the same, however, there are situations where they could be different.

Steven McLeod:

There is a small opportunity where a corporate policy owner and beneficiary can be different entities. And maybe before getting to that, I'll just take the audience through a bit of some background of how this arose. As I said before, the CDA credit is death benefit minus the ACB of the policy. There used to be some planning done probably in the excess of 10 years ago, I suppose, where there would be a corporate policy owner and say a holding company, because often you wouldn't want a permanent life insurance policy in an operating company just to protect the cash value of the policy, if there is any. So you'd have, for example, a holding company owning the policy and then an operating company would be the beneficiary or perhaps another company.

Steven McLeod:

And because the beneficiary receiving the death benefit would not have an adjusted cost basis in the policy, the full amount of the death benefit would get credited to that corporation's capital dividend account, which would allow it to pay out a capital dividend. So over time, the CRA made several statements indicating that they don't like that type of planning and that they would apply something called the 246 benefit on the operating company, which is basically a benefit that would apply to the amount of the premium paid by the holding company. And that benefit would be assessed against the operating company. So the CRA said, "Well, we don't like that planning, we'll apply this 246 benefit." And then a few years after that, the definition of the capital dividend account or CDA was amended so that the adjusted cost basis of the policy would basically be attributed to whichever corporate beneficiary received the death benefit.

Steven McLeod:

So basically, if it was a million dollar death benefit and there was $100,000 ACB of the corporate policy owner, if there was another corporation that received the death benefit, only $900,000 would be credited to the CDA. Whereas before the amendment, there would be the full million dollars that would be credited to the CDA. Since that amendment, though, the CRA has not come back and said, "Well, what we said about that section 246 benefit, they haven't said anything about, about basically retracting that and allowing a corporate owner, that's a holding company to have a subsidiary or an operating company, be the beneficiary or another company, because presumably that the amendment that I spoke to earlier addressed the CRA is concerned. But at this point in time though, we're stuck in what seems to be a limbo point in time where we have to deal with the statement that CRA said earlier, but we also have this amendment that presumably dealt with the CRA's concern.

Steven McLeod:

So in any event, we're in a situation where if a holding company is not an arm's length with subsidiary, if the holding company owns the policy, and a subsidiary is the beneficiary, then you would have this 246 issue. Now there is a car vote from 246 where the whoever's benefiting from it, I guess in this case, it would be the subsidiary is at arm's length, in this case would be the holding company. So in the life insurance context, where would you get into that situation where you have a holding company that is at arm's length with a subsidiary and why would you want that? For the most part, that situation would be where you would have an insured buy-sell situation where you have insurance to fund a buy-sell provision in a shareholder's agreement.

Steven McLeod:

So basically if you had, Mr. A and Mr. B, they have their own holding companies and each of those holding companies own 50% of the operating company, each of Mr A and, and Mr. B could have in their respective holding companies, a life insurance policy and the operating company could be a beneficiary of those life insurance policies because the holding company and the operating company would be at arm's length in that situation. So, if you had siblings who in that situation instead of Mr. A and Mr. B, who are at arms length, if instead you had two brothers or brother and sister, or, not arm's length people, you could not do that type of arrangement. And you'd have to do other type of planning. That is one of several issues that we look at when we're assessing a plan that involves corporate own life insurance. So there are other considerations as well. Marco, do you want to touch on some other considerations?

Marco D'Aversa:

Yeah, absolutely. Thanks, Steve. So once we go down the route, and decide that a corporate own policy makes sense, as there's a lot of considerations that you would have to look at the structure probably. Now, typically, when we deal with business clients with corporate structures, there's likely going to be multiple companies. So you want to make sure you do the proper analysis to make sure that the corporations put in the right place from the start. Failing to do that, and Steve, you probably had many experiences with this when you were in the wholesaler role, is that failing to do that from the start may require you to transfer the policy out of the corporation, into another corporation down the road. And without getting into the details that transfer down the road could have adverse tax implications to both the transfer and the transferee.

Marco D'Aversa:

So again, another rule of thumb is that you want to get the insurance in the right place from the start. So that would entail gathering your part of the business and probably getting the client's accounting involved to make sure that the insurance is placed in the right corporation from the start. Now, when you're looking to put insurance in a corporate structure, there's various considerations. Steve, talked about one of them being the ownership versus the beneficiary in the previous section. The other considerations are, one is, the business could be sold in the future or one of the businesses could be sold in the future. Are obviously you don't want to put the policy in a corporation that's going to be sold down the road, because that would mean that you would have to move the policy out of that corporation down the road, which would lead to the adverse tax implications.

Marco D'Aversa:

The other thing is predator protection. When you own a policy within a corporation, just like any other assets in that corporation, if you have a life insurance policy with tax values, that policy is subject to the creditors of that corporation. So typically when we put a policy in a corporate structure, we try to put it into a sale company or a holding company that doesn't have any creditors in order to minimize the creditor protection risk of the life insurance policy. And the last thing I would want to mention quickly is the capital gain adjustment. Now, every individual resident in Canada is eligible for capital gains conjunction when they sell shares of a Canadian controlled private corporation. And in order to get that exemption upon those shares, there are certain rules that have to be met, namely 90% or more of the fair market value of the assets of the corporation have to be used in an active business or used primarily in an active business.

Marco D'Aversa:

Passive assets, don't qualify for that exemption. They're not considered to be active business assets. For that reason, if you have a significant post value product within a corporation, it could possibly put that corporation offsite from being able to claim the capital gain exemption down the road if you're selling that business. That said, there's various ways to structure the insurance policies so it doesn't put the corporation offside for the capital gain conjunction. So again, there's a lot of consideration Steven. A lot of things to go through before putting a policy in a corporation. And again, I reemphasize the fact that, the key is to try to get the policy and the right corporation within the structure from the start to avoid any adverse tax implications on the road. One thing I didn't touch upon that maybe I'll give you a couple minutes to talk about is the impact of the cash value of the product on the estate value of the shareholder shares in the business and the impact of that.

Steven McLeod:

Okay. I'll certainly touch on that. And maybe before moving on though, I'll just clarify for the audience about the creditor protection is when a life insurance policy is owned individually, each province has an insurance act. And typically these afford a level of creditor protection where the life insured, rather, the beneficiary is a part of a certain class of family members to the life insured. In Quebec, it's still a policy owner. And basically, in those circumstances, absence of a fraudulent convence the cash value of the policy is protected. And there's also similar credit protection where an irrevocable beneficiary is named of the policy as well. So that's in the individual context, but that doesn't apply in the corporate context when you have the corporation named as beneficiary. So I just wanted to bring that up as a very important benefit of individually owned insurance that you don't necessarily see in the corporate context. So I'm not sure, did I leave anything out on in that, Marco?

Marco D'Aversa:

I think you covered that well, it was good. It was good to get a lawyer's perspective on that. I tend not to get into the legal things being an accountant, but yeah, that was a great summary, Steve. Thanks.

Steven McLeod:

Okay. So the other consideration that Marco brought up was the impact of the cash value on the value of the shares at death for tax purposes. So as many of you know, when you die, you're deemed to dispose of your capital property for fair market value or at fair market value. So there's a particular provision in the income tax act that basically deems the impact of a corporate life insurance policy on the value of the shares at death to be at its cash value, not fair market value. Just as an example, the only thing a corporation owns is a life insurance policy and the death benefit is a million dollars. And the cash value at the time of death is $100,000 for example, for tax purposes, the shareholder is deemed to dispose of the shares at fair market value.

Steven McLeod:

And the fair market value is deemed to be in this case, because the only thing the corporation owns is a life insurance policy is deemed to be $100,000, which is the cash value of the policy. Now, in some instances, that can be a great benefit with life insurance, because for example, if a minimum funded level cost of, or minimum funded UL policy with level cost of insurance, it might have no or nominal amount of cash value, which basic leads to no increase in the share value at death, which is a great benefit. In other cases, we could have for example, a lot of our participating whole life policies have very rich cash values and therefore the cash value can definitely have an impact on the share value at death and therefore contribute or result in the potential tax liability at death.

Steven McLeod:

So, that is certainly something that is a consideration that plays into some planning. A lot of business owners, however, will not actually run into this problem because for two reasons, actually. The main reason is, a lot of business owners will do what's called an estate freeze, where they exchange the common shares for fixed value, preference shares that do not grow in value no matter what the assets and the corporation are doing. They can go down in value. If the assets of the corporation go below the redemption of the state of redemption amount of the shares, but the fair market value of those shares will not go over the redemption amount of those shares. So that's one area where the cash value of a life insurance policy won't actually increase the tax liability of the shareholder of the corporate policy or another situation that's very common as well is if the policy is on the life of the shareholder and the shareholders, the state planning is designed so that the shares will be transferred to their spouse on death and and the spouse survives the shareholders.

Steven McLeod:

So in that case, there's an automatic spells rollover if the shares go directly to the spouse, or if the shares go to a spousal trust, which is basically a trust that's set up for the spouse and only the spouse can benefit from the capital in the trust or receive the income from the trust during their lifetime, that a rollover is achieved as well. So basically in that situation, the life insured passes away. The corporation gets the death benefit as the corporation is the beneficiary of the policy, the shares roll over to the spouse. Basically the policy is gone, as a result the corporation has the death benefit and can basically pay out the death benefit to the spouse as a capital dividend, to the extent that there's a CD credit and the remainder comes as the taxable dividend.

Steven McLeod:

tax liability. I think for the context of this podcast, we covered a lot of ground. We talked about the benefits of Corporate Owned Life Insurance in terms of the cost savings of having a corporation owned, that earns active business income, pay the premiums and own the policy, the benefits of the capital dividend account in terms of getting that death benefit out of the corporation tax free to Canadian resident shareholders. Marco, you talked about the tax free growth or the tax advantage growth of let's say cash value within the policy during the lifetime of the life insured. We discussed various considerations that are involved when a corporation owns a life insurance policy. And some of the planning that you want to cover when there is that corporate ownership of a life insurance policy. Marco, did I miss anything or is there a place where audience members can go to get more information?

Marco D'Aversa:

Thanks, Steve. For more information on today's topic, including a tax and estate planning article on corporate owned life insurance, please visit our website@tepg.salesstrategies.ca again, that's tepg.salesstrategies.ca

Steven McLeod:

Okay, well, thank you, Marco. We'll, wrap up on that point and maybe I'll just leave on one note that Marco, you talked about transferring life insurance policies as something that you get a lot of questions on, and that that can have tax implications. And I just wanted to highlight that we will have a podcast just on that topic of transferring life insurance policies. And I just offered you the audience too. If you have any other suggestions or ideas for a podcast topic, please get a hold of myself at Steven with a V.McLeod, M-C-L-E-O-D@canadalife.com with ideas. And we'd happily explore that. So thank you very much, everyone.