Transferring a Life Insurance Policy to a Corporation

(“UPDATE” This Strategy was good until it has been banned by CRA in the 2016 budget)
The Corporate Extraction Strategy involves transferring a personally owned life insurance policy to a corporation for its fair market value (FMV). When handled properly, it could result in withdrawing capital from the corporation tax free!

The preferred candidates for this strategy
• Own a life insurance policy that they wish to maintain;
• Own all the shares in a corporation;
• Are usually older and/or would be rated or declined for life insurance due to health concerns.

The life insurance policies best suited for this strategy
• Term insurance policies with an option to convert to permanent insurance;
• Permanent policies with or without cash value where the Adjusted Cost Base (ACB) exceeds the Cash Surrender Value (CSV).

There are two separate transactions with income tax implications
• The shareholder transfers his or her policy to the corporation. This will result in a disposition of the policy and the excess of cash value over the ACB will create taxable income. Where the policy has no cash value or cash value that is less than the ACB, no tax will result. The company receives the policy with its ACB set equal to the Cash Surrender Value on date of transfer.

• The company may pay any amount for the policy to the shareholder up to the FMV of the insurance. If the FMV is higher than the CSV, the proceeds of the transfer are received by the shareholder tax free.

Establishing the Fair Market Value of the policy
This will require the services of an actuary to provide a proper valuation of the insurance contract. Also required will be a projected age of mortality most commonly provided by a life insurance underwriter.

The actuary will consider all factors relevant to the appraisal and provide a report indicating the FMV of the policy. This report will be used to justify the payment to the shareholder. Under ideal situations, this payment from the corporation to the shareholder is often substantial.

Factors to consider
• Since the life insurance will be now owned by and payable to the corporation, proceeds at death will no longer be creditor proof as the corporation is not a preferred beneficiary;

• Changing the policy back to personal ownership at a later date, could have adverse tax consequences;

• Even though the proceeds at death are payable to the corporation, those proceeds can still be received tax free by your heirs via the Capital Dividend Account.

Uses of life insurance in the corporation
It is always advisable to have a business reason other than just the tax results in any strategy involving life insurance. Below are some of the more common reasons for corporate owned life insurance:
• Key person coverage;
• Stock redemption or buy/sell coverage;
• Paying insurance premiums in a low tax rate (small business rate) environment;
• Corporate tax shelter – transferring highly taxed corporate investments into the tax deferred cash value account of a life insurance policy;
• Capital Dividend Account planning.

What does the Canada Revenue Agency say?
The CRA has acknowledged this strategy and refers to the tax result achieved as an anomaly under the Income Tax Act. In 2003 they stated, “The result of this transaction is that the shareholder is effectively receiving a distribution from the corporation on a tax-free basis.

We previously brought this situation to the attention of the Department of Finance and have been advised that it will be given consideration in the course of their review of policyholder taxation”. These comments were echoed again in 2009.

The recent changes to the Income Tax Act introduced in 2013 were silent on this issue so the strategy remains viable. Given the CRA comments, however, we expect the door to close on this planning opportunity in the near future.

The Corporate Extraction Strategy Case Study
Dan is a 66 year old lawyer. In 2003, he purchased a $500,000 term insurance policy that was issued at standard non-smoker rates. He had a series of health episodes between 2005 and 2008 that rendered him uninsurable. As a result, Dan wanted to ensure that he maintained his life insurance for the rest of his life.

In 2012 he converted his policy to a $500,000 Term to 100 policy with an annual premium of $15,800. Shortly after the conversion he requested an actuarial valuation of this policy.

The actuary involved concluded that based on the mortality assessment that put Dan’s life expectancy at 9 years (age 75), the policy had a fair market value of $282,000.

The policy was then sold to his Law Corporation. As the policy was just converted and there was no cash value, there was no taxable disposition on the transfer. His Law Corporation paid to him the FMV of the policy – $282,000. Dan received this amount tax-free.