It is very common for owner/managers to have life insurance policies issued to cover various cash requirements that would arise in the event of an untimely death.  These cash needs may include the repayment of business loans and payables, providing cash flow to the business during the difficult time following death, shareholder commitments in buy/sell agreements which are triggered on death of a shareholder, or providing a nest egg for family members left behind.

The type of insurance used may be term or permanent coverage.  Many permanent policies also allow a significant cash build-up by “overfunding” the policy (i.e. paying more than the required insurance premiums).  The growth of the investment pool can then occur on a tax-free basis.

In most cases, the policy owner should be the corporation because it is more tax-efficient to use corporate dollars to fund the premiums.  In the past, it was possible to separate the policy ownership from the beneficiary (e.g. operating and holding companies, respectively).  However, recently, the Canada Revenue Agency has stated that the policy owner and the beneficiary must be the same corporation or a shareholder benefit will be assessed.  This would apply in the case where a subsidiary corporation owns a policy with a parent company named as the beneficiary.  It is not clear if the ownership was reversed because the subsidiary corporation is not a shareholder but other issues can arise when the parent corporation is the owner of a policy with cash value.

The death benefit in excess of the adjusted cost basis of the policy will increase the “capital dividend account” (CDA) of the beneficiary corporation.  The CDA can then be paid out tax-free to the surviving shareholders.

Canada Revenue Agency has stated this new assessing position is effective January 1, 2011.  You should ensure that any existing policies are reviewed with your Chartered Accountant and your insurance broker.  Any applicable shareholder agreements should also be reviewed to ensure that changes to the insurance structure are possible under the agreement.

An unintended loss of an addition to the capital dividend account can occur when a corporation has a life insurance policy pledged as collateral for a loan.  Canada Revenue Agency’s long standing position is that where a corporation is the policyholder and the insured dies, the amount that the corporation can add to its capital dividend account depends on whether the company or the creditor is the beneficiary under the insurance policy.  If the corporation remains the beneficiary under the policy, the proceeds less the adjusted cost basis of the policy would be added to the corporation’s capital dividend account notwithstanding that the proceeds are paid to the creditor.  In the past, where the creditor received the life insurance proceeds directly because there had been an absolute assignment of the policy, there was no addition to the capital dividend account.  A recent court case overturned the Canada Revenue Agency’s assessing practise, and allowed a full addition to the capital dividend account even though part of the proceeds was paid directly to a bank.

Despite the recent victory, extreme caution should be taken as Canada Revenue Agency has not yet accepted the result of this Court decision.  Future insurance should still be structured, where possible, to ensure that the policy beneficiary is the debtor corporation and not the financial institution.  A good practice would be to have the insurance provided by a separate carrier and simply pledged as security for the loan.  This will ensure that all proceeds will be paid to the company and leave little to the Canada Revenue Agency to challenge.


If you have any questions regarding the above or any other tax issues, please contact Joseph A. Truscott at 905 528-0234 x. 224 or e-mail Joe at: