Oftentimes I am asked about the impact to the owner or the corporation when an owner wants to transfer the policy to their corporation. This is generally beneficial to the owner because the corporation will pay for the policy with money that is subject to less taxation.
Prior to 2016 we were able to “sell” these policies to the business. Usually by way of obtaining a Fair Market Value (FMV) from an actuary and disposing of the policies to the corporation for tax-free proceeds. This is no longer applicable as the proceeds are no longer tax-free. Going forward these, typically non-arm’s length types of transactions, may be taxable depending on how the policies are transferred to the corporation. The tax implications to the corporation, and some of those to the shareholder, are determined by subsection 148(7) of the Act. Pursuant to this provision, the greatest of the:
fair market value (FMV) of the consideration given for the policy
policy’s cash surrender value (CSV); and
policy’s adjusted cost basis (ACB)
Is deemed to be the shareholder’s transfer price for tax purposes (the proceeds) and, generally, the corporate transferee’s new ACB in the policy. If the proceeds exceed the policy’s ACB then the excess over the ACB is a taxable policy gain that’s treated as ordinary income in the case of an individual shareholder and passive income in the case of a corporate shareholder.
Based on the current version of subsection 148(7), shareholders have a range of potential tax outcomes depending whether they take back any consideration from the corporation on the transfer. If the corporation receiving the policy pays:
No consideration: the shareholder’s proceeds are the higher of the policy’s CSV and ACB.
Consideration up to the policy’s CSV : then the shareholder’s proceeds are that amount, unless the ACB is higher.
Consideration up to the policy’s ACB: then the shareholder’s proceeds are that amount, unless the CSV is higher.
Consideration equal to the FMV of the policy: the shareholder’s proceeds are that amount, unless the CSV or ACB is higher.
Consideration in excess of the FMV of the policy: the shareholder’s proceeds are that amount, unless the CSV or ACB is higher.
Generally, an amount equal to the life insurance death benefit received by a private corporation less the policy’s ACB may be added to its notional tax account called the “capital dividend account” (CDA). To the extent there’s balance in the corporation’s CDA, it may pay tax-free capital dividends to its Canadian resident shareholders. The initial ACB of the policy to the corporation is equal to the transferor’s proceeds as determined by subsection 148(7). This may result in either an increase or decrease of the ACB of the policy to the transferee. If, for example, the ACB of the policy to the shareholder was $10,000; but after the transfer the ACB of the policy to the corporation increased to $50,000, the higher the ACB, the lesser the amount that is credited to CDA at death and, consequently, the lower the amount of the death benefit that may paid out as tax-free capital dividends to Canadian resident shareholders.
Ken Poniatowski, CFP®
Business Development Specialist
Qualified Financial Services
Cell 416 805 8532