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Policy Transfers (Part 2): Taxation issues for both Parties




In last month's article, we explored the various circumstances that lead individuals or corporations to consider transferring their life insurance policy(s). Policy Transfers (Part 1): Why and What to Consider? (qfscanada.com). In this article, I’ll dive deeper into the tax implications of transferring ownership in the three most common non-arms length scenarios:


A. Individual shareholder to Corporation

B. Corporation to individual shareholder

C. Corporation (Opco) to Corporate Shareholder (Holdco/Parent Co.)


How is it taxed: Taxation Section 148(7) ITA and non-arms length?


Before we delve into each scenario, let me review the definition of a “non-arms length” transaction and the taxation issues involving policy transfers. The idea of “non-arms length” refers to the person who is connected by blood relationship, or marriage, as common-law partners, or same-sex couples, or by adoption. Such a relationship may also exist between an individual and a corporation or a trust, or between two corporations. As an example, a corporation and a person who controls the corporation, or a person who is a member of a related group that controls the corporation are related and are deemed not to deal at arm’s length. Similarly, two corporations that are controlled by the same person or related group are deemed not to deal at arm’s length. A life insurance policy transfer is considered a “disposition.”


Tax Issues for the Transferor:


A life insurance policy transfer may trigger a policy gain which is taxable in the hands of the transferor. The policy gain is equal to the proceeds of disposition minus the adjusted cost basis (ACB) of the policy. For transfers after March 16, 2016, subsection 148(7) deems that the proceeds of disposition to the transferor and the new ACB to the transferee is the greatest of:

• the “value” of the interest in the policy at the time of disposition,

• the fair market value (“FMV”) of the consideration, if any, given for the interest in the policy, and

• the ACB to the policyholder of the interest in the policy immediately before the disposition time.


To the extent that the deemed proceeds of disposition exceed the ACB, the transferor will realize a policy gain which is taxed as regular income.


The term “value” is defined in subsection 148(9) of the Act as the amount the holder of the policy would be entitled to receive if the policy were surrendered (the cash surrender value (CSV) of the policy net of policy loans). It should be noted that the CSV of a term policy would normally be nominal or zero and as such, the value for the above calculation would be zero.


Taxation issue for the Transferee:


When a life insurance policy is transferred it is ALSO important to look at whether a “taxable benefit” will be assessed to the shareholder (either corporate shareholder or individual shareholder). CRA confirms that it does. This benefit is added to the transferee’s taxable income for the year. The amount equals the fair market value (FMV) that exceeds the consideration paid by the shareholder to acquire the policy.


The fair market value (FMV) of a life insurance policy is difficult to determine and must be estimated based on the facts and circumstances of the situation. In general, the longer a policy remains in force, the more valuable it becomes. CRA has listed the following factors that would be considered in determining the value of life insurance:


• the cash surrender value of the policy;

• the policy loan value;

• the face value of the policy;

• the state of health of the life insured and his/her life expectancy;

• conversion privileges;

• other policy terms, such as term riders, double indemnity provisions; and

• the replacement value of the policy.


Using these general valuation metrics can result in an FMV that is significantly greater than the cash surrender value of the policy. If the death of the life insured is considered imminent, the FMV of an interest in life insurance may approach the total death benefit. Once again, the taxable benefit to be included in the shareholder’s income will be the excess of the FMV over the amount of consideration paid to the corporation for the policy. It’s important to note the difference in the definition of the “FMV” and the “Value” of the policy, especially as it applies to two parties of the transaction. FMV assessments are usually completed by third-party actuarial firms for a fee (not the actuarial department of the carrier as is often mistakenly presumed).


(A) Individual shareholder to Corporation:


Tax Implication for the Transferor (individual shareholder): A policy gain can be triggered. See (“Taxation issues for the Transferor”) above for more details.


Tax Implications for the Transferee (Corporation): Contrary to what is described in the section above (“Taxation Issues for the Transferee”), since the corporation is not a shareholder a taxable benefit is not triggered. Therefore “NO” taxation arises at the corporate level. The new ACB of the policy to the corporation is assessed as the greater of the three values mentioned in the section above (Taxation issues for the Transferor). Shareholders who are interested in this strategy are well advised to accept consideration (payment) from the corporation for the amount that is at least the greater of the CSV and the ACB of the policy. Doing this will have no additional impact on the policy gain triggered for the transferor. The amount received by the shareholder is considered tax-free.


(B) Corporation to Shareholder:

The two most common reasons why someone would want their corporation to transfer out a policy on their life are:


• The corporation will be sold.

• Its business has stopped and it’s the only remaining assets is the life insurance policy.


(1) Corporation to “Individual” Shareholder:


Taxation Implications for the Transferor (Corporation): A policy gain can be triggered. See (“Taxation issues for the Transferor”) above for more details.


Tax implications for the Transferee (individual shareholder): See (“Taxation issues for the Transferee”) above for more details. As an alternative to assessing a “shareholder taxable benefit,” the corporation has the option to issue a “dividend in-kind” which may help both the corporation and shareholder to experience a better tax result. The shareholder can potentially access favorable dividend tax rates and the corporation may have the opportunity to regain refundable taxes previously paid on passive income. Either way you go the shareholder taxable benefit, or the dividend in-kind, both are assessed at the policy’s FMV.


(2) Corporations to “Corporate” Shareholder (Holdco or Parent Co.):


Tax implications for the Transferor (Corporation: “Opco”): A policy gain can be triggered. See (“Taxation issues for the Transferor”) above for more details. As mentioned in scenario #B1 above, as an alternative to assessing a “shareholder taxable benefit”, the corporation has the option to issue a “dividend in-kind” which may help both the corporation and shareholder to experience a better tax result. If this option is chosen, the corporation’s proceeds of disposition are considered to be the greater of FMV, ACB, and CSV.


Tax implications for the Transferee (Corporation: “Holdco/ParentCo”): See (“Taxation issues for the Transferee”) above for more details. Once again, as an alternative to assessing a “shareholder taxable benefit,” the corporation has the option to issue a “dividend in-kind.” See (#B1 taxation to the transferee above for more details). In addition to those points, corporate dividend recipients (Holdco/ParentCo) that are “connected” to the corporation transferor (Opco) may receive these dividends (dividend in-kind in this situation) as a “tax-free intercorporate dividend” assuming there’s sufficient safe money in the transferor corporation (Opco). Remember, similar to the shareholder benefit, the dividend-in-kind is assessed to be the FMV. To learn more about how “connected” and “safe money” are defined, please refer to my article from Nov 2023 (Intercorporate Dividends: Are they always tax free). Intercorporate Dividends: Are they always TAX FREE?(Issues related to insurance solutions)


Although this was highlighted in Part 1 of this article, it’s worth repeating. If significant tax consequences result from transferring the policy, the business owner may consider the following options:


• Selling the corporation’s business assets (instead of the shares) so the corporation’s ownership doesn’t change.

• Transferring the policy as a dividend-in-kind to a connected corporation (as a tax-free intercorporate dividend,(see article “Intercorporate Dividends: Are they always tax free” Nov 2023).

• Selling the corporation with the policy but acquiring and retaining life insurance shares (see article: “Life Insurance Shares: What are they and When to use them” July 2022);

• Keeping the corporation in good standing until the insurance proceeds are paid out (in the case where the business has ceased)


All, and all, you can see that care must be taken when considering transferring a policy between parties. If not done properly, the client will be faced with a rude awakening if and when CRA audits the transaction.


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