When life insurance aims to meet personal protection needs, the question does not arise. In the vast majority of cases, the insured will be the policyholder. However, when the time comes to take out a life insurance policy in a corporate structure, strategic thinking is required, because its holder, the insured(s), the payer and the beneficiary can all be persons (physical or morals) distinct.
Talk to Catherine, a reader who submitted the following question to me: “I recently sold my company shares to my former partner. We had several company-owned policies, each of which was whole life insurance purchased a few years ago with cash values in excess of $250,000. How can I recover this amount? Should I keep this contract or cancel it? »
First: never take the choice of your owner lightly. Such a formula always requires analysis, but, a priori, if a permanent life insurance policy in an operating company has been recommended to you, then red lights should automatically come on to alert you. Why ? For several reasons, but at least two main ones.
First, if you want your shares to qualify as qualified small business shares (QBSE), allowing you to benefit from your capital gains deduction when the business is sold, you should know that the accumulated redemption values can prevent this status. Among the criteria for qualifying the shares, it is indeed necessary that, during the 24 months preceding the disposition, the shares must have constituted a private corporation under Canadian control (CCPC) of which more than 50% of the fair market value of the assets consisted of items actively used in the operation of the business. Remember, therefore, that any form of investment, whether investing or the accumulation of cash values in an operating company, can “corrupt” this test.
Second, if your insurance needs are permanent, you will probably want to transfer this policy to your holding company or personal ownership. Given the non-arm’s length relationship between you and your company, this transfer will be made according to the application of subsection 148 (7) of the Income Tax Act (ITA). The proceeds of disposition for the transferor and the new adjusted cost base (ACB) for the transferee will be the greater of the ACB, the value of the interest in the contract and its fair market value.
However, few people know that a life insurance policy can acquire a fair market value. This must be confirmed by an actuarial certificate and the surprise can be very bad if several years have passed since the subscription of the policy, in particular if the state of health of the insured has deteriorated or if the accumulated values are important.
Why such a basic error?
In many cases, the company benefits from a lower tax rate than its shareholder. It is therefore a safe bet that, in the context of a sale, it will be easier to convince a shareholder to use the company’s liquid assets for a permanent life insurance plan. In addition, it also often happens that the shareholder is the sole shareholder of his company and he does not think he will be able to sell his shares one day.
I like to remind my clients that nothing is more certain than the unpredictable! Holding a permanent life insurance policy in a corporation should ideally only be done if one thinks of dying with it. For some entrepreneurs whose assets are very important, it is also a must in order to optimize the heritage. For others, however, the issue merits consideration.
Finally, there may be several reasons for using life insurance in a business context: to protect the company in the event of the death of a key employee, to guarantee a creditor’s loan or to allow the financing of the terms of redemption of shares in the event of death, provided for in your shareholder agreement. These needs are, and in most cases should be, met by term life insurance.
While it is true that the transfer of term insurance in the context of a non-arm’s length relationship more rarely leads to serious tax consequences—unless, for example, the insured’s state of health has seriously deteriorated—it it is better to warn and have all the life insurance policies held by the management companies of the shareholders or even in their personal name. However, nothing prevents the company from paying the premiums afterwards.
As for Catherine, our reader, I unfortunately have no good news for her. Or she disposes of the policy and recovers its cash values tax-free — provided the remaining shareholder of the owner company is willing to pay her that amount and she first consults with her tax advisors as to the handling of this transaction — or it carries out a transfer after an actuarial valuation to find out the fair market value of its policy. This is completely unnecessary tax stress, which could have been avoided from the outset by choosing the right holder.