Finance offers scant tax relief to business owners

By Melissa Shin | August 23, 2016 | Last updated on September 21, 2023
6 min read

This article has been updated for accuracy and clarity.

Small business and insurance advisors alike were disappointed when Budget 2016 halted two popular strategies involving life insurance.

Read: Finance gives corporate-class shareholders a break

The strategies, which involved generous tax treatment for life insurance transfers, had been used for decades without interference from Finance. The industry knew how good things were — in fact, in 2013, the Conference for Advanced Life Underwriting (CALU) recommended that Finance change the legislation to make it less advantageous.

Fast forward to Budget 2016, when not only did Finance remove the tax advantages, but it also made it so the changes applied to strategies enacted both prior to and after Budget Day. Some say this unfairly penalizes folks who had no idea Finance would target their planning, while others have said the plans were inappropriate regardless of what the Income Tax Act allowed.

Draft legislation released July 29, 2016 did not address this perceived unfairness, but it provided relief in three areas.

We asked Kevin Wark, president of CALU, to explain what advisors need to know.

Change #1

Using a HoldCo-and-OpCo structure for insurance

What was possible before: A few points of background first. When a Canadian-controlled private corporation receives the proceeds of a life insurance policy, an equivalent amount — minus the adjusted cost basis (ACB) of the policy — goes to the business’ capital dividend account (CDA) to be paid out as tax-free dividends. The more that can go into the CDA, the better.

When a business owns an insurance policy, pays the premiums and is the beneficiary, the amount that goes to the CDA is the death benefit, minus the ACB. So on a $1 million policy with a $100,000 ACB, $900,000 goes to the CDA. “That other $100,000 is sitting in the company and can only be distributed on a taxable basis, typically as a dividend,” says Wark.

But say a shareholder owns a HoldCo and an OpCo. The shareholder could have HoldCo own the insurance and pay the premiums, and make OpCo the beneficiary when the shareholder died. That would allow the OpCo to receive the $1-million death benefit without having to subtract the ACB (since the OpCo never paid premiums). This means the shareholder’s estate can ultimately receive $1 million in tax-free dividends, instead of $900,000, from HoldCo.*

In 2013, CALU recommended the legislation be changed to remove the tax benefit on a go-forward basis.

The HoldCo-OpCo structure has non-tax benefits as well. It provides creditor protection for the policy as long as the insured is alive. It also “allows the shareholder to retain the policy in the event the OpCo is sold in future without having to transfer it out,” says Wark.

What was in Budget 2016: Finance will be changing the rules so they “apply as intended,” says Budget 2016. That means, in our example, that regardless of whether the HoldCo or OpCo pays the premiums, the OpCo will have to subtract the ACB of the policy so that $900,000 goes to the CDA. To ensure compliance, there will also be “information-reporting requirements that will apply where a corporation or partnership is not a policyholder, but is entitled to receive a policy benefit.”

Crucially, these new rules apply regardless of when the HoldCo-OpCo structure was put into place — so even if someone had planning in place before Budget 2016, the CDA will still be adjusted as per the new rules.

What’s in the draft legislation: The draft legislation is about the same, says Wark.

Read: Collateral damage: The impact of new life insurance transfer rules

Change #2

Insurance transfers from shareholder to business

What was possible before: Let’s say a shareholder owns a $1-million insurance policy and wants to transfer it to his corporation. We’ll assume that it has a $60,000 ACB, and that it has a $100,000 cash surrender value, and a FMV of $220,000. “There’s a rule in the Act that says if the insurance is transferred to a non-arm’s length person, say your corporation, irrespective of what you actually received for it — $0 or $1 million — it’s deemed to be disposed of for its cash surrender value,” explains Wark.

In this example, the shareholder would be deemed to have disposed the policy for $100,000 and to have received $40,000 in income ($100,000 CSV less $60,000 ACB), regardless of what the company gives him. What happens if the fair market value of the insurance is much higher than the CSV, and the corporation gives the shareholder consideration of, say, $220,000 (the FMV)? “The same rule kicks in,” says Wark. “You’re deemed to have disposed of the policy for $100,000, so the person receives $220,000 in cash” but is only taxed on the $40,000.

Another plus: after this transaction, the corporation itself has an ACB of $100,000 (equal to the CSV), even though the company paid $220,000 for the policy. That means that when the death benefit is paid out, assuming the ACB remains $100,000, the company only has to subtract $100,000 from the death benefit to determine the CDA credit — which, as we recall, can be distributed to shareholders tax-free. In this case, $900,000 could be distributed tax-free.

The industry had also advised Finance about these generous benefits.

What was in Budget 2016:** Finance finally decided to take action, but it also decided to have the new rules affect existing strategies, not just new ones.

Under the new rules, for transfers on or after Budget Day, if the shareholder gets $220,000 in consideration from the corporation, that will result in a $160,000 policy gain ($220,000 less the ACB of $60,000). When the shareholder dies, the corporation will have to subtract the ACB based on the original transfer value of $220,000 from the CDA credit. In the above case, assuming an ACB of $220,000, only $780,000 could be distributed to shareholders tax-free.

For transfers before Budget Day 2016, there will be an additional deduction of $120,000 from the CDA as the policy gain plus CSV ($220,000 in our example; so, the CDA credit is $780,000). The new rules do not affect the tax treatment of the original transfer.

But for transfers after Budget Day 2016, the subtracted amounts will be equal to the ACB, which can be close to zero for longstanding policies. That means the CDA credit can be closer to the death benefit amount ($1 million in our example).

What’s in the draft legislation:^ Three points of relief, explains Wark.

  • For policy transfers made before March 22, 2016, when the insured dies, the CDA credit will be reduced by the amount by which the original consideration paid ($220,000 in our example) exceeded the greater of the CSV and the ACB of the policy. Previously, only the CSV was part of this formula. “So there is some relief in situations where the ACB exceeded the CSV at the time of the original transfer,” says Wark. For transfers made on or after Budget Day, the proceeds of disposition will now be deemed the greatest of the consideration paid, the CSV of the policy and the ACB of the policy. Previously, it was just the greater of the consideration paid and the CSV of the policy. If the ACB of the policy exceeded the CSV and consideration paid at the time of transfer, this will increase the ACB to the corporation.
  • Budget 2016 targeted any transfers made after 1972 — 44 years prior. The draft legislation reduces that window to transfers made after 1999.
  • The rule for transfers before Budget Day will not apply if the transferor is a taxable Canadian corporation.

Have your say

The draft legislation’s comment period closes September 27, 2016. Send your thoughts to or to:

Tax Policy Branch Department of Finance 90 Elgin Street Ottawa, Ontario K1A 0G5

*A previous version of this story stated that OpCo would pay the dividends. Return to the corrected sentence. **This section has been updated for clarity and accuracy. Return to the corrected section. ^This section has been updated for clarity and accuracy. Return to the corrected section.

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Melissa Shin

Melissa is the editorial director of and leads Newcom Media Inc.’s group of financial publications. She has been with the team since 2011 and been recognized by PMAC and CFA Society Toronto for her reporting. Reach her at You may also call or text 416-847-8038 to provide a confidential tip.