An Anomaly: Transfers of Personally-Owned Policies to a Corporation
There is a curiosity in the tax rules relating to the transfer of insurance policies from an individual shareholder to a non-arm’s length corporation. (This is essentially a corporation controlled by the individual and/or family members.)
The rules in question provide that, where a policy is transferred in theses circumstances, the deemed proceeds will equal the policy’s CSV even if the actual proceeds are a different amount. By way of example, assume that Thelma owns a $1 million Term to 100 policy on her own life that she acquired twenty years ago. The policy’s CSV and ACB are both zero. Using actuarial principals, and considering Thelma’s current insurability and state of health, an actuary has determined that the fair market value (FMV) of the policy is $600,000. On this basis, Thelma sells her policy to her corporation, Thelma Inc., for $600,000. The tax consequences of this transfer are as follows:
| Actual proceeds: $600,000Deemed proceeds for tax purposes (CSV): 0
ACB of policy to Thelma Inc.: 0
Taxable income to Thelma: 0
As a result of this transaction, Thelma receives $600,000 from Thelma Inc., tax-free, in exchange for the policy. Payment would be in the form of cash and/or a promissory note that could be paid down, without tax, at any time. This result assumes that the fair market transfer value of the policy can be substantiated if challenged by the CRA.
Although Thelma Inc. paid fair market value for the policy, it is deemed to have acquired the policy for proceeds equal to the CSV of zero. This means that on Thelma’s death the full death benefit of $1 million will be credited to Thelma Inc.’s CDA and can be distributed as a tax-free dividend to her estate or the surviving shareholders.
The CRA and the Department of Finance are aware of this anomaly in the Act and legislative change is always a possibility. In the meantime, this planning idea seems to be gaining in popularity.
Reprinted with permission, author Glenn R Stephens, “Estate Planning with Life Insurance, 4th Edition.”, copyright owner CCH Canadian.