Loophole in tax act that allowed business owners to benefit from life policies comes to an end
Savvy employers had been enjoying some serious tax advantages courtesy of an unusual life insurance strategy: however, this month’s Canada budget has put that to an end.
According to Kim Moody, director of the Canadian Tax Advisory at Moodys Gartner Tax Law, writing in his blog, a loophole was allowing business owners to transfer life insurance policies across to their corporation and in return pick up tax-free proceeds based on the fair market value of the policy.
The idea was that when the business owner died, the corporation picked up the proceeds, basically tax-free. This could then be added to the capital dividend accounts of the corporation which could then pay out dividends – which are not taxable when in the hands of shareholders.
However, assuming the budget changes go through successfully, the policy holder will now be required to pay income tax on amounts received in excess of the adjusted cost base.
Writing in his blog, Moody goes on to explain that the new rule will also require the adjusted cost base of the insurance to be increased by the amount of the deemed proceeds received. This means that the capital dividend is reduced when the policyholder dies and therefore so does the amount that could be extracted tax-free by the company.
In addition, according to Moody, people who made transfers prior to the budget but who die after it will also be affected.
According to Kim Moody, director of the Canadian Tax Advisory at Moodys Gartner Tax Law, writing in his blog, a loophole was allowing business owners to transfer life insurance policies across to their corporation and in return pick up tax-free proceeds based on the fair market value of the policy.
The idea was that when the business owner died, the corporation picked up the proceeds, basically tax-free. This could then be added to the capital dividend accounts of the corporation which could then pay out dividends – which are not taxable when in the hands of shareholders.
However, assuming the budget changes go through successfully, the policy holder will now be required to pay income tax on amounts received in excess of the adjusted cost base.
Writing in his blog, Moody goes on to explain that the new rule will also require the adjusted cost base of the insurance to be increased by the amount of the deemed proceeds received. This means that the capital dividend is reduced when the policyholder dies and therefore so does the amount that could be extracted tax-free by the company.
In addition, according to Moody, people who made transfers prior to the budget but who die after it will also be affected.
