Canada: Ownership Structures For Life Insurance Policy-Funded Buy/Sell Agreements

Last Updated: October 14 2016
Article by Ross Cammalleri

In our July 2016 Tax Alert we noted that new income tax legislation will impact the taxation of life insurance policies. Most notably, it will be advantageous, for estate planning purposes, to purchase life insurance before the end of 2016 to maximize the tax benefits associated with current life insurance rules.  

Many who have been through the exercise of purchasing a life insurance policy can attest to the difficulty of selecting the appropriate insurance product given the wide variety and complexity of products in today’s marketplace. 

Equally puzzling is choosing the optimal ownership structure for a life insurance policy that will be used to fund a buy/sell arrangement included in a shareholders agreement.  

It is critical in any succession/estate plan to ensure that financing is in place to fund the purchase of a business interest. In the context of most privately held Canadian corporations, a shareholders agreement is often a means to include buy/sell provisions that reflect the needs and wishes of the surviving shareholders following the death of a shareholder.  

Generally, buy/sell arrangements use one of three structures after the death of a shareholder:

  1. The surviving shareholders may purchase the deceased shareholder’s shares from the deceased’s estate.
  2. The corporation may purchase the deceased shareholder’s shares from the deceased’s estate.
  3. There is a combination of a purchase of some shares by the surviving shareholders and purchase by the corporation of the remaining shares from the deceased shareholder’s estate. 


Regardless of the structure, life insurance generally is the most cost-efficient way to fund the obligation of a surviving shareholder/corporation. In selecting the appropriate ownership structure, many factors should be considered. 

One key factor is deciding whether the life insurance policy should be held personally by the shareholders or by the operating corporation, given that the receipt of the death benefit proceeds is tax-free to both individual and corporate recipients. Furthermore, the excess of the death benefit proceeds, over the adjusted cost base of the life insurance policy immediately before the death of the life insured, may be paid out to the shareholder(s) of a corporation as a tax-free capital dividend, as the excess is added to a corporation’s capital dividend account. Thus, a corporate-owned life insurance policy allows for much of the insurance proceeds to be received free of corporate and personal tax.

Life insurance premiums generally are not deductible for income tax purposes. Accordingly, where possible, it is usually preferable to have a corporation own and pay for the life insurance policy, as corporate tax rates generally are lower than individual tax rates. The savings can be significant. For example, the highest marginal tax rate for an individual resident of Ontario is 53.53 per cent, while the general corporate income tax rate is 26.50 per cent. Thus, an individual already earning a salary of $220,000 would need to earn an additional $21,500 to pay for a life insurance policy with an annual premium of $10,000. In contrast, a corporation would only need to earn just over $13,600 to pay for the same $10,000 premium.  

Creditor protection is another relevant factor. The death benefit received by a corporation may be subject to claims by the corporation’s creditors. However, as noted above, owning the life insurance policy personally to avoid claims by the corporation’s creditors can be costly. In such cases, it is possible to incorporate a holding company to hold the shares of the operating company. The holding company will not guarantee the debts of the operating company. The holding company is the owner and beneficiary of the life insurance so that any death benefit proceeds are received by the holding company and thus are not exposed to claims from the operating company’s creditors. The death benefit proceeds are then paid to the shareholder(s) as a tax-free capital dividend.

A further consideration is selecting an ownership structure that will ensure the premiums are paid. It is much more difficult to ensure that premiums on life insurance policies are being paid if the policies are owned by individual shareholders. Furthermore, there is always a risk that if death benefit proceeds are received by an individual shareholder, the funds will be used for purposes other than fulfilling the shareholder’s obligation under a buy/sell arrangement.

Where life insurance policies are owned by a corporation, either by an operating company or a holding company, each shareholder should be in a position to review the financial records of the corporation to ensure the premiums are paid on a timely basis. Further, the corporation is in a better position to ensure that the death benefit proceeds are used to fund the obligations under a buy/sell arrangement.

Another concern with personally owned life insurance is apparent where one shareholder is older or in poorer health than the other shareholder(s). The cost of the life insurance policy on the life of the older shareholder is higher and often is borne by the other shareholder(s), while the buy/sell arrangement is structured in a manner that requires the surviving shareholder(s) to purchase the shares of the deceased shareholder’s estate. 

For example, at times a “criss-cross” purchase method is used to structure a buy/sell arrangement. With this method, each shareholder is the owner and beneficiary of a life insurance policy on the life of the other shareholder(s). When one shareholder dies, the surviving shareholder(s) will receive the death benefit proceeds, free of tax, and then use the funds to purchase the shares of the corporation from the deceased shareholder’s estate. If the deceased shareholder was much older, the other shareholder(s) will pay much higher premiums to own the life insurance policy on the life of the older shareholder. 

On the other hand, the cost may be effectively shared among the shareholders according to their proportionate share in the corporation if the criss-cross purchase method is used in a manner wherein the corporation, preferably a holding company, owns all the life insurance policies of all the shareholders. Under this structure, a surviving shareholder may purchase the shares of the deceased shareholder’s estate. Instead of paying the estate in cash, the surviving shareholder issues a promissory note payable on demand. Following receipt of the tax-free death benefit proceeds, the corporation pays a tax-free capital dividend to the surviving shareholder who uses the funds to settle the promissory note.

A final consideration in structuring a buy/sell arrangement to be funded by life insurance is a possible transfer of the ownership of the life insurance policies that might occur at a later time. For example, this situation is often encountered when one shareholder sells his or her shares in a corporation.

A transfer of a life insurance policy to a shareholder is a disposition to a corporate owner for tax purposes, and there is a potential for a taxable benefit to the shareholder to the extent that the fair market value of the policy exceeds the consideration, if any, paid by the shareholder. However, where the shareholder does not deal at arm’s length with the corporate transferor, such disposition will be at the “value” of the policy, where no other consideration is given for the policy. For these purposes, “value” is defined as essentially the cash surrender value of the policy. As such, a policy gain, of which 100 per cent is taxable, will result only where the cash surrender value exceeds the adjusted cost base of the policy. Where the policy has no cash surrender value, the policy’s “value” is nil and thus no policy gain should result. 

Consequently, in situations where a shareholder is the sole shareholder of a corporation, corporate-owned life insurance should be considered as the policy may potentially be distributed to the shareholder without triggering a policy gain to the corporation.  

Where the shareholder does deal at arm’s length with a corporation, such as a minority shareholder, consideration should be given to transferring the shareholder’s interest in the corporation to a wholly owned holding company. A life insurance policy on the life of the shareholder may then be purchased by the holding company. Premiums may be paid from funds received from tax-free, inter-corporate dividends declared and paid by the operating corporation. Under this structure, the life insurance policy may be distributed to the shareholder should a sale of the operating corporation occur, and the shareholder may sell the shares of his or her holding company in order to use any capital gains exemption available.

Clearly, there are several alternatives available to shareholders for structuring a buy/sell arrangement. There is no one solution that fits all situations. Each alternative has its own advantages and disadvantages that must be analyzed in light of each set of circumstances. A Collins Barrow tax advisor can help navigate the many alternatives and help you structure a tax-effective buy/sell arrangement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Ross Cammalleri
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions