Has a popular perk for insurance advisors been eliminated?

For years, insurance advisors who have bought policies based on their own lives or the lives of their spouses have believed that the commissions they earned on those policies were exempt from taxes. But two 2009 Tax Court of Canada decisions have cast some doubt on whether advisors can continue to enjoy this privilege.

In both Bilodeau v. The Queen and Li v. The Queen, the TCC upheld decisions by the Canada Revenue Agency that disallow such exemptions. In both cases, the TCC ruled that the Income Tax Act clearly states that such commissions are considered to be taxable — notwithstanding administrative guidance from the CRA itself suggesting that commissions earned on policies that an advisor sells based on his or her own life, or that of his or her spouse, can be considered exempt under certain conditions.

“Based strictly on the case law, the old, relaxed position from the CRA is no longer available,” says Joel Cuperfain, an estate planning specialist with RBC Dominion Securities Inc. in Toronto.

In Bilodeau, a Quebec-based insurance advisor named Jacques Bilodeau bought two $1-million universal life policies in 2003: one based on his own life, with his spouse as beneficiary; and one based on the life of his spouse, with himself as beneficiary.

Bilodeau paid $57,000 in premiums for the two policies over the course of 2003 and 2004. On the other hand, he earned $43,000 in commissions for selling the two policies.

In his 2003 tax return, Bilodeau included the $43,000 in commission as income, but deducted the same amount as an insurance rebate. In doing so, Bilodeau was following a common practice in the insurance industry, which treats commissions on policies bought on one’s own life, or that of one’s spouse, as tax-exempt.

That industry view is based on long-standing administrative guidance from the CRA in the form of Interpretation Bulletin IT-470R: Employees’ Fringe Benefits, first released in 1988 and amended in 1999.

In IT-470R, the CRA appears to draw a parallel between two situations involving employers and employees: discounts that employees might receive on merchandise they buy from their employers and commissions that salespeople might receive for merchandise they buy for their own personal use.

This interpretation also extends to insurance advisors, according to IT-470R: “Where a life insurance salesperson acquires a life insurance policy, a commission received by that salesperson on that policy is not taxable provided the salesperson owns that policy and is obligated to make the required premium payments thereon.”

However, in the case of Bilodeau, the CRA reassessed his tax return, arguing that the commission was taxable because the policies were bought not for personal insurance purposes but instead for investment purposes. (UL policies contain an investment component.)

At the 2000 annual meeting of the Conference for Advanced Life Underwriting, the CRA drew a distinction between life insurance policies bought solely for risk-management purposes and those policies that feature an investment component. Commissions earned on policies featuring an investment component — an annuity or a segregated fund, for example — would be considered fully taxable.

In ruling against Bilodeau, the TCC acknowledged the influence IT-470R might have had on Bilodeau’s decision to claim the commission as being tax-exempt, but stated that the CRA bulletin granted a tax break that was “inconsistent with tax legislation.” The TCC concluded that it was in no way bound by IT-470R.

“[IT-470R] is not a substitute for the ITA,” wrote Justice Lucie Lamarre in presenting the decision. “In the present case, there is no doubt in my mind that the commission received by the Appellant [Bilodeau] was income earned from his profession” — and, therefore, taxable.

The decision in Li, which followed the Bilodeau case, seemed to reinforce this point.

In Li, an insurance advisor, Linzi Li, had claimed a wide variety of deductions, totalling $36,000, that the CRA disallowed in a tax return reassessment. Included in the list of expenses was $7,200 in commission on a policy that Li had bought based on her life.

In Li, the TCC upheld the CRA’s decision to disallow the exemption of that commission. “The commission for her own insurance, claimed as an expense, was properly disallowed by the Minister [of national revenue],” wrote Justice François Angers. “There are no provisions in Section 8 that allow such a deduction.” (Sec. 8 refers to the part of the ITA that deals with deductions for employment income.)

@page_break@One noteworthy aspect of the Li case, Cuperfain says, is that the TCC dismissed the claimed exemption on the commission without mentioning any mitigating factor, including any acknowledgement of the effect of IT-470R. “There was no debate on the issue,” Cuperfain says. “If you receive a commission on a life insurance policy, it’s taxable.”

In both Bilodeau and Li, the TCC appears to have drawn no distinction between whether or not a policy was bought solely for risk-management purposes or for investment purposes. The TCC ruled only that the policies’ commissions were to be regarded as income under the ITA and, therefore, taxable.

Insurance industry observers say the two cases leave IT-470R in limbo — at least, for now.

“Bulletins don’t have the force of law; [they’re] just the CRA’s administrative policy,” says Jamie Golombek, managing director of tax and estate planning with Canadian Imperial Bank of Commerce’s private wealth-management division in Toronto. “Now, here you have a couple of cases that basically strike down the policy.”

Tax experts suggest that it’s likely the CRA will issue further guidance in the coming weeks or months to clarify its assessment position in light of the Bilodeau and Li decisions. But, for the moment, the CRA has made no move to withdraw its bulletin regarding commissions.

“I would expect there should be some sort of clarification coming,” Cuperfain says. “If we don’t get clarification before the annual meeting of CALU [to be held May 2 to 5 in Ottawa], I expect [someone] will ask for clarification from the CRA then.”

Says Golombek: “The question is, administratively, will the CRA stick to the comments it made at the 2000 CALU conference, where if you buy a policy, such as a term life policy, on your own life for personal protection purposes, it will allow those commissions to be treated like an [employee] discount and not taxable.”

Two factors in the Bilodeau case — the amount of the claimed commission exemption and the fact that the CRA regarded the two policies as having been purchased primarily for investment purposes — are likely to have led the CRA to target the case, experts say.

In fact, Bilodeau himself, in arguing his case, acknowledges that he would never have purchased the policies if the commissions weren’t exempt from taxes — a statement that could be seen to be bolstering the CRA’s argument.

In Li, the claim of an expense deduction on the commission earned on a policy was merely one item in a longer list of expense claims that were being challenged by the CRA.

Insurance advisors who are concerned about their own situations regarding the tax status of commissions would do well to consult with their tax professional, Golombek suggests: “Advisors who have significant exposure in this area because they excluded or deducted significant commissions over the past three years should contact a professional tax advisor to determine whether or not they should be amending prior years’ tax returns on a voluntary basis.” IE