The federal government is cracking down on certain tax loopholes involving life insurance that have been used by high net-worth (HNW) clients to extract funds on a tax-free basis from private corporations, which would otherwise be taxable.
In the federal budget, released in Ottawa on Tuesday, the Liberal government proposed amendments to the Income Tax Act that would prevent clients from engaging in certain sophisticated planning strategies involving life insurance.
“Over the years, a number of strategies have been developed that maximize the amount of money that can be extracted by a life insurance policy from a corporation,” says Jamie Golombek, managing director of tax and estate planning with Toronto-based Canadian Imperial Bank of Commerce’s wealth strategies division. “The government is closing several loopholes that are seen as abusive in the area of the taxation of life insurance.”
Specifically, the budget proposes changes to ensure that the capital dividend account rules for private corporations, and the adjusted cost base rules for partnership interests, apply as intended.
There’s a limit on the portion of a life insurance policy benefit received by a corporation or a partnership, which can be added to the capital dividend account of a corporation, or to the adjusted cost base of a partner’s interest in a partnership. The budget highlights scenarios in which taxpayers have structured their affairs so that this limit does not apply as intended, enabling them to avoid income taxes on dividends paid by their corporation or on gains from the disposition of a partnership interest.
Those results are “unintended,” according to budget documents, and erode the tax base.
The budget also tackles certain scenarios involving the transfer of an interest in a life insurance policy to a non-arms length person. The government proposes amendments to the Act to ensure that funds are not inappropriately received tax-free by policyholders as a result of a disposition of an interest in a life insurance policy.
“This would affect very narrow types of planning for ultra HNW clients,” Golombek says.
Even with the changes, he says, life insurance remains an attractive planning tool for HNW clients.
“There’s still a benefit of life insurance, in being able to extract the proceeds tax-free,” Golombek says. “You may be able to extract less than you previously could, had this change not been made. But there’s still no reason to abandon the policy.”
The new measures take effect immediately. The government expects the initiative to generate an additional $30 million in tax revenue in fiscal 2016-17 and $35 million in fiscal 2017-18.