Insurance Planning After The Recent Changes

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1 2016 British Columbia Tax Conference Vancouver, BC Insurance Planning After The Recent Changes, CPA, CA, TEP PPI Advisory, Vancouver Disclaimer: This material is for educational purposes only and is not intended to be advice on any particular matter. No one should act on the basis of any matter contained in these materials without considering appropriate professional advice. The presenters expressly disclaim all liability in respect of anything done or omitted to be done wholly or partly in reliance upon the contents of these materials.

2 Changes for 2017 Agenda Grandfathering rules and transitional issues 2016 Federal Budget proposals Leveraged insured annuities update on the CRA s views on grandfathering Corporate owned insurance and the capital dividend account impact of the increase in dividend rates The Golini case British Columbia Tax Conference

3 Changes for 2017 Primary focus of the legislation updating the exempt test rules MTAR line, other actuarial based rules No changes since 1982 Passed into law December 2014 Applies to policies issued after 2016 and to those issued previously that lose grandfathered status Potentially some additional clarification to come?? Reviewed in the grandfathering/transitional section British Columbia Tax Conference

4 Changes for 2017 Single premium policies are no more No shelter advantage to high surrender charges Minimum premium paying period roughly 8 years significant reductions in longer-term maximum funding levels for level cost of insurance (LCOI) policies British Columbia Tax Conference

5 Changes For 2017 Impact on the exempt test and contribution room Impact on CDA for corporate owned insurance Impact on paragraph 20(1)(e.2) New products for 2017?? British Columbia Tax Conference

6 Impact on the Exempt Test and Contribution Room 2017 level cost of insurance (LCOI) policies Face plus fund policies decrease in the ability to accumulate cash over the long term Early years similar results for pre-2017 and post-2016 policies Older ages the decrease over the long term is not as significant Examples British Columbia Tax Conference

7 Max FV per $1,000 of LCOI Face 6,000 Male 40 NS 5,000 4,000 3,000 Post 2016 Today Max Fund Value in year 20: $1,355 $400 2,000 1, British Columbia Tax Conference

8 Max FV per $1,000 of LCOI Face 6,000 Male 60 NS 5,000 4,000 3,000 Post 2016 Today Max Fund Value in year 20: $2,810 $1,230 2,000 1, British Columbia Tax Conference

9 Impact on CDA for Corporate Owned Insurance Corporate owned insurance CDA = life insurance proceeds less adjusted cost basis (ACB) of the policy ACB many components, but Simplified calculation = premiums less net cost of pure insurance (NCPI) For 2017 changes in the calculation of NCPI Lower amounts Results higher ACB in the earlier years; longer until ACB gets to zero (may never become zero for older ages) 2016 Federal Budget proposal on tracking ACB British Columbia Tax Conference

10 CDA Credit per $1,000 of LCOI Face 1,000 Male 40 NS Post 2016 Today Max CDA differential of $140 at age British Columbia Tax Conference

11 CDA Credit per $1,000 of LCOI Face 1,000 Male 60 NS Post 2016 Today Max CDA differential of $195 at age British Columbia Tax Conference

12 Significant CDA Benefits for LCOI under Today s Rules Issue Age CDA greater by as much as % % % % % % British Columbia Tax Conference

13 Significant CDA Benefits for LCOI Pre-2017 Level cost of insurance policies Pre more attractive CDA benefits versus other permanent cash value products After 2016 LCOI and other permanent cash value products will have similar CDA results British Columbia Tax Conference

14 Impact on Paragraph 20(1)(e.2) 20(1)(e.2) - may deduct lesser of policy premium and the net cost of pure insurance (NCPI) Other requirements Changes in the calculation of NCPI for policies issued after 2016 Lower amounts (as reviewed in the CDA discussion) Therefore, the paragraph 20(1)(e.2) deduction will be lower British Columbia Tax Conference

15 Cumulative Percentage of Total LCOI Premiums Deductible as CID over Period Indicated* 1 st 10 Years 1 st 20 Years Issue Age Post 2016 Today Post 2016 Today 40 12% 16% 25% 38% 50 18% 27% 39% 58% 60 27% 44% 56% 72% 65 33% 52% 62% 76% 70 41% 56% 68% 78% 75 45% 96% 70% 98% *Assumption: Loan balance at least equal to the LCOI face amount British Columbia Tax Conference

16 New Products for 2017 What will be coming in 2017?? Very little information yet Premium increases?? Hybrid type products?? ACB type riders to compensate for the CDA loss in the early years?? British Columbia Tax Conference

17 Grandfathering Rules and Transitional Issues What actions could lose grandfathered status? some examples: Adding a new coverage or term rider after 2016 Substituting a new life for an existing life in a policy where medical underwriting is required Certain multi-life changes British Columbia Tax Conference

18 Grandfathering Rules and Transitional Issues What actions are OK? some examples: Change of status from smoker to non-smoker Change of status from substandard to standard rating Purchase of paid-up additions with dividends (whole life policies) Exercising a guaranteed insurability option underwritten prior to 2017 provided the coverage is added to an existing policy British Columbia Tax Conference

19 Grandfathering Rules and Transitional Issues LCOI contracts especially important to preserve grandfathered status If lose such status - could require partial withdrawal on following anniversary to maintain exempt status Any coverage increases requiring underwriting should be done before 2017 Term conversions complete before British Columbia Tax Conference

20 Transitional Rules When is a policy issued before 2017? CRA technical interpretation to come? Finance comfort letter to come? British Columbia Tax Conference

21 Transitional Rules CLHIA letter to Finance June 2, 2016 Signed application received by the insurer before 2017 Includes all the information to begin underwriting All values relating to the insurance would be determined by reference to an effective date before 2017, Premiums would be paid from that effective date in or before 2016 The first anniversary of the policy would be in or before 2017 Policy in effect on or before March 31, British Columbia Tax Conference

22 Transitional Rules Other Issues Cut off dates for the insurance companies Applications prior to October 1?? Conditional insurance agreement Temporary insurance agreement Other tinkering to the rules?? British Columbia Tax Conference

23 2016 Federal Budget Proposals Transfers of life insurance policies Tracking the ACB of a policy and the impact on separating owner and beneficiary Draft legislation and CALU submissions British Columbia Tax Conference

24 Transfers of life insurance policies Income inclusion = the amount by which the proceeds of disposition exceed the ACB of the policy not a capital gain Rollovers are available for transfers to a child, spouse or common-law partner, if requirements are met, but not to corporations British Columbia Tax Conference

25 Proceeds of disposition Proceeds = the purchase price unless subsection 148(7) applies 148(7) applies when policy interest is transferred: by way of a gift, by corporate distribution to any person, by operation of law to any person, or in any manner whatsoever to any person with whom the policyholder does not deal at arm s length British Columbia Tax Conference

26 Pre Budget - What is value? 148(7) deems proceeds to be = value Value - defined in subsection148(9) Where the interest includes an interest in the cash surrender value (CSV) of the policy, value is the amount receivable by the policyholder if that interest were surrendered to the life insured, and In any other case, nil British Columbia Tax Conference

27 What is the FMV of the policy? FMV should be determined by an independent actuary Factors an actuary would consider include: the current state of health of the insured, the policy's death benefit, expectations of future interest rates, the premiums relative to what would be currently available in the market British Columbia Tax Conference

28 Transfers from Shareholder to Corporation old rules If FMV of policy > CSV, shareholder can receive FMV consideration (for example cash or a promissory note) without realizing any additional gain If policy has no CSV no income gain ACB to corporation = CSV and not consideration paid to the shareholder Therefore, if no CSV, ACB to corporation is nil corporation receives a higher CDA addition Budget eliminated this favourable result British Columbia Tax Conference

29 Transfers of Policies 2016 Federal Budget Two sets of rules introduced Transfers on budget day (March 22, 2016) or later proceeds of disposition will include the amount of fair market value consideration received - therefore shareholder now taxable for amounts received in excess of CSV Pre-budget transfers CDA credit on death reduced by excess of fair market value consideration received over value (CSV) on date of transfer No grandfathering British Columbia Tax Conference

30 Policy Transfers Post Budget Transfer Jane owns 100% of Janeco Jane has a $1 million T100 life insurance policy that has FMV of $400,000 (no CSV or ACB) that she transfers to Janeco on or after March 22, 2016 New Rules Old Rules Proceeds $400,000 $0 Income gain $400,000 $0 ACB to Janeco $400,000 $0 CDA addition if Jane dies soon after transfer $600,000 $1,000, British Columbia Tax Conference

31 Tracking The ACB of a Policy Policy ACB now follows the beneficiary ACB will reduce CDA credit even if beneficiary corporation is not the policy owner Separating owner and beneficiary no longer the full CDA result if there is ACB in the policy Applies where death occurs on or after Budget Day Double counting of ACB if more than one corporate beneficiary? Reporting obligation where the corporate owner and beneficiary are different details?? HelpDesk British Columbia Tax Conference

32 Draft Legislation - July 29, 2016 Policy Transfers Transfers after March 21, 2016 Subsection 148(7) will be amended to so that the deemed proceeds of the disposition will be the greatest of The FMV of the consideration given for the policy; The CSV of the interest in the policy; and The ACB of the policy to the policyholder immediately before the disposition The person acquiring the policy will be deemed to have acquired the policy at a cost equal to the above amount British Columbia Tax Conference 32

33 Draft Legislation July 29, 2016 Policy Transfers Transfers after 1999 and before March 22, 2016, death after March 21, 2016 The CDA addition from the life insurance policy will be reduced by the amount by which the FMV of the consideration given on the transfer exceeds the greater of the CSV of the and the ACB to the policyholder of the interest immediately before the disposition Permanent reduction remains Pre-2000 transfers no longer subject to the new rules British Columbia Tax Conference

34 Policy Transfers Not Affected by the Proposals Since no FMV consideration given the new rules should not apply to: Donations of life insurance policies to charities Dividend in kind between corporations However - watch out for new section 55 rules British Columbia Tax Conference

35 Draft Legislation July 29, Tracking ACB Still no grandfathering No clarification for ACB calculation where more than one corporate beneficiary No details on the reporting requirements British Columbia Tax Conference

36 CALU Submissions April 29, 2016 and July 19, 2016 One more to come? Focus on the permanent reduction in the CDA for a pre- Budget transfer? Perhaps a change to an ACB addition? Could therefore be reduced over time until the death of the insured British Columbia Tax Conference

37 2016 Federal Budget Proposals Additional Thoughts Consider the benefits of a corporate owned policy: Access to corporate dollars to pay premiums Potential post mortem tax planning advantages with the CDA Sale price to corporation does not have to be FMV But be careful re: Creditor issues Capital gains exemption Transfer to corporation with multiple shareholders Maintaining original purpose of insurance British Columbia Tax Conference

38 2016 Federal Budget Proposals Additional Thoughts Why separate owner and beneficiary? Post-Budget: CDA no longer maximized but was an extra benefit and a timing issue Separation often motivated by difficulty in transferring insurance policies if corporation sold Section 85 not available - longstanding request and CALU still pursuing For transfers between corporations often a dividend in kind subsection 55(2) issues Protection of life insurance policy from creditors of the operating company British Columbia Tax Conference

39 Leveraged Insured Annuities 2013 Federal Budget Definition of LIA policy subsection 248(1) - a person becomes obligated after March 20, 2013 to repay an amount to another person determined by reference to the death of an individual whose life is insured under a life insurance policy; a lender is assigned an interest in the policy and annuity Elimination of most of the tax benefits associated with leveraged insured annuity arrangements British Columbia Tax Conference

40 Explanatory notes: LIA Policies - Grandfathering An LIA policy does not include a policy in respect of which the amount of borrowings outstanding as of March 21, 2013 does not increase on or after that date Not specifically in the legislation British Columbia Tax Conference

41 LIA Policies Grandfathering 2014 CALU Roundtable If a new loan comes into existence after March 20, 2013 then the person has become obligated after that date to repay an amount If the loan is increased or replaced after March 20, 2013 the arrangement will not be grandfathered Changes to the terms of the loan while not increasing the borrowing may not affect grandfathering Replacement of insurance should not impact grandfathering British Columbia Tax Conference

42 LIA Policies Grandfathering Additional clarification to come? CRA assignment of a loan acceptable? Finance legislative amendments Golini case (to come) more legislative amendments? British Columbia Tax Conference

43 CDA and the Impact of the Increased Dividend Rates Value of a capital dividend Taxable dividend rates 31.3%/40.61% Post mortem planning for private company shares Corporate owned insurance creating CDA Typical to use in the post mortem planning Grandfathered situations/roll and redeem 50% solution 100% solution British Columbia Tax Conference

44 CDA and the Impact of the Increased Dividend Rates Case Study $1 million capital gain $1 million of CDA from corporate owned insurance British Columbia Tax Conference

45 Case Study Post Mortem Planning Alternatives Grandfathered 50% Solution Ineligible Dvds 100% Solution Pipeline Capital gain $1,000,000 $1,000,000 $1,000,000 $1,000,000 Capital loss ($1,000,000) ($1,000,000) ($1,000,000) $0 Capital dividend $1,000,000 $500,000 $1,000,000 $0 Taxable dividend $0 $500,000 $0 $0 Tax payable by deceased $0 $0 $119,250 $238,500 Tax payable by estate $0 $203,050 $0 $0 CDA remaining $0 $500,000 $0 $1,000, British Columbia Tax Conference

46 Another Alternative? Pipeline Planning + CDA What if? Fully fund the value of the shares with life insurance Case study - $1 million Pay tax on the capital gain pipeline planning funded with the insurance proceeds Use the CDA for future distributions Capital gains rates vs. dividend rates Net win for pipeline planning plus CDA British Columbia Tax Conference

47 CDA and the Impact of the Increased Dividend Rates Cost of the insurance? Other considerations Availability of the proceeds Liquidity vs selling other assets to finance the tax bill or other distributions What if Pipeline planning is not available? Increase in the capital gains rate? British Columbia Tax Conference

48 Golini Case Tax Court of Canada decision Complex series of transactions Not the best set of facts Contrasts significantly from most leveraging arrangements when corporate-owned insurance is used to secure a personal loan to a shareholder British Columbia Tax Conference

49 Facts A life insurance policy and annuity were used as security for a $6 million loan received by the individual shareholder, Mr. Golini, from a Canadian corporation ( Metropac ). The insurance and annuity contracts were both acquired from offshore insurers and owned by Mr. Golini s corporation ( Holdco ). The annuity paid $400,000 per year to Holdco British Columbia Tax Conference

50 Facts The annuity payments were payable for 15 years or until Mr. Golini s death, whichever occurred first Holdco guaranteed the loan provided to Mr. Golini and provided the annuity and the life insurance as security on a non-recourse basis Mr. Golini paid an annual guarantee fee of $40,000 to Holdco Mr. Golini used the loan proceeds to purchase shares in a private corporation and deducted the interest British Columbia Tax Conference

51 Court Findings The Court determined that Mr. Golini had received a taxable benefit of $5.4 million Representing the amount of insurance premiums payable by Holdco over the 15 year term described above, minus the guarantee fees payable by Mr. Golini British Columbia Tax Conference

52 Key differences From Other Corporate Owner/Personal Borrower Arrangements Metropac had recourse only against the annuity and insurance contracts owned by Holdco Golini was not legally obliged to repay the loan The annuity and insurance contracts appeared to have been issued without reasonable commercial terms Insurance premiums = death benefit No underwriting? Offshore financial institutions used to circulate the loan proceeds prior to being received by Mr. Golini British Columbia Tax Conference

53 Summary Significant changes coming Lock in insurance now? However, getting late Watch out for grandfathering/transitional rules Separating owner and beneficiary may still be worthwhile for non-cda reasons Post mortem planning a re-think? British Columbia Tax Conference

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