Infinite Banking Through a Corporation in Canada

Introduction

Infinite banking describes using the cash value of a permanent life insurance policy as a source of financing rather than borrowing from a conventional lender each time capital is needed.

When the arrangement is presented to incorporated business owners, it is usually proposed with the corporation as the policy owner. The reasoning offered is that the corporation funds premiums more cheaply than the owner could personally.

That reasoning is sound as far as it goes. What it leaves out is that corporate ownership changes almost every other feature of the arrangement, and several of those changes work against the owner who intends to use the policy as a personal source of capital.

Why the Corporation Is Proposed as Owner

The funding argument is genuine and worth stating accurately.

Premiums are not deductible to anyone. The question is how much pre-tax income is required to generate the dollars that pay them.

A corporation paying from income taxed at small business rates needs materially less pre-tax income than a shareholder who must first extract funds personally and pay tax at personal rates before funding the same premium.

In an arrangement built on heavy early funding, which most of these are, that difference is the largest single number in the comparison. It is why corporate ownership dominates the proposals.

The Complication Nobody Mentions

The strategy is marketed as a way for the owner to access capital. Corporate ownership puts the capital in the wrong place for that purpose.

When the corporation accesses the policy, the funds arrive in the corporation. Moving them to the shareholder is a separate transaction with its own tax cost, whether by salary, dividend or otherwise.

An owner who understood the arrangement as a personal line of capital discovers it is a corporate one.

Where the capital is genuinely needed for business purposes, this is no obstacle at all. Where the intended use was personal, the funding advantage that justified corporate ownership is partly consumed by the extraction step that corporate ownership created.

The Shareholder Benefit Problem

This is the exposure most frequently mishandled in corporate arrangements of this kind.

Where corporate policy value is used to support borrowing the shareholder undertakes personally, the corporation has provided something of value and received nothing for it. The value of that benefit can be included in the shareholder’s income, with no deduction available to the corporation.

The outcome is worse than a dividend of the same amount, because a dividend carries the dividend tax credit and a shareholder benefit does not.

The exposure is manageable, but it has to be addressed when the arrangement is put in place. The corporation should receive consideration on commercial terms for what it provides, and the arrangement should be documented at the time rather than reconstructed later.

An arrangement that has gone unexamined for several years has not been accepted. It has simply not yet been looked at.

Creditor Exposure

A policy with substantial accumulated value is a substantial corporate asset.

Where that policy sits in an operating company, it is exposed to the claims of that company’s creditors. For a business carrying real operating risk, this can undo the purpose of the accumulation entirely.

Holding the policy in a holding company rather than the operating company usually addresses this while preserving the funding advantage.

This is a decision best made before the policy is issued. Moving a policy between corporations afterward is a disposition with its own consequences, and no deferral is available.

What Happens at Death

Corporate ownership produces its clearest advantage at the end.

Where the corporation owns the policy and receives the death benefit, most of the proceeds become available to distribute to shareholders without further tax.

For an owner whose actual objective is to pass value to an estate efficiently, this is the strongest argument for the whole structure, and it is a better argument than the financing feature.

It is worth noting that this benefit accrues at death, while the financing feature operates during life, and the two objectives pull in opposite directions. Drawing heavily on the policy during life reduces what is available at death.

An arrangement sold on both propositions simultaneously is overstating what it can deliver.

Questions to Settle Before Proceeding

The following should be resolved before any policy is issued:

• Whether the capital will be needed by the business or by the owner personally
• Which entity in the group should own the policy, given operating risk
• How the corporation will be compensated if it supports personal borrowing
• Whether the primary objective is lifetime access or estate value
• What happens to the policy if the business is sold

The last of these is routinely overlooked. A policy owned by a corporation that is subsequently sold has to be dealt with in the transaction, and extracting it is a taxable event in which the shareholder is generally taxed on the full value of the policy rather than its surrender value.

The Underlying Purchase Still Has to Make Sense

Whatever the ownership structure, the transaction at the centre of the arrangement is the purchase of a permanent life insurance policy.

If the business or the owner has a genuine long term need for that coverage, the arrangement is worth examining. If there is no such need, the owner is paying the costs of insurance to obtain a financing feature, and those costs do not disappear because the corporation is paying them.

Cash value in the early years sits well below the total contributed. The accumulation requires a horizon measured in decades, and the policy illustrations rest on dividend assumptions that are not guaranteed.

A corporation can fund all of this more cheaply than an individual. That does not make it a good use of corporate funds if the underlying need is absent.

Common Planning Mistakes

Several errors recur.

Proceeding on the funding comparison alone, without considering that corporate ownership puts the capital inside the corporation.

Using corporate policy value to support personal borrowing without consideration or documentation.

Placing the policy in the operating company where a holding company would have carried less risk.

Treating lifetime access and estate value as objectives that can both be fully satisfied by the same policy.

Entering the arrangement without a genuine insurance need, on the basis that the corporation can afford it.

Conclusion

Corporate ownership of a policy used for infinite banking funds premiums more efficiently than personal ownership, because the corporation uses income taxed at lower rates.

That advantage is real, but corporate ownership places the accumulated capital inside the corporation, so an owner intending to draw on it personally faces a second extraction with its own cost.

Where corporate policy value supports personal borrowing, shareholder benefit exposure arises and should be addressed with consideration and documentation at the outset.

A policy held in an operating company is exposed to that company’s creditors, which often points toward a holding company as the appropriate owner.

The clearest advantage of corporate ownership arrives at death, when proceeds can be distributed to shareholders largely without tax, and that objective competes with drawing on the policy during life rather than complementing it.

The ownership question should be settled before the policy is issued, because reversing it later is a taxable event with no deferral available.

Tax Partners can assist you in structuring your affairs properly and ensuring full compliance while optimizing your tax position.

This article is written for educational purposes.
 

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