Life Insurance Inside a Holding Company in Canada

Introduction

A business owner who has decided to hold life insurance corporately faces a second question that is frequently skipped: which corporation should own it.

In a group with an operating company beneath a holding company, the default is usually the operating company, because that is where the cash is generated and where the premiums are easiest to pay.

The default is often the wrong answer. A holding company is frequently the better owner, and the reasons are not purely about tax.

The Creditor Argument

This is the strongest reason and the one most often raised too late.

A policy with substantial accumulated value is a substantial asset. Where it sits in the operating company, it is an asset of a business that carries commercial risk, and it is available to that business’s creditors.

An owner who has spent twenty years accumulating value inside a policy precisely because it was meant to be secure has not achieved that if the policy sits in the entity carrying the risk.

A holding company that does not trade carries far less exposure. Moving the policy there does not eliminate risk entirely, but it removes the policy from the entity most likely to face claims.

For owners in industries with meaningful liability exposure, this consideration frequently outweighs everything else in the analysis.

The Premium Funding Question

The complication is that the holding company often has no income of its own.

Where the operating company generates the cash and the holding company owns the policy, the funds have to move between them. This is usually achieved through intercorporate dividends, which can generally be paid between connected Canadian corporations without immediate tax.

That route works, but it requires the movement to be deliberate and documented rather than assumed.

What does not work is the operating company simply paying premiums on a policy the holding company owns. That arrangement has one entity bearing a cost while another receives the benefit, which creates exposure rather than solving a funding problem.

Where the operating company is going to fund the premiums, the mechanism should be a proper distribution to the holding company, which then pays the premiums as owner.

Where the Distribution Credit Lands

The entity that receives the death benefit is the entity whose distribution account is credited.

Where the holding company owns the policy and receives the proceeds, its account is credited and it can then distribute to the individual shareholders without tax.

This is usually the desired outcome, because the holding company is typically where the shareholders hold their interest and where value is intended to accumulate.

Where the operating company owns the policy, the credit arises there, and the funds then have to move up through the structure before reaching the shareholders. That is achievable, but it adds a step and makes the result dependent on the intercorporate distribution being handled correctly.

For an owner whose objective is to deliver value to an estate, the shorter path is generally the better one.

Buy-Sell Arrangements

Where insurance funds a buy-sell arrangement between shareholders, the structuring question becomes more involved.

The mechanism chosen determines which entity should own the policy. A share redemption funded by the corporation points one way. A cross purchase between shareholders personally points another. A structure in which each shareholder’s holding company acquires the departing shareholder’s interest points a third.

Each has different consequences for where the proceeds need to arrive, which entity needs the distribution credit, and how the tax outcome for the departing shareholder’s estate is achieved.

This is one of the few areas where the ownership decision genuinely cannot be made without first settling what the buy-sell arrangement is going to do. Placing the policy first and designing the arrangement afterward produces structures that do not fit.

Multiple Holding Companies

Where each shareholder has their own holding company above a jointly owned operating company, the structure offers flexibility that a single holding company does not.

Each shareholder’s holding company can own coverage relevant to that shareholder’s own objectives, funded through distributions from the operating company, without the other shareholders participating in the result.

This avoids a persistent problem in shared structures, where a corporation insures one shareholder more heavily than another and the benefit is distributed across a share class that does not reflect the difference.

The arrangement does require the operating company’s distributions to be structured so each holding company can fund its own premiums, which is a matter for the shareholders agreement.

Policies Already in the Wrong Place

Many groups discover this issue with policies already in force in the operating company.

Moving a policy between corporations is a disposition. The transferring corporation may realize a taxable amount, the receiving corporation takes a cost basis determined by rules rather than by the parties, and no deferral is available.

Where a policy has accumulated significant value, the cost of relocating it can be substantial, and it may be that leaving it in place is the better of two imperfect options.

This is the strongest argument for settling the ownership question before any policy is issued. The decision is cheap at the outset and expensive to revisit.

What to Settle Before Issuing

The questions that should be answered first:

• Which entity carries the commercial risk, and which does not
• Where the cash to fund premiums will be generated
• Which entity needs the distribution credit, and who the ultimate recipients are
• Whether the policy supports a buy-sell arrangement, and what form that takes
• What happens to the policy if the operating business is sold

The last of these determines more than most owners expect. A policy owned by an operating company that is subsequently sold has to be extracted as part of the transaction, which is a taxable event. A policy owned by the holding company is unaffected by the sale of the business beneath it.

Reorganizations

Insurance is routinely overlooked when groups are reorganized, because nothing about a policy demands attention during the process.

Ownership that was appropriate before a reorganization may not be afterward. Beneficiary designations stop matching the structure. Policies end up in entities that were not intended to hold them.

Any reorganization involving a group that holds insurance should include confirming the policy’s ownership, beneficiary designation and funding arrangements against the new structure.

Common Planning Mistakes

Several errors recur.

Defaulting to operating company ownership because that is where the cash is, without considering creditor exposure.

Having the operating company pay premiums on a policy the holding company owns, rather than distributing funds and letting the owner pay.

Placing the policy before the buy-sell arrangement has been designed.

Leaving a policy in an operating company that is subsequently sold, and dealing with it after closing.

Omitting insurance from the diligence on a reorganization.

Conclusion

Where a group includes both an operating company and a holding company, the holding company is frequently the better owner of a life insurance policy, principally because it keeps a valuable asset away from commercial creditors.

Premium funding can be arranged through distributions from the operating company, but the owner of the policy should be the entity that pays the premiums.

The distribution credit arises in the entity that receives the death benefit, so ownership should reflect where the proceeds are ultimately needed.

Where insurance funds a buy-sell arrangement, the form of that arrangement determines the correct owner and should be settled first.

Because relocating a policy later is a taxable event with no deferral available, the ownership question should be answered before any policy is issued and revisited whenever the group is reorganized.

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.
 

Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at info@taxpartners.ca, or by visiting our website at www.taxpartners.ca.
 

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