Shareholder Benefits and Corporate-Owned Life Insurance

Introduction

A shareholder benefit assessment is one of the harsher outcomes in Canadian tax. The shareholder includes the value of the benefit in income, and the corporation receives no offsetting deduction for having provided it.

The same amount is effectively taxed once with no relief anywhere in the structure. There is no gross up, no credit, and no mechanism to undo it after the fact.

Corporate-owned life insurance generates this exposure more often than most corporate assets, because the arrangements are frequently set up by someone focused on the insurance rather than on who is receiving the benefit of the corporate expenditure.

The Underlying Principle

The rule exists to prevent value moving from a corporation to its shareholder outside the normal channels of salary or dividends.

A corporation that confers a benefit on a shareholder, in that capacity and without adequate consideration, causes the value of the benefit to be included in the shareholder’s income.

The concept is deliberately broad. It is not limited to payments of money, and it does not require any intention to extract value improperly. It captures the substance of what the corporation has provided and who has received the advantage of it.

Life insurance arrangements run into this because the corporation is frequently paying for something the shareholder, their family, or their estate ultimately receives.

Where the Exposure Arises

The common fact patterns are predictable, and most of them are visible on the face of the arrangement:

• The corporation pays premiums on a policy owned personally by the shareholder
• The corporation owns the policy but the shareholder’s family members are named as beneficiaries
• The corporation’s policy is used as security for the shareholder’s personal borrowing
• One corporation in a group pays premiums while an unrelated entity receives the benefit

Each involves the corporation bearing a cost while someone other than the corporation receives the advantage. That mismatch is what attracts attention.

Premiums on a Personally Owned Policy

This is the most frequent arrangement and the one business owners are most often surprised by.

The reasoning behind it is usually sound in intention. The corporation has the cash, the premiums are substantial, and paying them corporately appears to be the efficient route.

The difficulty is that the policy belongs to the shareholder. The corporation is paying an expense of the shareholder, and the value of that payment is a benefit conferred on them.

The result is generally worse than simply paying a dividend and funding the premium personally, because a dividend attracts the dividend tax credit while a shareholder benefit does not.

Where the corporation is going to bear the cost, corporate ownership of the policy is usually the appropriate structure rather than corporate payment of a personal policy.

Beneficiary Designations

A corporation can own a policy and still create exposure through the beneficiary designation.

Where the corporation pays the premiums but the death benefit is directed to the shareholder’s spouse, children or estate, the corporation has funded a benefit it will never receive.

This also removes the distribution credit that corporate ownership was intended to produce, since the corporation does not receive the proceeds.

The arrangement therefore manages to create exposure and forfeit the principal advantage at the same time. It usually arises from a beneficiary designation completed at application without reference to the ownership structure.

Policies Used as Security for Personal Borrowing

Where a shareholder borrows personally and the corporation’s policy is assigned as security, the corporation has provided a guarantee of value without receiving anything in return.

Arrangements of this kind are common in leveraged insurance planning, particularly where a policy is held corporately for funding reasons while the borrowing is undertaken personally.

They are not inherently problematic, but they require attention. Where the corporation provides security for a shareholder’s personal obligation, consideration should pass to the corporation on commercial terms, and the arrangement should be documented.

Doing this at the outset is straightforward. Reconstructing it after an assessment is not.

Groups With Multiple Corporations

Corporate groups introduce additional ways for the mismatch to arise.

An operating company pays premiums on a policy owned by a holding company. One corporation funds coverage on a life insured that benefits a sister corporation. A policy stays where it was placed years earlier while the group reorganizes around it.

Rules introduced in recent years tightened several structures of this kind, particularly where a corporation claimed a distribution credit on proceeds relating to a policy it had not funded.

In any group holding insurance, the entity paying premiums, the entity owning the policy and the entity named as beneficiary should be confirmed to be consistent with the intended outcome.

Multiple Shareholders

Where a corporation has more than one shareholder, arrangements that appear acceptable in a single shareholder company can create a benefit flowing between shareholders.

A corporation insuring one shareholder more generously than another, or funding coverage that serves one shareholder’s estate planning rather than the business, is providing differential value.

These situations are usually best addressed through a shareholders agreement that sets out what the corporation will fund, for whom, and on what basis, rather than left to be inferred from the arrangements themselves.

Preventing the Problem

The exposure is almost always avoidable, and the steps are not complex.

Decide ownership before the policy is issued, and ensure the entity paying premiums is the entity that owns the policy.

Confirm that the beneficiary designation directs proceeds to the policy owner rather than to individuals connected with the shareholder, unless there is a specific reason otherwise and the consequences have been considered.

Where the corporation is providing something to the shareholder, document it and ensure the corporation receives appropriate consideration.

Review the arrangements whenever the corporate structure changes, because a structure that was correct at issue may not remain correct after a reorganization.

Record the business purpose of the insurance at the time it is put in place, particularly where it funds a buy-sell arrangement or protects against the loss of a key person.

Common Planning Mistakes

Several errors recur.

Having the corporation pay premiums on a policy the shareholder owns personally, on the assumption that corporate payment is simply more efficient.

Naming family members as beneficiaries of a corporately owned policy, which both creates exposure and forfeits the distribution credit.

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

Leaving beneficiary designations unchanged through a reorganization.

Assuming that an arrangement that has gone unchallenged for years has been accepted, when it has simply not yet been examined.

Conclusion

A shareholder benefit assessment includes the value of the benefit in the shareholder’s income with no deduction to the corporation, which makes it more costly than paying a dividend and funding the expense personally.

Corporate-owned life insurance attracts this exposure wherever the corporation bears a cost while the shareholder, their family or their estate receives the advantage.

The recurring patterns are a corporation paying premiums on a personally owned policy, a corporately owned policy with family members named as beneficiaries, and corporate policy value supporting personal borrowing.

Each is straightforward to avoid at the outset by aligning ownership, premium payment and beneficiary designation, and by documenting any value the corporation provides to the shareholder.

These arrangements should be reviewed whenever the corporate structure changes, because insurance is easily overlooked in a reorganization and nothing about the policy itself signals that anything has shifted.

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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