Business
Insurance
Part 1
Working with Business
Owners
A PARTNER YOU CAN TRUST.
Jorge Ramos, CFP ,CLU
Director of Advanced Marketing
1
Business Structures and
Taxation
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1
Business Structures
> Self
Employed
> Partnerships
> Incorporated
private business
> CCPC
> Publicly
listed corporation
> Professional
Corporations
Business Taxation 101
> Self
Employed
> Commission
income or sales
> Can deduct expenses
> Net profit taxed as personal income
> Partnerships
> Commission
income or sales
> Can deduct expenses
> Net profit added taken as income proportionately by
each partner
Business Taxation 101
> Incorporated
> General
Private business
corporate tax rates
26%
> 25%
>
(11% Provincial, 15% Federal)
(manufacturing, farming, mining)
> CCPC
>
15.5%
> Publicly
> Do
(4.5% Federal, 11% Provincial)
> On first $500,000
Traded companies
not qualify as CCPC
Canadian Controlled Private Corporation
> CCPC
> Corporation
resident in Canada
> 51% controlled by Canadians
> Not listed on a stock exchange
> Not owned by a publicly traded firm
CCPC - Advantages
> Lower
corporate tax rates
> 15.5%
> An
vs. 26%
additional month to pay taxes
> Enhanced
> Qualifies
> First
investment tax credits
for Capital gains exemption - CGE
$750,000 of capital gains on shares is tax-free
Capital Gains Exemption
> First
$750,000 of capital gains are tax-free
> Qualified
small business shares
> Qualified Farm property
>
50% of assets “actively” used in the business for the last 24 months
>
90% of assets “actively” used in the business at time of sale
>
Shares owned by individual for last 24 months
Publicly Listed Corporation
> Everyone
is an employee, including Founder
> Company
can own Life insurance on employees
> Requires
resolution of the board
> Insurance
premiums not tax deductible
Professional Corporations
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1
Professional Corporations
> Can
only carry on business of profession
> Majority
must be owned by professionals (voting shares)
> Non-professional
spouse/children can also be
shareholders (non-voting shares)
> Cannot
be a numbered company
When to set-up a Professional Corp
> Income
> No
> In
higher then needed for lifestyle
personal non-deductible debts
highest personal tax bracket
> Spouse
> Creditor
and children in lower tax brackets
protection needed
> Deductions
against income needed
Professional Corp. – Advantages
> Qualifies
for small business tax rates
> Expenses
> Tax
deduction
deferral
> Corporate
tax vs. personal tax rates
> Dividend vs. salary
> Income
splitting
> Hiring
family members
> Dividend sprinkling
> Creditor
Protection
Professional Corp. - Disadvantages
> CGE
– triggered on sale of shares
> Cannot
> No
sell professional corp. shares easily
protection against Professional negligence
> Increased
costs to administer
> Increased
regulation and complexity
> Employee
health tax charged on income
> Business
losses cannot be flowed to shareholders
The Mechanics of
Corporate Policies
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1
Theory of Tax Integration
> Income
earned at a corporate level may ultimately end
up being distributed to someone and as a bonus/income
or as a dividend to someone personally.
> Income
should be Tax Neutral, ie: taxed equally
whether income is earned corporately or personally.
> There
are various mechanisms used by CRA to ensure
that this is true:
RDTOH – Refundable Dividend tax on hand
> CDA – Capital Dividend Account
>
RDTOH – Refundable Dividend Tax on Hand
>
Acts as a disincentive to accumulate investment income in the
corporation.
>
The federal government levies a tax on any investment income earned by
a CCPC, the tax goes into the company’s RDTOH account (functioning
like an inventory) with CRA and is refunded to the CCPC when it pays a
taxable dividend to shareholders.
>
For every $3 in taxable dividends that are paid to shareholders, the
company is refunded $1 up to the balance of the RDTOH account.
CDA - Capital Dividend Account
> The
CDA is a notional account.
>
It is not an actual bank account but rather an accounting notation
> The
CDA tracks any amounts that a company receives tax
free, such as:
>
>
>
Insurance death benefits, net of ACB
Tax-free portion of capital gains
Capital dividends received
> The
CDA amount allows the corporation to pay a tax-free
capital dividend from their retained earnings.
>
>
Must be paid to a CDN resident
Must be a CCPC – CDN controlled private Corp.
Calculating CDA
> CDA
= Life insurance death benefit – ACB
> Life
insurance death benefit
net of policy loans
> not net of collateral loans
> Applies to permanent and Term policies
> Applies whether there is cash value or not
>
> Notes:
>
>
ACB usually goes to zero after 20+ years, cannot be negative
CDA has to be paid out equally to all shareholders of the same
class
ACB
> ACB
– Adjusted Cost Basis
Ensures that corporate money gets taxed properly in
personal hands
> The ACB of policy tracks the original premium paid by a
company for life insurance minus the NCPI
>
> Formula
Premiums Paid increase ACB
> NCPI decreases ACB
>
NCPI
> NCPI
>
– Net Cost of Pure Insurance
Net amount at risk (NAAR) for the year multiplied by the
probability of death in that year, ie: similar to T1 rates
> Based on 1975 Select and Ultimate mortality table
> Costs for any benefits or riders removed
> Removes any ratings on substandard risks
Calculating CDA
> CDA
= Life insurance death benefit – ACB
> Life
insurance death benefit
net of policy loans
> not net of collateral loans
> Applies to permanent and Term policies
> Applies whether there is cash value or not
>
> Notes:
>
>
ACB usually goes to zero after 20+ years, cannot be negative
CDA has to be paid out equally to all shareholders of the same
class
Impact of CDA
> Client
> Policy
Male 50, Std. NS, Corp.
Death benefit
$5 million UL face only
> Premium
$200,000 per year for 10 year
> Min
$66,219.24
Level COI Cost
NCPI vs COI
>
> ACB
in year 5
$ 945,709
($54,291 vs $331,096)
> ACB
in year 20
$1,333,791
($666,209 vs $2 million)
> ACB
in year 30
$
0
Impact of CDA – Year 5
> Death
Benefit
> ACB
$5,000,000
$ 945,709
> CDA
Credit
$4,054,291
> How
much did Corp. receive from InsCo.?
> $5,000,000
> How
much could Corp pay tax free to shareholders?
> $4,054,291
> What
happens to the rest?
Impact of CDA – Year 5
> Death
Benefit
> ACB
> CDA
> Tax
$ 945,709
Credit
free Capital dividend paid
> Taxable
> Tax
>
dividend paid
paid on dividend
> What
$5,000,000
$4,054,291
$4,054,291
$ 945,709
$ 308,017
is the net death benefit received by shareholders?
$4,691,983
CDA Tax Trap
> Problem:
> Potential
death benefit shortfall created by CDA/ACB
> Net death benefit may fall short of required amount
>
Buy-sell
> Solution:
> Face
plus fund plus ACB
Increases face amount so that CDA paid is equal to or
greater than original death benefit
> Removes risk of the ACB tax grind on CDA
> Removes risk of underinsuring the need
>
Accounting for Corporate
Owned Policies
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Deductibility of Insurance Premiums
> Premiums
paid by a corporation for a life insurance
policy are generally not tax deductible
> Considered
a capital outlay and not an expense
> Exceptions:
1.Group
insurance premiums
2.Charitable gifting of a life insurance policy
3.Collateral insurance
1. Group Insurance Premiums
> Group
medical insurance
> Group
life insurance
> IPP’s
> RCA’s
2. Charitable gifting of a life insurance policy
>
Policy assigned to charity
> Charity
issues a tax receipt equal to actual premiums
paid
> Death benefit does not trigger a tax receipt
> Policy
not assigned to charity
> Charity
issues a tax receipt for value of death benefit
upon receipt of death benefit proceeds
> No tax receipt for annual premiums
3. Collateral Insurance
1.
Client secures a loan from a restricted financial
institution
2.
Lender requires a policy as collateral to secure the
loan
3.
The policy is assigned to the lender
4.
Loan proceeds are invested in a qualified income
generating investment
5.
Interest on loan must be tax deductible
Collateral Insurance - Interest Deductibility
> Loans
must be invested to earn income
> Rent,
dividends, profit, interest
> Capital gains does not qualify
> Interest
> There
must be a legal obligation to pay the interest
> Interest
> Policy
must be paid or payable in the year
deduction can only be taken by policy owner
loan interest must be confirmed by insurer
> Form
T2210
Collateral Insurance – Allowable deduction
> Step
1
> Lower
of:
NCPI for the year and
> Premiums actually paid in the year
>
> Step
2
> Pro-rated
>
by amount applicable to loan
Example:
Loan Amount = $250,000
Insurance DB = $1 million
Deductible amount = 25% of step 1 amount
MTAR
> Maximum
> Magical
Tax Actuarial Reserve
Table of Allowable Room
> The
maximum premium a policy owner can deposit into
a policy, tax sheltered.
> The
maximum amount that an insurance company can
claim as a policy reserve.
MTAR - Two Major Tests
> Exempt
Test Policy (ETP)
> designed
to measure the funding level of a life insurance
policy relative to its death benefit
> 250%
or “Anti Dump-In” Rule
> applies
if the accumulating fund on the tenth anniversary
or any subsequent anniversary date, exceeds 250% of
accumulating fund on the third preceding anniversary
date
Exempt Test Policy (ETP)
> Based
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
ETP
0 20 40 60 80 85
upon the
actuarial reserves
required for a 20 pay
policy to endow
(cash surrender
value equal to death
benefit) at age 85
Issues with Exempt Test
> Rules
in Regulation 306 of Tax Act outlining exempt
policies are open to interpretation
Based on CSV or Fund Value ??
> Increase in Fund value considered new deposit ??
>
> Test
ends at age 85
>
No insurance needed to tax shelter funds
> Changes
coming in 2014
250 percent rule (anti dump-in rule)
> 10th
year test
>
Maximum deposit in year 10 is
>
Year 7 Fund value times 250%
>
Growth in fund value is considered new money
> Prior
>
to 7th Year
Need to start contributing more than the minimum
Corporate Financial
Statements
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1
Income Statement
> Premiums
paid minus increase in CSV
= Net Insurance Expense
> Increase
in CSV minus premiums paid
= Income
Balance Sheet
> Cash
surrender value of policy
= Asset
Corporate Minutes
> Approve
purchase of Life insurance
> Key-Man
> Buy-Sell
> IPP/RCA
> IRIS
Financial notes
Notes to reflect that policy pledged as collateral
Advantages of Corporate
Owned Life Insurance
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1
Corporate Insurance Advantages
> Personal
marginal tax rates vs. Corporate rates
> 46.4%
> Ease
vs. 15.5%
of administration
> Buy-Sell
premiums shared equally
> Multiple policies centrally owned
> Capital
dividend account
Disadvantages of
Corporate Owned Life
Insurance
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1
Corporate Insurance Disadvantages
> CDA
Tax trap
> Increased
value to corporate shares
> Increases
> Opco
capital gain
vs. Holdco
> Potential
sale of Opco
> CCPC/CGE offside risk
Thank You
Jorge Ramos, CFP, CLU
Director of Advanced Marketing
416-206-7050
jorge.ramos@inalco.com