1

Business Insurance

Part 1Working with Business

Owners

Jorge Ramos, CFP ,CLUDirector of Advanced Marketing

A PARTNER YOU CAN TRUST.

1

Business Structures and Taxation

A PARTNER YOU CAN TRUST.

> Self Employed> Partnerships> Incorporated private business> CCPC> Publicly listed corporation> Professional Corporations

Business Structures

> 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 Private business> General corporate tax rates

> 26% (11% Provincial, 15% Federal)> 25% (manufacturing, farming, mining)

> CCPC> 15.5% (4.5% Federal, 11% Provincial)

>On first $500,000>Publicly Traded companies

>Do not qualify as CCPC

Business Taxation 101

> CCPC> Corporation resident in Canada> 51% controlled by Canadians> Not listed on a stock exchange> Not owned by a publicly traded firm

Canadian Controlled Private Corporation

> Lower corporate tax rates> 15.5% vs. 26%

> An additional month to pay taxes

> Enhanced investment tax credits

> Qualifies for Capital gains exemption - CGE> First $750,000 of capital gains on shares is tax-free

CCPC - Advantages

> 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

Capital Gains Exemption

> Everyone is an employee, including Founder> Company can own Life insurance on employees> Requires resolution of the board> Insurance premiums not tax deductible

Publicly Listed Corporation

1

Professional Corporations

A PARTNER YOU CAN TRUST.

> 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

Professional Corporations

> Income higher then needed for lifestyle> No personal non-deductible debts> In highest personal tax bracket

> Spouse and children in lower tax brackets> Creditor protection needed> Deductions against income needed

When to set-up a Professional Corp

> Qualifies for small business tax rates> Expenses deduction> Tax deferral

> Corporate tax vs. personal tax rates> Dividend vs. salary

> Income splitting> Hiring family members> Dividend sprinkling

> Creditor Protection

Professional Corp. – Advantages

> CGE – triggered on sale of shares> Cannot sell professional corp. shares easily

> No 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

Professional Corp. - Disadvantages

1

The Mechanics of Corporate Policies

A PARTNER YOU CAN TRUST.

> 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

Theory of Tax Integration

> 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.

RDTOH – Refundable Dividend Tax on Hand

> 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.

CDA - Capital Dividend Account

> 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

Calculating CDA

> 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

ACB

> 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

NCPI

> 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

Calculating CDA

> Client Male 50, Std. NS, Corp.> Policy Death benefit $5 million UL face only> Premium $200,000 per year for 10 year> Min Level COI Cost $66,219.24>

> ACB in year 5 $ 945,709> ACB in year 20 $1,333,791> ACB in year 30 $ 0

Impact of CDA

NCPI vs COI

($54,291 vs $331,096)

($666,209 vs $2 million)

> Death Benefit $5,000,000> ACB $ 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 $5,000,000> ACB $ 945,709> CDA Credit $4,054,291

> Tax free Capital dividend paid $4,054,291> Taxable dividend paid $ 945,709> Tax paid on dividend $ 308,017> What is the net death benefit received by shareholders?

> $4,691,983

Impact of CDA – Year 5

> 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

CDA Tax Trap

1

Accounting for Corporate Owned Policies

A PARTNER YOU CAN TRUST.

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 premiums2.Charitable gifting of a life insurance policy3.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 must be paid or payable in the year> There must be a legal obligation to pay the interest> Interest deduction can only be taken by policy owner> Policy 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 = $250,000Insurance DB = $1 millionDeductible amount = 25% of step 1 amount

MTAR

> Maximum Tax Actuarial Reserve> Magical 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 upon the actuarial reserves required for a 20 pay policy to endow (cash surrender value equal to death benefit) at age 85

00.10.20.30.40.50.60.70.80.9

1

0 20 40 60 80 85

ETP

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

1

Corporate Financial Statements

A PARTNER YOU CAN TRUST.

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

1

Advantages of Corporate Owned Life Insurance

A PARTNER YOU CAN TRUST.

Corporate Insurance Advantages

> Personal marginal tax rates vs. Corporate rates> 46.4% vs. 15.5%

> Ease of administration> Buy-Sell premiums shared equally> Multiple policies centrally owned

> Capital dividend account

1

Disadvantages of Corporate Owned Life

Insurance

A PARTNER YOU CAN TRUST.

Corporate Insurance Disadvantages

> CDA Tax trap> Increased value to corporate shares

> Increases capital gain> Opco vs. Holdco

> Potential sale of Opco> CCPC/CGE offside risk

Thank You

Jorge Ramos, CFP, CLUDirector of Advanced Marketing

416-206-7050jorge.ramos@inalco.com