B02080 ― SHAREHOLDER AGREEMENT: LIFE INSURANCE FUNDING METHODS 3.4
B02080
SHAREHOLDER AGREEMENT: LIFE INSURANCE FUNDING METHODS
B02080-11 (CFPC/Corporate – 2007)
B02080 ― SHAREHOLDER AGREEMENT: LIFE INSURANCE FUNDING METHODS 3.4
TABLE OF CONTENTS
PAGE
INTRODUCTION 4
scenario no. 1 6
1 CROSS INSURANCE BUY-SELL BY THE SURVIVING SHAREHOLDERS 6
1.1 Underwriting and Payment of Life Insurance by “A”, “B”, “C” 6
1.2 Payment of the Face Amount Upon the Death of “A” 6
1.3 Taxation of “A” 6
1.4 Acquisition of the Shares by the Estate 6
1.5 Transfer of Shares 7
1.6 Alternative / Rollover to Spouse 7
ILLUSTRATION 8
SCENARIO NO. 2 10
2 LIFE INSURANCE TAKEN OUT BY THE CORPORATION PURCHASED BY THE SURVIVING SHAREHOLDERS 10
2.1 Underwriting and Payment of the Life Insurance Policies by a Corporation Earning
Active Business Income in Canada and Entitled to Claim the Small Business
Corporation Deduction (OPCO) 10
2.2 Payment of Face Amount to OPCO 10
2.3 Taxation of “A” 10
2.4 Taxation of the Estate of “A”: Acquisition and Disposition of Shares by the Estate 10
2.5 Transfer of Shares 10
2.6 Dividend to Surviving Shareholders, “B” and “C” 11
2.7 Alternative / Rollover to Spouse 11
2.8 Alternative to Avoid the Problem of Reassessment of the Shares 11
SCENARIO NO. 3 13
3 INSURANCE TAKEN OUT BY THE CORPORATION PURCHASE BY THE CORPORATION 13
3.1 Underwriting and Payment of Life Insurance Policies by a Corporation Earning Active Business Income in Canada and Entitled to Claim the Small Business Corporation
Deduction (OPCO) 13
3.2 Payment of the Face Amount upon Death to OPCO Inc. 13
3.3 Taxation of “A” 13
3.4 Taxation of the Estate of “A”: Acquisition and Disposition of the Shares by the Estate 13
3.5 Capital Dividend to the Estate of “A” upon Redemption 14
3.6 No Tax Consequences upon Disposition of the Shares by the Estate of “A” 14
3.7 Increase of the ACB 14
illustration 17
SCENARIO NO. 4 19
4 CROSS-INSURANCE BUY-SELL BY UNRELATED CORPORATE SHAREHOLDERS 19
4.1 Underwriting and Payment of Life Insurance Policies 19
4.2 Payment of Face Amount upon Death of “A” to Holdco “B” and Holdco “C” 19
4.3 Taxation of “A” 19
4.4 Acquisition of the Shares of “A” by his Estate 19
4.5 Sale of the Shares of OPCO by Holdco “A” 19
4.6 Transfer of Shares 19
4.7 Potential Dividend to the Surviving Shareholders 20
4.8 Winding-up 20
SCENARIO NO. 5 24
5 INSURANCE TAKEN OUT BY THE CORPORATION PURCHASE BY THE CORPORATION OF THE SHARES HELD BY A CORPORATE SHAREHOLDER 24
5.1 Underwriting and Payment of the Life Insurance Policies 24
5.2 Payment of Face Amount upon Death to OPCO Inc. 24
5.3 Taxation of “A” 24
5.4 Acquisition of Shares by Estate 24
5.5 Redemption or Purchase of the OPCO Shares 24
5.6 Winding-up 25
5.7 Increase of the ACB 25
SCENARIO NO. 6 27
6 INSURANCE TAKEN OUT BY THE CORPORATION BUY-SELL
BY THE CORPORATE SHAREHOLDERS 27
6.1 Underwriting and Payment of the Life Insurance Policies by OPCO 27
6.2 Payment of Face Amount to OPCO Inc. 27
6.3 Taxation of “A” 27
6.4 Acquisition of Shares by Estate 27
6.5 Sale of Shares of OPCO by Holdco “A” 27
6.6 Transfer of Shares 28
6.7 Potential Dividend to the Surviving Shareholders 28
6.8 Winding-up 28
INTRODUCTION
This document provides for different arrangements to be implemented using a combination of funding methods by way of life insurance and redemption or purchase for cancellation of shares from the deceased estate, spouse or spousal trust, or purchase of such shares by surviving shareholders (or their holding corporations), in order to reduce tax effects resulting from the deemed disposition of shares on the death of a shareholder. It focuses primarily on planning techniques involving the use of insurance proceeds to enable surviving shareholders to purchase the deceased shares from the estate, which is collected either by the surviving shareholders (cross insurance) or the corporation (corporate insurance), the corporation to redeem such shares using the funds collected from the life insurance (corporate insurance), the surviving shareholders’ holding corporations to purchase the shares using proceeds from a cross insurance, and the corporation to purchase for cancellation shares held by the holding corporation of the deceased shareholder, funded by a corporate insurance.
SCENARIO NO. 1
1 CROSS INSURANCE BUY-SELL BY THE SURVIVING SHAREHOLDERS
1.1 Underwriting and Payment of Life Insurance by “A”, “B”, “C”
Premiums non-deductible, except under certain circumstances [Ref.: 18(1)(a) I.T.A.].
After-tax cost higher than if the corporation were the owner and beneficiary of the life insurance and paid the premiums. In order to pay the premiums, the corporation will pay to each shareholder the amount of money required by way of salary, bonus, dividend, loan, etc., each of these means of payment having a specific tax treatment. In general, it is better to have this payment taxed by way of dividend to the extent that the corporation is able to claim the small business deduction.
1.2 Payment of the Face Amount Upon the Death of “A”
No income tax.
1.3 Taxation of “A”
Taxation of “A” on the portion of his taxable capital gain from shares not eligible for the cumulative lifetime capital gains deduction. The capital gain represents the difference between the adjusted cost base (ACB) and the fair market value of his shares immediately before his death; the rollover to the spouse of the deceased shareholder “A” is not available in light of the requirement to sell the shares and the inability to qualify as “indefeasibly vested” as required by the Act for the purposes of the rollover [Ref.: 70(5) and (6) I.T.A.].
The corporation is neither the owner nor the beneficiary of the life insurance. In addition, the proceeds of life insurance are not taken into consideration in the determination of the FMV of the shares, since the proceeds of insurance are payable to “B” and “C”.
1.4 Acquisition of the Shares by the Estate
For the purposes of the I.T.A., deemed acquisition of the shares at a cost equal to their fair market value. The sale of the shares to the other shareholders will not give rise to a capital gain or a capital loss, if the sale price (i.e., the price payable pursuant to the Shareholders’ Agreement) is equal to the fair market value of the shares of the deceased [Ref.: 70(5) I.T.A.].
1.5 Transfer of Shares
Acquisition of the shares by “B” and “C” at the price payable according to the Shareholders’ Agreement, thereby increasing the ACB of the shares of “B” and “C” [Ref.: 54 and 47 I.T.A.].
The price is paid out of the proceeds of the life insurance. If it is insufficient, “B” and “C” must make up the shortfall with their own funds, therefore with after-tax dollars, or with borrowed dollars. Where the sale price is not paid in cash, it is possible for the vendor to claim, for the purposes of the computation of the capital gain, a reserve enabling him to average the gain out over a maximum of five (5) years. The reserve is equal to the lesser of the portion of the capital gain attributable to the amount due at the end of the year or 4/5 of the capital gain, and, for the subsequent years, 3/5, 2/5 and 1/5 respectively [Ref.: 40(1)(a)(iii) I.T.A.]. Where the disposition is to a child of certain types of farm and fishing property (land, depreciable property of a prescribed class, shares of a family farm corporation or interest in a family farm partnership) or shares of the share capital of a small business corporation of the taxpayer, the reserve allows the capital gain to be spread out over a maximum of ten (10) years.
1.6 Alternative / Rollover to Spouse
It may be interesting to avail oneself of the rollover provisions to a spouse or a spousal trust [Ref.: 70(6) I.T.A.]. The taxable capital gain otherwise realized after death will be included in the computation of income of the spouse or of the trust at the time of the actual disposition of the shares. It is also possible to allocate the gain between the deceased and the spouse or the trust if the proper election is made as provided for in the Subsection 70(6.2) I.T.A. Since the rollover to the spouse is only possible where there is an indefeasible vesting in the spouse or in a spousal trust within 36 months following death, the agreement may not provide for a mutual buy-sell requirement. The solution is to provide a double buy-sell option whereby the spouse has the option to sell to the surviving shareholders within a specific time period, failing which, the surviving shareholders have the option of purchasing the shares of the deceased. It will therefore be possible, inter alia, for the deceased and the surviving spouse to claim the capital gains deduction.
Common law spouses, including same-sex couples, are deemed to be spouses by the I.T.A. even if they are not married [Ref.: 248(1) I.T.A.].
ILLUSTRATION
SALE TO THE SURVIVING SHAREHOLDERS
INCOME TAX RETURNOF THE DECEASED / BUY/SELL REQUIREMENT
(No rollover) / MUTUAL OPTION
(Rollover and election)
70(6.2) I.T.A.
Adjusted cost base / 100 / 100
Paid-up capital / 100 / 100
Proceeds of disposition 70(5) (FMV) / 1 200 000
Proceeds of disposition 70(6.2) (FMV) / 500 000
Capital gain / 1 199 900 / 499 900
Qualified small business corporation
shares deduction / (500 000) / (499 900)
Capital gain / 699 900 / ø
INCOME TAX RETURN OF THE ESTATE
OF THE SPOUSAL TRUST OR OF THE SPOUSE / BUY/SELL REQUIREMENT
(No rollover) / MUTUAL OPTION
(Rollover and election)
70(6.2) I.T.A.
Adjusted cost base / 1 200 000 / 500 000
Proceeds of disposition / 1 200 000 / 1 200 000
Capital gain / ø / 700 000
Qualified small business corporation
shares deduction / ø / 500 000
Capital gain / ø / 200 000
Consequence for the
surviving shareholders
Adjusted cost base / 1 200 000 / 1 200 000
SCENARIO NO. 2
2 LIFE INSURANCE TAKEN OUT BY THE CORPORATION PURCHASED BY THE SURVIVING SHAREHOLDERS
2.1 Underwriting and Payment of the Life Insurance Policies by a Corporation Earning Active Business Income in Canada and Entitled to Claim the Small Business Corporation Deduction (OPCO)
Premiums non-deductible, except under certain circumstances [Ref.: 18(1)(a) I.T.A.]. After-tax cost of the premiums less than if individuals had cross-financed!
2.2 Payment of Face Amount to OPCO
No income tax: 148(2)(b) and 148(9)(e.2)(iv) I.T.A. for OPCO.
The excess of the insurance proceeds over the adjusted cost base of the policy increases the capital dividend account (CDA) of OPCO, as of the receipt thereof.
2.3 Taxation of “A”
Taxation of “A” on the portion of his taxable capital gain on shares which do not entitle him to claim the cumulative lifetime capital gains deduction. The capital gain for “A” is equal to the difference between the adjusted cost base (ACB) and the fair market value of his shares immediately prior to his death. The rollover to the spouse of “A” is not available in light of the requirement to sell the shares and the inability to qualify as “indefeasibly vested” as required by the Act [Ref.: 70(5) and (6) I.T.A.].
Only the cash surrender value of the life insurance policy immediately prior to the death will be taken into consideration in the valuation of the fair market value of the shares of the deceased shareholder [Ref.: Subsection 70(5.3) I.T.A.].
2.4 Taxation of the Estate of “A”: Acquisition and Disposition of Shares by the Estate
Deemed acquisition of the shares at a cost equal to their fair market value. The sale of the shares to the other shareholders will not result in a capital gain or loss, if the sale price (i.e., the price payable according to the Shareholders’ Agreement) is equal to the FMV of the shares [Ref.: 70(5) I.T.A.].
2.5 Transfer of Shares
Acquisition of the shares by “B” and “C” at the price payable according to the Shareholders’ Agreement which will increase the ACB of the shares of “B” and “C” [Ref.: 54 and 47 I.T.A.]. The price is paid by way of a tax-free dividend. If it is insufficient, “B” and “C” are required to make up the shortfall with their own funds, in other words with after-tax dollars or with borrowed funds. Where the price is not paid in cash, it would be possible to claim a reserve (See Scenario No. 1, para. 6).
2.6 Dividend to Surviving Shareholders, “B” and “C”
No taxes if OPCO pays a capital dividend out of the CDA [Ref.: 83(2) I.T.A.].[(]
2.7 Alternative / Rollover to Spouse
(See Scenario No. 1, Alternative / Rollover to Spouse).
As for the ability of the spouse to claim the capital gains deduction resulting from the disposition of qualified small business corporation shares, Subsection 110.6(15) of the I.T.A. provides that the cash surrender value of the life insurance alone shall be considered to be an non-qualifying asset and not the entire proceeds of insurance.