On October 1, the Canada Revenue Agency (CRA) published its long-awaited income tax folio explaining how the tax benefit rules will apply to RRSPs, RESPs, RRIFs, RDSPs and TFSAs.
In addition to detailing how the rules would apply to a range of aggressive tax planning, the folio also discusses how the CRA views life insurance and segregated funds.
“A registered plan may contain or be structured as an annuity contract,” the insurance section of the folio begins. “If this contract includes a life insurance component, the CRA considers that there is a benefit each year.”
It later wrote that “there is no benefit if the death benefit under the life insurance component is nominal, as is the case with a typical segregated fund annuity contract.”
That’s good news, says Kevin Wark, managing partner at Integrated Estate Solutions and tax advisor at the Conference for Advanced Life Underwriting.
“They don’t see the insurance element of a segmented fund as an advantage,” he says. “For many it would be a shock and surprise.”
However, the folio specifically targets split-dollar or co-ownership life insurance contracts included in registered plans, arguing that they provide an advantage. These arrangements allow a permanent insurance policy to have two owners: one party owns the death benefit under the permanent policy and pays the fair value for it, while the other party owns the cash surrender value of the policy and contributes to the exemption amount. The two parties are generally connected (e.g., family members or corporate shareholders), and the arrangement works because “one party is looking for permanent insurance coverage and the other is looking for an investment vehicle,” Wark says.
Wark says it would be unusual for a registered plan to include a split-dollar or co-ownership arrangement, adding that neither he nor his colleagues have encountered such scenarios.
“I’m not sure if (mentioning them specifically) was out of an over-cautiousness on the part of the rating agencies or if they managed to find some of them,” he says.
However, if advisors have clients who have these arrangements under their registered plans, Wark says clients may be charged additional taxes. He suspects the CRA would determine the amount of the benefit by taking into account “the cost of insurance that would have been charged if the arrangement had not been put in place.”
The benefits are taxed at 100%, which means that if the CRA determines that your client received a $500 benefit, they will be taxed $500, disallowing the benefit entirely.
The folio also states that the CRA will not approve a proposed registered plan if “it is clear from the terms of the (proposed) sample plan that there would be a benefit.”
