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  • Charles Rotenberg

TROUBLE, OH WE GOT TROUBLE...

THAT’S TROUBLE WITH A CAPITAL “T” AND THAT RHYMES WITH “P” AND THAT STANDS FOR “PASSIVE INVESTMENT INCOME"




Anyone in business has heard the pitch about the need for life insurance. There are many forms of insurance policies. I will assume that all policies a reputable insurance advisor will recommend are “exempt” policies, and I will leave it to the experts to debate whether one form of policy is preferable in any given circumstance.


Suffice it to say, that if a policy qualifies as an exempt policy, any investment income generated by funds invested in the policy is not included in the policy owner’s investment income, and the proceeds of the insurance, together with all investments, will be received on a tax-free basis by the beneficiaries on the death of the person whose life is insured.


Usually, premiums for life insurance are not deductible. Given the difference between personal and corporate rates, it can be considerably cheaper to have a corporation purchase life insurance than to purchase it personally.


You have all heard the very good reasons why your company needs corporate owned life insurance:


  • Creditor proofing

  • Movement of surplus cash from the balance sheet where it can upset your entitlement to the capital gains exemption

  • Reduces the value of the shares to determine taxation at the time of death

  • Can usually be paid out fully to the family on a tax free basis, through the capital dividend account


In or around 1982, the insurance companies developed a form of whole life policy called a Universal Life Policy (UL). Within certain limits, a UL policy can effectively be segregated into an insurance component and an investment component.


In a traditional whole life policy, the insurance company will determine how the premium funds are to be invested. Within the investment component of a UL policy, the policyholder can determine the investments to be held. Within limits, a policyholder can design an investment portfolio that can mirror his or her own investments. The funds in a UL can be put into:


  • Savings accounts, short term or long term

  • Guaranteed investment accounts

  • Indexed accounts that can be set up to mirror various stock and other indices

  • Segregated funds that more or less mirror mutual funds

  • And many other types of investments


All investments within an exempt policy, are not subject to annual taxation on the investment income, are creditor proofed, will be received tax-free on death, and can, if properly structured, be accessed on a tax-free basis during the insured’s lifetime.


Passive Investment Income

When Messrs. Trudeau and Morneau launched their attack on small business in July 2017, one of the areas they went after was passive investment income earned in a Canadian Controlled Private Corporation (CCPC).


The Minister of Finance introduced a threshold of $50,000 of investment income that would continue to be taxed under the existing rules.


In addition, he promised to “grandfather” all capital existing as at December 31st, 2017, and to only apply the new rules in respect of investment income on “new” capital, but he out and out lied about grandfathering any investment income.


Under the new rules CCPC’s that have both investment income and business income, whether in one company or in associated companies, the tax on their active business income could increase by up to $70,000 annually.


The Small Business Deduction (SBD) is really a tax credit, rather than a deduction. It reduces the corporate income tax rate applying to the first $500,000 per year of qualifying active business income of a CCPC. A group of associated corporations must share the Small Business Limit (SBL) of $500,000. The difference in the tax rate is approximately 14.5%. In Ontario. Paying the low rate of tax rather than the full rate on $500,000 of net income represents a tax saving of approximately $70,000.


The SBD will be reduced by $5 for every $1 of investment income above the $50,000 threshold (equivalent to $1 million in passive investment assets at a 5% return), such that the business limit will be reduced to zero at $150,000 of investment income (equivalent to $3 million in passive investment assets at 5%).


A CCPC with passive investment assets of $1.4 million at a 5% rate of return can earn up to $400,000 in business income per year and be taxed at the small business rate, rather than its full $500,000 of business income. This represents a tax increase of $14,500 in respect of the $100,000 that will now be taxed at the higher rate.


A CCPC with passive investment assets of $3 million or more pays the higher corporate tax rate on all its business income.


The tax paid by a CCPC on its investment income, in Ontario, is 50.2%.


As I stated above, if a CCPC earns $50,000 of investment income, there is no change to the tax paid on the active business income.


However, if the CCPC earns $150,000 of investment income, assuming a full $500,000 of active business income, the tax cost in respect of the additional $100,000 is $122,700. This is the actual investment income tax of $50,200 PLUS the $70,000 of additional tax on its active business income.


To me, 122.7% tax on $100,000 of investment income is too high a price.,


Here is where it gets exciting – yes insurance can get exciting.


The investment income earned within an exempt life insurance policy is not included in the corporation’s passive investment income, and continues to accumulate on a tax free basis.


I have written many times about the need to keep excess cash and investments out of active business corporations, in order to have the ability to claim the Lifetime Capital Gains Exemption.


A properly structured insurance portfolio will not only reduce passive investment income to avoid outrageous tax costs but also can be used to reduce excess cash and investment assets to ensure access to the LCGE, in addition to all of the regular benefits of life insurance.


I would be pleased to discuss this with you and your advisors.


Stay safe,

- Chuck


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