Using Corporate Owned Life Insurance to Reduce Passive Income Taxation

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Effective January 2019, new tax rules came into effect that will have a significant impact on some business owners with active operating companies. The small business deduction ($500,000) allows Canadian Controlled Private Corporations (CCPC) a lower rate of corporate tax on the first $500,000 of income. Starting in 2019, passive investment income can now expose business owners to more tax on their active business income.

The small business deduction will be reduced by $5 for every $1 of passive investment income that exceeds $50,000, in which the small business deduction will reach NIL once $150,000 of passive income is earned in a year. This includes passive income in all related companies, thus passive income in a holding company over $50,000 will affect the tax rate of a related operating company. This new tax rule begs the question: how to redirect a portion of excess cash flow that would traditionally produce passive income, and subsequently some unfavorable tax consequences?

There are a few strategies to mitigate the effect of the new passive income rules and minimize taxes. Depending on the situation, the best approach may include a combination of strategies, such as: a family trust, a Personal Pension Plan, tax deferred investment vehicles, and corporate owned life insurance. We have covered a few of such strategies previously. In this article we discuss how corporate owned life insurance can lower passive investment income and corporate taxes.

Insurance has an important role to mitigate risk and, in certain circumstances, can also be a strategy to enhance wealth. Strategies such as these are a viable option for a private corporation with a substantial amount of investment/passive income. The information below provides an overview of how corporate owned life insurance can be used to defer tax and grow the corporation’s estate.

Who is This Strategy Suitable For?

A corporate owned asset transfer plan is best suited for those who are a shareholder of a Canadian Controlled Private Company (CCPC) that has significant assets in taxable investments and is looking for a way to reduce the tax on passive income earned from surplus cash/investments in a corporation.

How Does This Strategy Work?

  • Purchase a participating whole life or universal life policy.
  • Pay the premiums with the corporation’s excess cash flow or by transferring assets from the corporation’s investment portfolio.
  • Cash value accumulates on a tax preferred basis. If access to the cash is needed, it can be accessed through a policy withdrawal, a policy loan, or assigning the policy as collateral to a lending institution, however if this is a possibility, planning and tax considerations should be performed prior to obtaining the policy to ensure this is a prudent strategy.
  • Upon death, the death benefit of the policy is paid tax free into the corporation.
  • The amount of death benefit in excess of the adjusted cost base can be paid out of the corporation as a tax-free capital dividend.

Why Does This Strategy Work?

This strategy works because it addresses a legitimate way for companies to reduce tax on passive income within a corporation’s investment holdings, the effect on the small business tax rate, as well as offering life insurance as a means to mitigate risk.

Investment earnings such as interest, dividends, and capital gains are taxed on a yearly basis. This yearly taxation can slow the accumulation of assets in a company over time. Also, with the new tax laws in 2019, passive income can have a greater effect on a CCPC’s taxation than in the past as passive income exceeding $50,000 will reduce the small business deduction on a straight-line basis.

These changes are providing even more incentive to find alternative investment strategies in order to reduce the amount of passive income in a corporation. This strategy first and foremost focuses on building estate value.


Correctly implementing this approach takes careful planning and consideration in order to avoid unintended tax consequences that could render this strategy unsuitable.

When using life insurance in the way mentioned above, it is assumed that the shareholders of the corporation are taking a long-term planning approach. Accessing the cash value of a life insurance policy may not be the most efficient way to access funds in your corporation as there can be tax consequences for taking a withdrawal, or surrender.
How the premiums are paid depends on each entity’s unique situation. It is important to work with a team of professionals to ensure that this is done in the most tax efficient manner.
In order to qualify for a life insurance policy, the insured person(s) must be in reasonably good health.
It would not be prudent to tie up any cash that may be needed in the short term for business operations. This strategy offers a long-term, tax efficient solution for surplus cash.

The Bottom Line

Correctly implementing corporate asset transfer plans is a complex tax planning strategy. Business owners should work with their team of tax professionals to determine if they have the available capital to fund a long-term plan such as this. Your advisor can help guide you regarding what portion of your corporate taxable surplus should be transferred into a policy, depending on your specific goals and timelines. It is important to remember, with plans such as these, that you are first and foremost purchasing a life insurance policy and then subsequently taking advantage of the tax benefits available to you.

All examples are for illustrative purposes only and are not intended to provide individual financial, investment, tax, legal or accounting advice. This material is for general information and is subject to change without notice. Every effort has been made to compile this material from a reliable source. However, we cannot guarantee that information will be accurate, complete and current at all times. Before acting on any of the above, please make sure to see a financial professional for advice based on your personal circumstances.

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