This year’s federal budget cracks down on a range of strategies and products which use complex structures to minimize taxes. Several popular loopholes will close for sophisticated, high net worth individuals when the government eliminates the tax benefits of leveraged life insurance and annuity arrangements and character conversion strategies. Small business owners will get some breaks, including an increase in the lifetime capital gains exemption for the sale of small business shares. As well, a new tax treatment may be coming for testamentary trusts.
With the March 21 budget, the federal government signaled its intention to eliminate a number of so-called “unintended tax benefits” in efforts to increase revenue and direct investments away from strategies that support investing primarily for the tax benefits involved. A number of these proposals may directly affect policy owners, including changes to the tax treatment of leveraged insured annuities (LIAs), leveraged life insurance arrangements (such as 10/8 arrangements), triple back-to-back annuities, testamentary trusts, and the dividend tax credit.
I will go into further detail with two of these items, LIAs and 10/8s, after the jump.
Leveraged insured annuities (LIAs, triple-back-to-backs)
The budget proposes to introduce new rules for LIA policies. A life insurance policy will be an LIA policy if:
- A person or partnership becomes obligated after March 20, 2013 to repay an amount to the lender when the insured dies and,
- An annuity contract that makes payments for the life of the insured, and the policy is assigned to the lender.
The following changes will apply:
- Income that accrues in an LIA policy will be subject to annual accrual-based taxation (like a non-exempt policy).
- No deduction will be allowed for any portion of a premium paid on the policy.
- The capital dividend account will not be increased by the death benefit received in respect of the policy.
- For the purposes of a deemed disposition of the corporation’s shares on death, the fair market value of an annuity contract that is assigned to the lender in connection with an LIA policy will be deemed to be equal to the total of the premiums paid for that annuity.
These changes will apply to taxation years that end after March 20, 2013 but will not apply to LIAs for which all loans were entered into before March 21, 2013.
Leveraged life insurance arrangements (10/8 arrangements)
The government is continuing to challenge what are typically referred to as 10/8 arrangements under existing income tax provisions. In addition, the budget proposes specific measures that will apply to existing and future arrangements, regardless of the actual level of the policy and loan interest rates.
A 10/8 arrangement is usually a universal life insurance policy that has a policy loan or is assigned as security for a loan, and either:
- The interest rate received on an investment option under the policy is determined by reference to the interest rate on the loan, or
- The maximum value of an investment option under the policy is determined by reference to the amount of the loan.
The following changes will apply to 10/8 arrangements for taxation years that end after March 20, 2013:
- No deduction of interest on the loan that relates to a period after 2013
- No deduction of premiums that relate to a period after 2013
- The credit to the capital dividend account for life insurance claims will be reduced by the outstanding loan balance for deaths after 2013.
In order to facilitate the termination of existing 10/8 arrangements before 2014, the budget also proposes to alleviate the income tax consequences on a withdrawal from a policy under a 10/8 arrangement, made to repay a loan under the arrangement, if the withdrawal is made after March 20, 2013 and before Jan. 1, 2014.
The government will monitor structures and transactions in this area and if required, take further and possibly retroactive action.
If you are currently involved in these or other complex tax-planning insurance strategies, and would like to speak with someone regarding your options going forward, please contact our office to arrange an appointment.