Insurance Grey Areas | E123

Insurance Grey Areas | E123

Navigating Gray Areas in Insurance and Tax Law In this episode, host Jason Pereira, alongside guest Jason Watt, embarks on an in-depth discussion about the gray areas in insurance and tax law that Canadian business owners need to be aware of. They explore complex issues surrounding the Income Tax Act’s treatment of insurance, the potential risks involved with current sales tactics, and the specifics regarding corporate-owned insurance and individual policies. They discuss critical illness insurance, the implications of using corporate assets for personal loans, the nuances of the Capital Dividend Account (CDA), the mechanics of health spending accounts, and group benefits. They also touch upon the responsibilities and potential liabilities for insurance agents and financial planners. This episode aims to provide clarity and caution on often misunderstood and convoluted topics in the insurance field.

00:00 Introduction to Financial Planning for Canadian Business Owners

00:11 Gray Areas in Insurance and Tax Law

01:04 Historical Context of Insurance in the Income Tax Act

02:01 Critical Illness Insurance and Tax Code Gaps

02:59 Taxation of Corporate-Owned Insurance

05:06 Complexities of Borrowing Against Insurance Policies

10:45 Offshore Insurance Arrangements

13:56 Capital Dividend Account (CDA) Explained

17:05 Critical Illness Insurance with Return of Premium

20:43 Understanding Actuarial Valuation for ROP

21:06 Critical Illness Insurance: Real-Life Scenarios

21:56 Tax Implications and Full Disclosure

24:21 Group Benefits: Tax Outcomes and Gray Areas

29:14 Health Spending Accounts: Rules and Risks

33:43 Shareholder Benefits and Tax Risks

37:49 Agent's Obligations and Client Protection

41:52 CRA's Response and Tax Court Realities

45:11 Conclusion and Final Thoughts

Resources Mentioned:

Full Transcript

FPCBO 123 - Insurance Grey Areas

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Jason Pereira: [00:00:00] Hello and welcome to financial planning for Canadian business owners. I'm your host, Jason Pereira. Today on the show, I brought back my friend Jason Watt. You have two Jasons today, make it nice and confusing, uh, to basically discuss an interesting area. That's gray areas in insurance law, insurance and tax law, that is.

And there are a number of them you should be aware of. A number of them that are, uh, Let's just say not quite lining up with some of the sales tactics we see out there and can be a risk to you if you do not understand how they work. So let's, uh, let's dive in. Jason, thanks for your time again.

Jason Watt: It's always

Jason Pereira: great to be here,

Jason Watt: Jason.

Appreciate the opportunity.

Jason Pereira: All right. So for those who don't know, Jason is a long time educator of this industry and, uh, was, uh, more recently exited a company called Business Career College, where he worked previously and family founded. And, uh, now you're just doing a bunch of things, including, I believe, coaching and a bunch of other stuff on the side, right?

Jason Watt: Bunch of odds and ends to keep me busy Jason. That's right.

Jason Pereira: Excellent. Okay, so let's get started Uh gray areas in the insurance world like first [00:01:00] off Let's let's address why they exist in the first place

Jason Watt: Yeah, the income tax act is so light on insurance stuff. And really what happens here is, you know As you well know, the insurance act runs or the income tax act runs to a couple thousand pages, uh, but only a small portion of that about five or six pages is dedicated to insurance and it's really kind of this carve out where when the income tax act and his current iteration was written, there was some.

Some life insurance being used in a way that that required some special tax treatment. And I mean, that's now almost 100 years ago, right? So we can look back to 1922 for the original treatment of this 1946. It gets a little bit of an update in 1968. It gets a little more of an update, but really.

Insurance, uh, the insurance sections of the Income Tax Act haven't really evolved to match, as you say, some of what we see sold out in the market today.

Jason Pereira: Okay. [00:02:00] And I mean, like, some of these are pretty glaring. Like, critical illness still doesn't exist in the insurance world, in the tax code. So we have an entire type of insurance policy that's arguably the second most sold form of life and health.

Uh, that basically just doesn't exist on paper.

Jason Watt: So, critical illness gets one tiny mention only with respect to group benefits. So we know within a group benefits policy, if you include a critical illness policy, uh, and it's actually not even explicitly mentioned, you're right. There's, if you did a control F for critical illness insurance, In the income tax act, you wouldn't find it.

Uh, but we do know from some fairly clear language in the income tax act, that if you have an employer who gives a group CI policy, uh, that that is a, the premiums paid on that are a taxable benefit of paid by the employer. That's, that's what we know. That's the whole thing.

Jason Pereira: That's, that's, that sums up the entire thing.

Okay. So let's dive into some of the, uh, the more interesting areas you've basically addressed, or basically that you've, um, identified. So [00:03:00] So let's let's start with taxation of corporate owned insurance specifically. This is a well known area, right? So it's specifically talking about permanent life insurance areas.

Uh, well, let's just talk about where do you want to go with this one?

Jason Watt: Yeah, so first off I hear you you mentioned again these sales tactics and I hear it quite often you can You know only have to go so far as uh some recent linkedin conversations with people like Aravind and Martin McGrath to see

Jason Pereira: Get

Jason Watt: this

Jason Pereira: right.

Righteousness, and yes, let's make sure that we find that you only sell on need, as opposed to let's just sell for the sake of selling, but yes.

Jason Watt: And you'll, you'll see some insurance folks chime in with comments like you can have cash value insurance in your corporation and then extract that value tax free to fund your retirement.

Jason Pereira: No, you can't.

Jason Watt: Which, which the income tax act doesn't support. But one of the problems here is the Income Tax Act doesn't really deal with it explicitly. So you kind of have this situation where CRA is [00:04:00] left with a set of tools that do give you enough to, to address it, but not Explicit way. So

Jason Pereira: let's let's address what is there and and what the understanding is.

So the insurance policy with cash value is a Asset of the corporation first and foremost, right? So that value belongs to the corp Now what you'll see is something called a insured retirement plan a corporate insured retirement plan that tells you to pump A policy full of money. It'll be tax deferred In basically when you want to access it you have options you can Cash out the policy, which there will be a taxable disposition.

You can borrow against the policy, which will not have a taxable disposition, but there will be interest incurred with it. And if you can, well, you can borrow from the insurance policy itself, which there, then if you borrow too much, there could be tax implications. Or you can borrow from a third party.

But here is the problem, as you and I constantly discuss, is that that's nice, but it's the insurance company doing that, not the individual. And the money still needs to come out to the individual, [00:05:00] which is then a taxable dividend. So

Jason Watt: yeah, there's really a couple different things that can happen here. You see these structures where I mean, the most conventional or the simplest method to do this is, as you suggest, you know, my corporation has a big cash value policy, I go to a third party lender, the corporation borrows money using that cash value as collateral.

And then I take a taxable dividend out. That's a pretty plain vanilla strategy. Everything there is probably on board. Probably doesn't result in any, uh, we'll call it gray area for tax purposes. That's as kosher as it comes in

Jason Pereira: that purpose, in that topic,

Jason Pereira (2): actually.

Jason Pereira: I would, I would agree. Um, but hardly anybody.

Yeah, but it's always also glossed over that. Yes, it's actual to that point. And then you can pull it out tax free. Well, no, you can get some of it, but then the problem is it's still in the corp, right? So workaround people like to play. Right. So

Jason Watt: the, the second sort of layer of, I don't know, complexity or Whatever you want to call [00:06:00] it here is where I'm going to borrow using.

I'm going to borrow personally here using the cash value as collateral. So you're essentially using this corporate asset to create collateral for a personal loan. And this is where it gets so murky. There's a case from 2013, if I remember right, that went to the tax court, uh, called Golini. And this is. a pretty well known case in in these circles And my first caution here is if you're sold one of these deals or if somebody approaches you with one of these deals the person Selling it should understand golini and if they don't they have no business In this space, I think that's the default to no business, but continue Yeah, so the golini case was this situation where The insurance agent who put the structure together, uh, proposed a way so that using that corporate asset as a, um, sort of as a personal asset.

So that's a, that's a [00:07:00] taxable benefit. That's fairly clearly a taxable benefit, but they. Brought this work around in where the shareholder paid a value to the corporation. And in exchange for that, we're supposed to be creating like a commercial relationship. Now, the shareholder is now paying, I'm going to say fair market value in air quotes for access to that corporate asset.

Uh, the tax court did not agree with that. There was a really complicated method applied that doesn't make much sense, honestly. Um, And I agree with the tax court's handling here. What you will see done in practice, by and large, is insurance agents saying, well, if you charge, I don't know, 1 or 2%, I typically hear those two numbers.

I don't think those are necessarily correct. No, absolutely not. But the idea is you would charge a guarantor's fee. So the corporation now charges the shareholder, the shareholder pays that amount into the corporation. That's [00:08:00] passive income for the corp. And Probably deductible for the shareholder in order to access that cash.

Jason Pereira: Let's look at that. So really the structure is I own shares of corporation that owns that asset. There's the insurance policy. I then go to a lender and I borrow based off of the collateral that is that insurance policy. Now, from a lender standpoint, you know, as long as the policy is in force and, you know, again, the loan is smaller than what can be extracted from the corporation after tax.

That's a pretty. Safe bet I mean effectively right especially if it's a paid up policy, right? So from a lender's standpoint, that's not bad But there's a difference between borrowing with collateral versus borrowing Without collaterals anyone who basically has ever got an unsecured line of credit versus a HELOC knows So the reality is is there's a there's a net benefit To the to the shareholder for basically being able to stake their shares as collateral So effectively what CRA said was no.

No, that's that's that's too good That's not even your money. That's not even your [00:09:00] money. It's the corporate's money corporation's money technically so and the workaround being well, you know what we will pay a guarantee fee Equal to, you know, uh, to, to basically reflect this benefit. So therefore it's not aside from a tax purpose.

Now, arguably, what should that even be? Well, I mean, like, frankly, the argument should be the Delta between secured versus unsecured. Right. And, and frankly, if that's the case, then where's the net Delta, where's the net benefit, right. Other than being able to access a person personally. So it, um, it, you know, and to a best of our knowledge, have we seen these guarantee fees properly challenged?

And one of the,

Jason Watt: so that's an issue. And then also, a lot of the thought process around this was developed in around 2010 to 2015, and that's when, you know, rates were quite low. So, I heard, again, that 1 or 2 percent rates are higher now, and that delta between, as you say, secured and unsecured is quite a bit different now, too.

This is not like a [00:10:00] spousal loan. With a spousal loan, we know that when you Borrow that money that the income tax act is pretty explicit on how the rate is calculated. That's not true here.

Jason Pereira (2): And

Jason Watt: because we have no commercial guarantor businesses in Canada, this is quite a common business in the U S but no, no commercial guarantor businesses in Canada, there's really no way to set what that commercial

Jason Pereira: rate should be.

Yeah. What is the fair market value for basically pledging shares like this? No one is actually doing that. Without, without this sort of insurance policy. Yeah, it's, it's, it's gray. All right. So that's permanent.

Jason Watt: I have one more Jason, if I can with that, sorry, there's a third. So I said, there's like two layers.

There's, you know, the plain vanilla version. There's this slightly more aggressive version. And I have run into a very aggressive version of this and it involves offshore insurance. And, uh, Yeah, so you and I know that CRA and Department of Finance are sniffing around these offshore arrangements. [00:11:00] There's a whole world of these offshore arrangements where you have what is probably only on paper an insurance policy.

It's written like an insurance policy, but likelihood of actually ever having a claim is pretty much nil. And here you're going to have the corporation use one of these offshore shops.

Jason Pereira (2): They're

Jason Watt: going to set up the insurance policy. And they're going to actually act as sort of every intermediary here.

They're going to act as the lender. They're going to maybe create some shareholder loans up front. So that offshore entity says, well, we'll lend you based on the cash value of the policy. Hey, we control the policy. So no big deal. Although it's usually, you know, it's a Corp A, Corp B of that offshore entity.

And they will use what are called transfer shares or maintenance shares to Allow the shareholder to access that the theory being without paying that guarantor fee because your transfer share sort of gives you direct access to [00:12:00] the cash surrender value. Canadian lenders will not get involved in this, but these offshore lenders where they really kind of control every element of this, um, they will, and those offshore lenders are, I don't know what the right word here is,

Jason Pereira: um, Yeah, she, uh, well, I mean, let's take a step back.

There is absolutely valid reason in some cases to basically have an offshore policy, because any policy issued outside of Canada, right? So the reality is, is that the insurance companies in Canada tend to be pretty risk averse. And I've seen cases where people could not be insured in Canada, but were insurable in the U S or elsewhere.

Okay, great. That's a valid purpose. Now what we're talking about typically ends up being a tax play I mean i've seen cases where quite literally, um, you know insurance policies and annuities are bought simultaneously And a loan was taken out and lo and behold There's a big deduction for the for the basic, um for the insured person And it just so happens that all of this money ends up in the same Corp at the end of the day, which just makes it a pure [00:13:00] flow through and now suddenly You There's a deduction on this notional loan and oh, but no interest was actually paid.

Like it's just some of these things just are pure fraud, right? So CRA is right to question just about anyone they see here, especially when they're anything other than a straight premium. Uh, I absolutely believe that to be the case. So look, it gets, it gets messy. Uh, I mean, all right. So that's, that's those cases.

Uh, you know, let's talk about other concerns regarding the personal side. You have a couple of things regarding individual loan insurance.

Jason Watt: Yeah, so we can point to, um, well, individual owned. So I think maybe, oh, can we maybe instead look at, uh, health spending accounts? I know you said looking at

Jason Pereira: health spending

Jason Watt: accounts.

All right. Okay. Before

Jason Pereira: we do that, we're going to, we're going to jump around a bit. You had, you'd also put down CDA, something you want to talk about. Oh, right, right. Okay. So

Jason Watt: I just mentioned here that CDA, Okay. Um, the actual calculation of your capital dividend [00:14:00] account is pretty explicit in the Income Tax Act.

This is one of the areas that you can actually read the Income Tax Act and have a pretty explicit idea what your outcomes are going to be. So this is, um, I think well done.

Jason Pereira: It's, it's basic as a calculation, but in general, when it comes to non insurance assets, it is the non taxable portion of your capital gain on any, the sale of any asset, which used to be 50 percent inclusion until the summer.

And now it's down to one third incorporation. So that amount creates a credit, which does not just sit on the balance sheet, but sits in with something called a notional account. And that amount can be extracted tax free to the shareholders.

Jason Watt: And with it with insurance the the material consideration here is it's the death benefit only on a life insurance policy Paid in excess of the acb the adjusted cost basis of the policy again The income tax act is pretty good about helping us calculate the acb correctly

Jason Pereira: calculation.

Let's just go over that quickly So the [00:15:00] calculation on acb this really screws people up all the time. I covered this in a previous podcast You know people think of a cost base is what I put into it You The thing about insurance cost basis is they don't work that way. So yes, it's what you put into it since you started, but.

It also subtracts out what you basically needed to put into it to be insured for that given year. So something called yearly renewable term. What is the risk of you dying that year? There's a charge for that. That number subtracts out from your total contributions over time and can actually grind your ACB down to negative.

Well, zero is really the floor, but negative is basically it. So zero. And then that means that over time, it's entirely Normal for a policy to be a debt benefit to be a hundred percent credible to the capital dividend account So where's the issue? So issue

Jason Watt: with cda is you find lots of I think Misunderstanding here with cda now you already mentioned the leveraged insured annuity concept Which was really [00:16:00] just a play to maximize cda That's been shut down now.

The income tax act has a specific measure to shut that down ten eights Yeah, 10 eights. Similarly. So there was an old concept called 10 eight, where you had a combination of borrowing against the policy and investing within the policy. The income tax act has specific measures in it now to shut down the manipulation of CDA there.

But, you know, if you have a fairly simple. Like term insurance case or T to 100 case, insurance owned in the corporation, shareholder dies, death benefits paid out, probably the surviving heirs will be able to extract most or all of that death benefit tax free. So CDA by itself, pretty clean, uh, but I ran into a lot of misunderstandings here.

So as an example, no CDA on a critical illness policy. No CDA on cashing out

Jason Pereira: a policy. No CDA on cashing out a policy. Exactly. Cause I've heard that one before too. It's like, well, I'm going to, you know, the ACB exists, whatever's above that. It's going to count like, no, it's [00:17:00] fully taxable income, not capital gains.

So therefore there is no CDA. Perfect. Yeah.

Jason Watt: Um, and then the, so with, if we can switch gears then and move to CI with return of premium, this is another area where I see a lot of, yeah. Okay. So, um, this, yeah, the CI with return of premium is a evolution, I guess, of the old split dollar concept. This is where you have the corporation taking on the insurance risk and the shareholder paying the premium.

For the investment portion with critical illness insurance, that's return premium. So the idea is, you know, you pay a premium for 15 years. Usually after 15 years, you're going to get all the premiums paid. Plus the cost of return or premium paid back to you. It's kind of a questionable concept. I don't, I don't love it in general, but I know it can make CI sales easier.

Whatever. Um, but the, the thing that gets sold to business owners, very common concept, lots of insurers have dedicated marketing material around [00:18:00] this is you have the corporation pay the cost of the return of premium risk. And then the shareholder pays the return of premium rider, which is around 40 to 50 percent usually of the Uh base premium and then after 15 years the return on premium pays and the shareholder in theory, let's say Extracts all those dollars tax free.

I hear all the time that those dollars are going to be tax free paid to the shareholder And I think that's a murky concept at best.

Jason Pereira: Well, let's talk about the best practices in there We can talk about it still being murky because at the end of the day, there's no clarity on this So first off we have to acknowledge that a portion of the premium paid is Basically, in order to have the CDA owned by the shareholder, by the, by the insured, it has to be a taxable benefit to them because otherwise they're paying it outta pre-tax dollars and then that blows up the entire thing.

Right? So that's the first thing. It's gotta show up on their, on their T four. [00:19:00] But the second piece is. What is that amount? And this is another issue that's a little known, because I always hear it's like, well, it's the, the ROP premium specifically. So whatever the insurance company's charging for that.

And you're wincing because this is where we're going. Tell me why that doesn't make sense. Necessarily. Well,

Jason Watt: because, yeah, so I said about 40 to 50 percent of the cost as you're sort of Let's say actuarial calculation for the value of that return or premium rider, but you have insurers out there charging substantially less than that.

There's a real question as to whether, and there's a couple of insurers that do this. Well, there's a real question as to whether. The amount the shareholder is paying is a correct actuarial representation of the value they are getting. And that's where I think CRA has a bit of an opportunity to come after these structures to, and it's kind of like your argument before Jason about the difference between secured lending and unsecured lending, where, you know, you have this kind of secondary Level of benefit [00:20:00] that's not obvious on the surface, but when you dig into it, you say, well, really, you got to buy something a lot cheaper than you should have because of your relationship to your corporation.

Jason Pereira: Yeah. And split dollars have existed in life insurance for years. And, you know, we can discuss, I think they're less on the questionable side, um, because those ones tends to be a little bit more direct, right? Like we can, we can basically compare the price or Like with universal life, it's very straightforward, right?

There's a cost of insurance every month. And then anything beyond that is clearly going to cash value, right? With, with whole life, there's, there's proxies that can be used to compare, right? Like the same T 100 without cash values from the same insurance carrier can be used as a proxy. With, with CI, this ROP thing is a little bit different.

And I would say endeavoring or considering this, Needs to contemplate, actually shouldn't contemplate, needs to, needs to basically look at getting an actuarial valuation done as to the reasonable value of that ROP. Because if not, you know, if the insurance company is discounting it for, for sales [00:21:00] purposes, well, CRA doesn't care, right?

Like, end of the day, fair value is fair value.

Jason Watt: Yeah. The other thing that makes me nervous about CI with Returner Premium, and I've seen this happen a few times, is that it's sold, as you said earlier, as a tax play, right? The whole idea is to extract. What if you actually get sick? What if the person who owns the policy actually has a, like, they have, and I have this, I have a good friend right now who is in the business and seriously ill going through a CI claim.

Right. They need the cash. He's got a child with a disability. There's a lot going on. They're not on. Not unusual that you actually have an event happen. That's the whole purpose of critical illness insurance. And now you file a claim, presumably. The CI is going to be paid out to the corporation and as you said earlier, no CDA credit there.

Jason Pereira: No, hold on. But the thing is, is that that's not necessarily a bad thing, right? Because the cost [00:22:00] of carrying the insurance was lower because you're paying with corporate dollars, right? And again, if your income is going to get suffer because of it, well, you know, the tax coming out is less, lessened. But again, it comes down to Was this actually what was sold, right?

Was this explained at the time? Was this made with full disclosure? And, you know, this is when, when terms like tax free get thrown around constantly, right? Like that is what people remember. And that is what people basically typically sell. So like having a single page that bullets the scenarios and explains them in black and white, you know, I would think that you're setting yourself up, I mean, as the agent to potentially have a negative outcome and frankly, as the consumer to purchase something you don't truly understand.

Jason Watt: Absolutely agreed. And what, again, makes me nervous about this? Fine, if the person who bought the policy, like the business owner, gets sick and the, you know, money is paid into the corp, and they're there to manage it, they kind of understand, they were well educated when it happened, what if that person is without capacity, and it's their [00:23:00] spouse dealing with all of these questions?

It just becomes a source of friction that I don't think you need. And honestly, the kind of thing that's going to hurt the spouse's relationship with the financial advisor.

Jason Pereira: Yep. And, you know, it's one of those things where sometimes you do suboptimal things just to make it easy on the people left behind.

So, in particular, like, look, I could, I got this, I got several insurance policies. I have a sizable personal one, right? And I could have that on my holding companies and it would cost me less to basically pay that premium every year because it would be coming out of back to tax corporate dollars. But. I want X amount of dollars sitting in my wife's hands if anything happens to me so she can pay off the mortgage, not worry about anything else, and give it time for all the corporate stuff to get filtered out.

That, that's a conscious decision. So that delta in premium is worth it for the peace of mind that I'm going to give my family. So yes, I think sometimes what gets lost on all this is that it's nice that you're comfortable with this risk or what's going on here. The question is, Is the next, is the person taking over from you?[00:24:00]

If you can't be making these decisions, are they comfortable? And are they going to, and are you, their needs actually taken care of?

Jason Watt: It's a perfect way to put it right that's you know insurance after all it's about putting dollars in your loved one's hands When it's

Jason Pereira: exactly So, all right that covers the that one.

Let's let's move on to group benefits. So where are your concerns over group benefits?

Jason Watt: Yeah, this is actually mostly pretty straightforward and this is kind of nice So there's i'll go to a couple of gray areas But for the most part when an employer pays premiums On behalf of an employee, we know the tax outcomes with life insurance and critical illness insurance.

The premium paid by an employer results in a taxable benefit to the employee, just the same as if you paid for coffee at work or gave the employee a parking stall or all those types of taxable benefits. So that's Pretty straightforward. [00:25:00] Um, and we know then that the benefits of should the employee die and there's a death benefit paid.

We know that that's tax free. Same for critical illness. Disability insurance gives us a little bit of murkiness. And there's a couple things here. So the Income Tax Act is actually pretty clear on this. However, in practice, we run into lots more ambiguity. So the Income Tax Act says if the employee pays for their disability insurance and they end up with a claim that they'll get that benefit tax free.

And insurers build disability insurance under that assumption. That's where we normally see the base amount of LTD benefit as a two thirds income replacement. However, the income tax act also says if the employer, if the plan sponsor pays even 1 of the cost of that LTD benefit or that LTD premium, sorry, that that renders the [00:26:00] Benefit taxable.

There's a little bit more math to it, but it's kind of painful. It results in a truly taxable source of disability income now some plans are designed this way some employers say we're happy to pay the premium And we're going to then structure this with a plan design where the ltd is going to be taxable And in that case typically that

Jason Pereira: means that the benefit

Jason Watt: has to be higher to make sure that people get as much money as they need Yeah and you'll see a three quarters income replacement typically used as the starting point there.

It gets, it's less as income gets higher but effectively a three quarters income replacement. Okay so that's sort of the starting point. Now what happens here is that we sometimes see, and you especially see this in collective bargaining cases, where We have a non taxable plan. The employees or union members are paying their premium.

Everything's going along nicely. And then we end up at the bargaining table and at the bargaining table, one of the things that [00:27:00] the union rep brings to the table is, well, employer, why don't you start paying for the LTD benefit? The employer says, sure, we'll do that. No one talks to the insurer. Yeah, exactly.

And you end up with now at two thirds policy. Taxable, which isn't great for the plan members. It really means you're going to be if you have somebody who ends up with a disability, they're going to have less income as a result. And the other gray area here that shouldn't be a gray area, but it gets just some things.

Sometimes the accounting gets murky. Is with payment of premium. So no problem where you have the employee who is really having like a payroll deduction to cover off those premiums where we sometimes get a little bit of confusion is where the plan Sponsor at the year end assesses the employee a taxable benefit for all the premiums paid through the year.

That is according to CRA's old interpretation and bulletin, interpretation bulletin on this. [00:28:00] Okay, but I run into lots of different ways this gets handled and it, it can create some confusion.

Jason Pereira: Yeah, and for the record, it's not just in collective bargaining that we see that sort of thing happen. We see it happen all over the place.

I mean, like, it happens frequently with people who just don't, um, or, or employers altogether, right? Employee starts complaining, why am I not paying this, blah, blah, blah. And the employer says, sure, whatever. And then, you know, basically starts paying without even notifying the agent. And next thing you know, this is completely offside.

Jason Watt: Yeah, absolutely agreed. And then you also see it where the employer has a policy that says we pay 50 percent of every dollar of premium. They don't consider any sort of fidelity around what that 50 percent actually comprises depending on the age of the employee and their family situation. You can see it where the cost of the LTD surpasses 50 percent of the overall premium structure.

And again, there we can inadvertently render the policy taxable. [00:29:00]

Jason Pereira: Yep. Yep. It's just one of these things where they don't stop to think about, yeah, no, no one stops to think about the tax implications of these things. That's, that's the funny part. Yeah. And calling

Jason Watt: your insurance agent when you make a big change to the structure, right?

Jason Pereira: Yep. Yep. Yep. Yep. Right. So we mentioned health spending accounts previously. Let's go back to them.

Jason Watt: Okay. This is one of my favorite gray areas and in this, yeah, well, in this one, CRA has introduced a lot of confusion in my opinion. Okay. So the basic idea with a health spending account is you have. an employee and instead of maybe putting in place a very robust health and dental plan, you say we're going to put in place a health spending account and now the employee just gets an allocation of dollars that they are going to use for eligible medical expenses.

Those eligible medical expenses are pretty clearly defined in the Income Tax Act. I'm curiously with health spending accounts not 100 percent of [00:30:00] the dollars need to be for eligible medical expenses. The interpretation here is that 90 percent of the dollars need to be used for eligible expenses. You see actual providers of the health and dental plans or the sort of the health spending accounts interpret that differently, but there's a little bit of latitude there.

And it kind of makes sense when you look at the stuff that gets claimed. So, what ends up happening then, no problem, you've got an employer where they say, just for every employee we're going to put in place a 1, 000 plan through the year. The employees chip away at that 1, 000 to cover off things like, maybe vision care, or the deductibles on their prescription drugs, or dispensing fees, or just stuff that might not otherwise be covered.

No big deal. Where you run into some confusion here is if you have, like me, a solo owner operator of a corporation. That solo owner [00:31:00] operator of a corporation wants to put in place a health spending account. Now, CRA did have, still has actually, a public facing document on their webpage that indicates that if you have that owner operator of a corporation where there are no arm's length employees, a health spending account can be okay as long as that person is collecting a salary.

Or as long as they fill the role of an employee. Sorry.

Jason Pereira (2): Yes. Um,

Jason Watt: so the language here a little bit confusing because then distinct from that, uh, four years ago, the conference for advanced life, advanced life underwriting every year, they have a conference where CRA and Department of Finance come out and they give them a bunch of questions.

And then CRA and finance give their answers back. And one of those questions was about how spending accounts and despite what it says publicly on their webpage, uh, CRA issued a response to Kalu that [00:32:00] said we would consider such an arrangement offside in accordance with our longstanding policy.

Jason Pereira: Yes. Uh, everybody throws their hands up in the air going, wait a minute, which land a longstanding policy.

But yeah, so this is also to say that, uh, it's fluid to some degree. Uh, and, and then some cases rightly so, because the industry is always trying to find ways to make things work a certain way. So, all right. So the reality is, is that that might be offside. And in particular, I mean, there's already preexisting rules on private health service plans that basically limit the amount individual can get.

If they're not, if they're, if they're a solo runner, like If you're not incorporated, it's what, 1, 500 roughly? 1,

Jason Watt: 500 per adult and 750 per child in the household. You're right. Which, which

Jason Pereira: basically means that, you know, at least the interpretations I've seen is that they would apply said rule to the corporation with the solo practitioner.

And I've seen a couple of, a couple of carriers who very, after that notice, basically started saying, yeah, no, I think we're going to follow that rule now.

Jason Watt: [00:33:00] And that's fair. This is where there's some question of who is taking on tax risk and how much tax risk you're willing to take on. I still see a lot of owner operators where they are the sole employee of the corporation and they have these 20, 000 health spending accounts set up and you see all kinds of weird, I've seen kids, adult children sent to the United States for treatments or whatever the case is under those health spending accounts.

I think you're at least Playing with fire a little bit when you're doing that kind of thing.

Jason Pereira: Yeah, I mean, buyer beware. That's all I'm going to say there. All right, so we covered health spending accounts, we covered corporate, we covered leveraged life insurance, uh, you have something on the shareholder benefits.

Did we cover that yet?

Jason Watt: So just to point out here, there's a case that came out of, um, The federal court of appeal two years ago now, and it's in French. So my apologies here, I promise to avoid speaking French on your podcast. If I can help that. Chase Right. The

Jason Pereira: French [00:34:00] bowlings often have some of the more interesting things that come out.

And everybody doesn't notice them because they're in French happens all the time. The cases are just.

Jason Watt: Why? And it's, it's a case where you had a very complicated sort of intercorporate structure, seven or eight corporations with different relationships between them, some trust scattered in there just for good measure.

It's what, as you see, often happens when you have a long standing corporation where various family interests kind of get together. You've seen these structures, right?

Jason Pereira: Yep.

Jason Watt: Um, and in this case, You had one corporation that was paying the premiums on a policy and another corporation that was the beneficiary on a policy.

Yep. And what happened here is CRA traditionally has assessed shareholder benefits on the basis of Section 15 1 of the Income Tax Act, which is pretty linear. This is where just the amount of premium paid [00:35:00] creates a taxable benefit, and it's pretty easy to calculate. This actually kind of ties into, Jason, to your comments earlier about split dollar policies, where, you know, for doing what 15 1 assumes we're doing, you can just calculate that based on the dollar paid, this is the amount of taxable benefit, it's pretty straightforward.

246, which takes us to an area of the Income Tax Act that, um, finance has given CRA a lot more powers with recently and where CRA has taken advantage of that. So 246 is a much broader, uh, shareholder benefit section of the Income Tax Act where the benefit is actually based on More of what you talked about earlier actuarial principles, or, you know, if we weigh out your entire set of circumstances without that shareholder benefit versus your entire set of circumstances with that shareholder benefit.

What's the difference between the [00:36:00] two circumstances? And CRA's approach that was accepted at Federal Court of Appeal, um, was to apply a 246 benefit. And this is where it is much, much harder to kind of predict what the outcome will be when A tax measure is successfully challenged by the CRA. So it, to my mind, Jason, it's just a little bit more of a caution around what can happen.

Jason Pereira: That was an interesting one too, because I mean, I sat down and looked at that and was just like, okay, let me get this straight. Where's the problem here? Um, at the day, it's not unusual holding companies, operating companies, you want to structure things. I mean, just here's what it comes down to. It generally, when you look at it outside, it makes sense to own a policy in a holding company that can be segregated from the operating company in case you ever sever that tie, sell the company, and you can potentially keep the policy.

And yes, the premium would be paid for by the other policy because it has the benefit. [00:37:00] That seems that that's always passed the kosher sniff test. Now they seem to have an issue with it. Which I have to question why, especially given the fact that like the ACB carries over, so like there is no net taxable benefit anywhere I can smell.

So one has to wonder exactly what the problem was.

Jason Watt: Yeah, it's, it is an interesting one. I don't know where this is going to land again, to my mind, the, the ending point for the consumer is just to be aware of tax risk. And honestly, if you get into one of these structures where your agent slash financial planner hasn't discussed tax risk, you gotta, you gotta ask those questions.

Jason Pereira: Agreed. Agreed. I mean, it's not, it's definitely not without its risks. So, before we wrap up, we're going to touch upon, kind of, let's talk about the agent's obligations. Right? So, besides discussing these. So, where is the agent's obligations in all of this, [00:38:00] given that there's ambiguity and uncertainty? Okay, so

Jason Watt: this is a challenging one.

If you're dealing with somebody who is an insurance agent and only licensed as an insurance agent, the insurance world in Canada is still very much kind of a wild west. And that insurance agent really just has to show that the business that he did for you didn't actively harm you from achieving whatever you're trying to achieve.

So if you're working with somebody who only carries an insurance license, doesn't carry any sort of financial planning certification, or maybe a CPA, then you really want to question whether you should have a third party in to have a look at these structures. Now, I've seen some cases with, especially offshore structures, where part of the sales process is to get the client to sign a non disclosure agreement.

Jason Pereira: Yeah, I've seen those too, which is always frightening to [00:39:00] me. I mean, if you think you're getting something that only the rich have access to or something like, honestly, walk away. These things all blow up, at least in my experience.

Jason Watt: So then, if you're dealing with a financial planner or a CPA, that person does have a higher Uh, standard for what they have to do.

They actually have to dig in here, do some analysis, show that there was a plan A, plan B, plan C that they worked through. And at least that what you're getting here is not just going to, um, not harm you, but should actually At least get you closer to achieving your objective without doing you harm. So, you know, and I don't want to pick on the insurance folks out there.

Um, I think insurance folks have a strong role to fill here. If you're an insurance person listening, just. You know, partner up with a financial planner or a CPA or whatever the case is, uh, and you know, make sure that your clients are well educated. You've had a number of

Jason Pereira: fantastic ones on this podcast who do analysis that [00:40:00] is second to none.

And, but the reality is, is that more often than not, it is, it is, it is sold, uh, without said analysis. And if you don't believe me, just look at some of the arguments I get into on LinkedIn. Um, and, and frankly, like, let me get, and let's just also not forget that. Um, there is no fiduciary responsibility for insurance whatsoever, right?

Like I mean there is under common law the potential for one to exist Should the pattern of the dependency of the individual on the agent be one of a fiduciary nature like that? That can apply anywhere to any aspect of business. Okay that but that's it But I have but there is no obligation to operate as a fiduciary Unfortunately certain textbooks for certain licensing courses said the opposite for years yet You The conduct didn't follow, so it is what it is.

That's fair.

Jason Watt: Yeah,

Jason Pereira: I

Jason Watt: would point out Saskatchewan, so the um, insurance counsels of Saskatchewan have passed a set of bylaws where an insurance agent actually can be held to a [00:41:00] standard that looks more like what you see in the securities business.

Jason Pereira: Well, I will say this much. A, having dealt with Saskatchewan and other regulatory initiatives, they have been very forward thinking, and I will thank them for that, and I hope to continue to work with them on fixing a number of things in this country, and B, um, the, the reality is, is that there is a general appetite, depending on the jurisdiction, to increase the standards of what is happening in the insurance world, because, you know, I will say, from everything from technology, operations, And unfortunately regulation, um, well behind the securities world in terms of where it needs to be.

And the securities world isn't exactly where it needs to be either, but we're making progress. And, uh, so, so nevertheless, um, it's not fully caveat emptor, but I would say that the degree to which caveat emptor applies if you're dealing with an insurance advisor largely depends on their ability to address these concerns and needs.

Jason Watt: Can I just take one more second here on the response from CRA to these things, Jason? Because I think this is an area where we're often sold a bill of goods that [00:42:00] doesn't actually stand the test of reality. So a lot of times you'll hear people who are promoting more aggressive concepts, they'll say, Oh yeah, we've seen lots of these pay out now.

We have clients who are taking advantage of these and they're fully above board. CRA has no problem with them.

Jason Pereira: That's not no silence is not consent

Jason Watt: and and part of the issue here is how long it takes if you you can go to The tax court of canada website or go to canly and look at tax court of canada cases If you look at the matters more complex matters, especially that are before the tax court of canada today the this will This podcast you said will come out, uh, early 2025.

So go to, you know, new cases from 2025. You'll see that the matters that are being addressed at tax court are related to things that taxpayers did in 2009, 10, 11, 12. You know, CRA gets, you know, Kind of seven years potentially longer to look [00:43:00] at cases where they think the taxpayer is offside And with these more complicated cases, it can take two three four years before it gets to

Jason Pereira: tax court So well, and then it gets appealed and then we you know, the reality is just you know There's one going before the supreme court shortly, I believe and uh, the re like that that journey itself is probably a decade long So, you know, we don't get clarity fully until we get to the end of it so To think that all the rules of the game are spelled out, they absolutely are not.

And to think, again, I will also say again, Oh, CRA's never come down on something, sorry, silence is a consent. Silence is not approval, right? They have not, they, the only thing that that should make you is weary, weary that they're going, when they finally decide to turn the eye of Sauron towards that, that specific hobbit, trying to make it across the freaking, the field that is going to be struck down.

It's, it's

Jason Watt: fair. So I don't know who knows what happens out of that. It's, it's not fair to say CRA is always going to win those cases. [00:44:00] Taxpayers do win these cases, but again, do you want to, Get wrapped up in a tax court case, even if you win, you know, you seldom really win.

Jason Pereira: And so, you know, again, also you'd say get advice, not just from insurance.

Advisors, but also from tax authorities and everybody else and frankly like the more advantageous it looks to you be and I'm gonna be on Insurance in general looks advantageous, right? Like you you pay a small sum and over time you you're pretty much guaranteed to get a larger sum, right? Like that's there's an advantage right and there's a bunch of reasons why mortality credits interest time all of that But the reality is when we start looking at this and basically saying, you know, the more the tax tail starts to wag the dog on this, the more likely it is to be a little bit more questionable.

So, you gotta look into it. And as for questionable, there's an entire, I don't know, this March, this airs. Um, you, myself, Ben Felix have been working together on a bunch of papers regarding various insurance cases. Cash value tactics and whatnot that we hope to I hope this is going to be a [00:45:00] big year for paper releases But I will also say that the tax sheltering Features of these policies tend to be overhyped and that will be the subject of future puck.

All right Thanks so much. Jason

Jason Watt: really

Jason Pereira: really enjoyed it. My pleasure. Jason. Thanks for joining me yet again and to everybody listening today Hope you enjoyed that. Uh, please leave a review on apple podcast soundcloud spotify receive your podcast until next time. Take care.

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