1 Business Insurance Part 1 Working with Business Owners Jorge Ramos, CFP,CLU Director of Advanced Marketing A PARTNER YOU CAN TRUST.

1 Business Structures and Taxation A PARTNER YOU CAN TRUST.

> Self Employed > Partnerships > Incorporated private business > CCPC > Publicly listed corporation > Professional Corporations Business Structures

> Self Employed > Commission income or sales > Can deduct expenses > Net profit taxed as personal income > Partnerships > Commission income or sales > Can deduct expenses > Net profit added taken as income proportionately by each partner Business Taxation 101

> Incorporated Private business > General corporate tax rates > 26% (11% Provincial, 15% Federal) > 25% (manufacturing, farming, mining) > CCPC > 15.5% (4.5% Federal, 11% Provincial) > On first $500,000 > Publicly Traded companies > Do not qualify as CCPC Business Taxation 101

> CCPC > Corporation resident in Canada > 51% controlled by Canadians > Not listed on a stock exchange > Not owned by a publicly traded firm Canadian Controlled Private Corporation

> Lower corporate tax rates > 15.5% vs. 26% > An additional month to pay taxes > Enhanced investment tax credits > Qualifies for Capital gains exemption - CGE > First $750,000 of capital gains on shares is tax-free CCPC - Advantages

> First $750,000 of capital gains are tax-free > Qualified small business shares > Qualified Farm property > 50% of assets “actively” used in the business for the last 24 months > 90% of assets “actively” used in the business at time of sale > Shares owned by individual for last 24 months Capital Gains Exemption

> Personal service company does not qualify > Employee vs. self-employed test > Only one client or one major client > Client dictates hours and location of work > Fewer than 5 employees > Not considered a true arms-length company > Specified investment business (SIB) does not qualify > Considered non-active income if: > Main purpose is to earn rent, dividends, interest > Fewer than 5 employees Exceptions

> Everyone is an employee, including Founder > Company can own Life insurance on employees > Requires resolution of the board > Insurance premiums not tax deductible Publicly Listed Corporation

1 Professional Corporations A PARTNER YOU CAN TRUST.

> Can only carry on business of profession > Majority must be owned by professionals (voting shares) > Non-professional spouse/children can also be shareholders (non-voting shares) > Cannot be a numbered company Professional Corporations

> Income higher then needed for lifestyle > No personal non-deductible debts > In highest personal tax bracket > Spouse and children in lower tax brackets > Creditor protection needed > Deductions against income needed When to set-up a Professional Corp

> Qualifies for small business tax rates > Expenses deduction > Tax deferral > Corporate tax vs. personal tax rates > Dividend vs. salary > Income splitting > Hiring family members > Dividend sprinkling > Creditor Protection Professional Corp. – Advantages

> CGE – triggered on sale of shares > Cannot sell professional corp. shares easily > No protection against Professional negligence > Increased costs to administer > Increased regulation and complexity > Employee health tax charged on income > Business losses cannot be flowed to shareholders Professional Corp. - Disadvantages

1 The Mechanics of Corporate Policies A PARTNER YOU CAN TRUST.

> Income earned at a corporate level may ultimately end up being distributed to someone and as a bonus/income or as a dividend to someone personally. > Income should be Tax Neutral, ie: taxed equally whether income is earned corporately or personally. > There are various mechanisms used by CRA to ensure that this is true: > RDTOH – Refundable Dividend tax on hand > CDA – Capital Dividend Account Theory of Tax Integration

> Acts as a disincentive to accumulate investment income in the corporation. > The federal government levies a tax on any investment income earned by a CCPC, the tax goes into the company’s RDTOH account (functioning like an inventory) with CRA and is refunded to the CCPC when it pays a taxable dividend to shareholders. > For every $3 in taxable dividends that are paid to shareholders, the company is refunded $1 up to the balance of the RDTOH account. RDTOH – Refundable Dividend Tax on Hand

> The CDA is a notional account. > It is not an actual bank account but rather an accounting notation > The CDA tracks any amounts that a company receives tax free, such as: > Insurance death benefits, net of ACB > Tax-free portion of capital gains > Capital dividends received > The CDA amount allows the corporation to pay a tax-free capital dividend from their retained earnings. > Must be paid to a CDN resident > Must be a CCPC – CDN controlled private Corp. CDA - Capital Dividend Account

> CDA = Life insurance death benefit – ACB > Life insurance death benefit > net of policy loans > not net of collateral loans > Applies to permanent and Term policies > Applies whether there is cash value or not > Notes: > ACB usually goes to zero after 20+ years, cannot be negative > CDA has to be paid out equally to all shareholders of the same class Calculating CDA

> ACB – Adjusted Cost Basis > Ensures that corporate money gets taxed properly in personal hands > The ACB of policy tracks the original premium paid by a company for life insurance minus the NCPI > Formula > Premiums Paid increase ACB > NCPI decreases ACB ACB

> NCPI – Net Cost of Pure Insurance > Net amount at risk (NAAR) for the year multiplied by the probability of death in that year, ie: similar to T1 rates > Based on 1975 Select and Ultimate mortality table > Costs for any benefits or riders removed > Removes any ratings on substandard risks NCPI

> CDA = Life insurance death benefit – ACB > Life insurance death benefit > net of policy loans > not net of collateral loans > Applies to permanent and Term policies > Applies whether there is cash value or not > Notes: > ACB usually goes to zero after 20+ years, cannot be negative > CDA has to be paid out equally to all shareholders of the same class Calculating CDA

> ClientMale 50, Std. NS, Corp. > Policy Death benefit $5 million UL face only > Premium$200,000 per year for 10 year > Min Level COI Cost$66, > > ACB in year 5$ 945,709 > ACB in year 20$1,333,791 > ACB in year 30$ 0 Impact of CDA NCPI vs COI ($54,291 vs $331,096) ($666,209 vs $2 million)

> Death Benefit$5,000,000 > ACB$ 945,709 > CDA Credit$4,054,291 > How much did Corp. receive from InsCo.? > $5,000,000 > How much could Corp pay tax free to shareholders? > $4,054,291 > What happens to the rest? Impact of CDA – Year 5

> Death Benefit $5,000,000 > ACB$ 945,709 > CDA Credit$4,054,291 > Tax free Capital dividend paid$4,054,291 > Taxable dividend paid$ 945,709 > Tax paid on dividend$ 308,017 > What is the net death benefit received by shareholders? > $4,691,983 Impact of CDA – Year 5

> Problem: > Potential death benefit shortfall created by CDA/ACB > Net death benefit may fall short of required amount > Buy-sell > Solution: > Face plus fund plus ACB > Increases face amount so that CDA paid is equal to or greater than original death benefit > Removes risk of the ACB tax grind on CDA > Removes risk of underinsuring the need CDA Tax Trap

1 Accounting for Corporate Owned Policies A PARTNER YOU CAN TRUST.

Deductibility of Insurance Premiums > Premiums paid by a corporation for a life insurance policy are generally not tax deductible > Considered a capital outlay and not an expense > Exceptions: 1. Group insurance premiums 2. Charitable gifting of a life insurance policy 3. Collateral insurance

1. Group Insurance Premiums > Group medical insurance > Group life insurance > IPP’s > RCA’s

2. Charitable gifting of a life insurance policy > Policy assigned to charity > Charity issues a tax receipt equal to actual premiums paid > Death benefit does not trigger a tax receipt > Policy not assigned to charity > Charity issues a tax receipt for value of death benefit upon receipt of death benefit proceeds > No tax receipt for annual premiums

3. Collateral Insurance 1. Client secures a loan from a restricted financial institution 2. Lender requires a policy as collateral to secure the loan 3. The policy is assigned to the lender 4. Loan proceeds are invested in a qualified income generating investment 5. Interest on loan must be tax deductible

Collateral Insurance - Interest Deductibility > Loans must be invested to earn income > Rent, dividends, profit, interest > Capital gains does not qualify > Interest must be paid or payable in the year > There must be a legal obligation to pay the interest > Interest deduction can only be taken by policy owner > Policy loan interest must be confirmed by insurer > Form T2210

Collateral Insurance – Allowable deduction > Step 1 > Lower of: > NCPI for the year and > Premiums actually paid in the year > Step 2 > Pro-rated by amount applicable to loan > Example: Loan Amount = $250,000 Insurance DB = $1 million Deductible amount = 25% of step 1 amount

MTAR > Maximum Tax Actuarial Reserve > Magical Table of Allowable Room > The maximum premium a policy owner can deposit into a policy, tax sheltered. > The maximum amount that an insurance company can claim as a policy reserve.

MTAR - Two Major Tests > Exempt Test Policy (ETP) > designed to measure the funding level of a life insurance policy relative to its death benefit > 250% or “Anti Dump-In” Rule > applies if the accumulating fund on the tenth anniversary or any subsequent anniversary date, exceeds 250% of accumulating fund on the third preceding anniversary date

Exempt Test Policy (ETP) > Based upon the actuarial reserves required for a 20 pay policy to endow (cash surrender value equal to death benefit) at age 85

Issues with Exempt Test > Rules in Regulation 306 of Tax Act outlining exempt policies are open to interpretation > Based on CSV or Fund Value ?? > Increase in Fund value considered new deposit ?? > Test ends at age 85 > No insurance needed to tax shelter funds > Changes coming in 2014

250 percent rule (anti dump-in rule) > 10 th year test > Maximum deposit in year 10 is > Year 7 Fund value times 250% > Growth in fund value is considered new money > Prior to 7 th Year > Need to start contributing more than the minimum

1 Corporate Financial Statements A PARTNER YOU CAN TRUST.

Income Statement > Premiums paid minus increase in CSV = Net Insurance Expense > Increase in CSV minus premiums paid = Income

Balance Sheet > Cash surrender value of policy = Asset

Corporate Minutes > Approve purchase of Life insurance > Key-Man > Buy-Sell > IPP/RCA > IRIS

Financial notes Notes to reflect that policy pledged as collateral

1 Advantages of Corporate Owned Life Insurance A PARTNER YOU CAN TRUST.

Corporate Insurance Advantages > Personal marginal tax rates vs. Corporate rates > 46.4% vs. 15.5% > Ease of administration > Buy-Sell premiums shared equally > Multiple policies centrally owned > Capital dividend account

1 Disadvantages of Corporate Owned Life Insurance A PARTNER YOU CAN TRUST.

Corporate Insurance Disadvantages > CDA Tax trap > Increased value to corporate shares > Increases capital gain > Opco vs. Holdco > Potential sale of Opco > CCPC/CGE offside risk

Thank You Jorge Ramos, CFP, CLU Director of Advanced Marketing