Life insurance

Chapter 8 – Business life insurance

159

EXAMPLE:
Jack and Alfred each own 50% of the 200 shares of Jackal Inc., a frozen
dessert company. They implemented a buy-sell agreement funded with criss-
cross insurance. Jack died shortly thereafter. The overall process would look
like this:

1. Jack and Alfred pay the premiums for life insurance on each other.
2. Jack dies, and his 100 shares transfer to his estate.
3. The insurance company pays a tax-free death benefit to Alfred.
4. Alfred pays Jack’s estate for his 100 shares.
5. Jack’s estate transfers the 100 shares to Alfred, who now owns all 200 shares,
or 100% of the company.

8.4.4 Business-owned insurance

Another option for funding the buy-sell agreement is having the business buy the insurance
coverage on the business owners. This has several potential advantages over policies purchased
by the individual owners:
▪ If the cost of insuring each associate varies significantly due to age and health factors, a business-
owned option will ensure that the costs are shared equally;
▪ Because the associates have access to the company’s financial statements, they can assure
themselves that the premiums for the insurance are actually being paid. If the policies are owned
individually, it may be harder to obtain this proof;
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Chapter 8 – Business life insurance
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▪ Because premiums are generally not tax-deductible and are paid with after-tax dollars, it will be
cheaper for a corporation to buy the insurance if its tax rate is lower than the personal tax rates
of the associates;
▪ If there are more than two associates, it will generally be more efficient and more cost-effective
for the business to own policies on each associate, compared to each owner buying individual
policies on each of the other associate;
▪ If the buy-sell agreement will be funded by business-owned insurance and there are only two
shareholders, a joint first-to-die policy may be appropriate.

Business-owned insurance can be used to fund both cross-purchase buy-sell agreements and
share redemption plans, as discussed shortly. However, first it is necessary to understand how a
capital dividend account works.

8.4.4.1 Role of the capital dividend account (CDA)

A private corporation uses its capital dividend account (CDA) to record various amounts that it
receives on a tax-free basis, such as the tax-free 50% of capital gains and some or all of the
death benefits received from a life insurance policy. It can then pass those tax-free amounts on to
shareholders on the same tax-free basis as a capital dividend.31

The CDA is only a notional account, which means it does not actually hold funds; it just keeps track
of them for tax purposes. It keeps a running balance of the amounts that a private corporation
can pay to its shareholders tax-free. A private corporation can elect to designate a payment to its
shareholders as a tax-free capital dividend when it has a positive CDA balance and sufficient cash
to do so. When the corporation pays out a capital dividend, the CDA balance is reduced by the
same amount.

Note that only the portion of the death benefit that exceeds the policy’s ACB is credited to the
CDA, and ultimately paid out as a tax-free capital dividend. The remainder (i.e., an amount equal
to the policy’s ACB) is taxable to the corporation.

In the case of a term policy, the ACB is zero, which means that the full death benefit can be
credited to the CDA. However, for whole life or UL policies, a portion of the death benefit equal to
the policy’s ACB is in fact taxable to the corporation.

31. Manulife Financial. Capital dividend account and life insurance. [online]. Revised March 2019. [Consulted
May 9, 2022]. https://www.manulife.ca/advisors/insurance/tax-retirement-and-estate-planning/technical-planning-
support/capital-dividend-account-and-life-insurance.html