March/April 2004: by Dale Berg

A less taxing strategy for your investment company

For those business owners with large cash positions in their holding companies, or estate planning needs for an investment company, a corporate insured annuity strategy could be worth looking into.

This particular strategy could help former business owners who now own an investment company for tax purposes, eliminate the volatility of market-based investment securities, reduce the annual taxation of interest-bearing investments, and virtually eliminate any tax on the transfer of the investment assets to beneficiaries. Sounds too good to be true? Well, there are some stars that need to be lined up for this strategy to work, but if they are in alignment, it can be a very successful financial planning strategy.

Under the corporate insured annuity strategy, the corporation would buy and own an income payout annuity and life insurance policy on the shareholder. One of the immediate drawbacks of a corporation owning an annuity on the life of a shareholder is the annuity does not qualify as a prescribed annuity, as regulation 304(1)(c)(iii) states that the holder of a prescribed annuity must be an individual, testamentary trust, or spousal trust. Therefore, a corporateowned annuity does not receive the preferential prescribed annuity tax treatment, and the corporate-owned annuity will have a variable amount of taxable income every year. The good news is that the amount of taxable income will decrease each year the payment is made, as future payments will be made up of a larger capital component, and a lower investment component.

Table 1 (click to see table in pop-up window) shows a hypothetical example where the stars were in alignment, and the strategy works. We have compared this particular example to an alternative interest-bearing investment earning a generous guaranteed rate of return of six per cent. We have made the following assumptions in regards to our example:

• The corporate tax rate is assumed to be 50 per cent.
• The company has approximately $500,000 of cash.
• The shareholder is male, 65, healthy and nonsmoking.
• The annual cost of a $500,000 T100 life insurance policy would be $13,982 per year.
• The annual annuity payment would be $41,880.

Now that we have ascertained that the taxes payable every year are less, and the after-tax cash flow would be greater under an annuity than an interest-bearing investment,we now need to explore the estate benefits to the shareholders' heirs upon death.

Under subsection 70(5) of the income tax act, an individual is deemed to have disposed of all capital property immediately before death, which would include the ownership of shares in a private company. If the private company only owns an annuity at the time of death, and a term-to-100 life insurance policy with no cash values, the value of this company should be nil. Unfortunately Canada Revenue Agency does not see it this way. CRA's calculation of the value of the company would be based on an estimate of the life expectancy of that shareholder immediately preceding death. This calculation would be based on a present value estimate of future annuity payments. Therefore it would be prudent to suggest that over time, as the shareholder ages, the present value of the annuity contact would decrease, and the value of the company would eventually be nil as the shareholder reaches his/her life expectancy.

The final particularly attractive tax-planning point falls under subsection 89(1) of the income tax act which allows the amount of death proceeds received by a corporation in excess of the adjusted cost basis of the life policy to be credited to the corporation's capital dividend account. Using a term-to-100 contract under the corporate insured annuity strategy will allow for most, if not all, of the death benefit proceeds to flow from the corporation into the hands of the beneficiaries tax-free.

Summary
The nature of an insured annuity is very attractive for older, healthy individuals who desire guaranteed long-term rates of return. There are additional benefits by using a corporate insured annuity such as potentially reducing the value of the corporation's shares over time as the present value of the expected annuity payments are reduced; and the other very important estate planning advantage of being able to flow through the capital dividend account the $500,000 life insurance policy virtually tax-free.

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About the author
Dale Berg, CLU, Ch.F.C., CFP, is a Senior Financial Advisor with Assante Financial Management Ltd. He can be reached at 1-877-837-3377 or 306-665-3377, or click to email Dale Berg.

Disclaimer
Please contact a professional advisor to discuss your particular circumstances prior to acting on the information above. The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd.

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