Taxation of Disability and Critical Illness Insurance

1
Taxation of Disability and Critical Illness
Insurance
Understanding

• November 2005
• This material is for information purposes only
  and should not be construed as legal or tax
  advice. Every effort has been made to ensure its
  accuracy, but errors and omissions are possible.

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Focus of This Presentation

• Review of the taxation of Disability Insurance
  (DI)
• focus on individual salary continuation contracts
• owned individually
• wage loss replacement
• Dispelling the myths surrounding the taxation of
  Critical Illness Insurance (CI)

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Important Terminology

• Accident Sickness Insurance Plan
• Disability Insurance Plan
• Income Maintenance Plan
• Wage Loss Replacement Plan
• Group Plan

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Important Terminology

• Accident Sickness Insurance Plan
• Disability Insurance Plan
• Income Maintenance Plan
• Wage Loss Replacement Plan
• Group Plan

5
Individually-Owned Contracts

• personal and living expenses
• not deductible
• paid for with after-tax dollars
• benefits are not taxable

6
Employer Sponsored Plans

• Why businesses provide DI
• helps attract and retain high quality employees
• moral and financial commitment
• cost of disability vs. budgeted premium

7
Wage Loss Replacement Plans

• Subsection 18(1) of ITA
• premiums paid are a business expense
• 18(1) and 67 require that the expense must be
  incurred by employer for purpose of earning
  income and must be reasonable

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Wage Loss Replacement Plans

• 6(1)(a) of ITA
• all benefits included in income except
  contributions under group sickness or accident
  insurance plan

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Wage Loss Replacement Plans

• 6(1)(f) of ITA
• benefit from plan included in income
• sickness or accident insurance plan
• disability insurance plan
• income maintenance insurance plan
• IT-428 - Wage Loss Replacement Plans

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Rules for Establishing a WLRP

• Plan must be established
• declaration
• recording in minutes of Board of Directors
• Communication
• Plan must be in place prior to disability
• At least two employees
• For employees

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Rules for Establishing a WLRP

• Shareholder-employees
• Direct flow of benefits to employees
• Employer must contribute to plan
• Only insurable income is salary

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Tax Consequences of WLRP reviewed

• Premiums paid are deductible under section 9 and
  subject to 18(1) and 67 of ITA as business
  expense
• Employer-paid premiums are not a taxable benefit
  to the employee under 6(1)(a)
• Benefits payable under the DI policy are taxable
  to employee under paragraph 6(1)(f) of the ITA

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Risky WLRP Strategies

• Token Policies
• Only Shareholders covered
• Excessive Shareholder income covered

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Premium as a Taxable Benefit

• no formalities
• one or small number of employees
• single shareholder/employee for own benefit
• employer pays for and expenses premium as a
  bonus/salary
• employee pays tax on additional salary

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DI Conclusion

• Different tax treatments for different structures
• Canada Life recommends independent legal and tax
  advice be sought to structure the plan to meet
  clients circumstances
• Equipped to help you negotiate the pitfalls and
  provide competitive products

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CI Tax Issues

• Income Tax Act contains no definitions
• CRA has provided limited rulings
• CALU roundtable comments are not law
• Given the lack of clarity in the law and in the
  guidance provided by CRA, all that can be done is
  to identify some of the issues

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Tax Issues

• characterization of policy
• ownership
• deductibility of premium
• characterization of benefit

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Tax Issues - Characterization of Policy

• Accident and Sickness Insurance
• Life insurance return of premium at death
  benefit?
• Investment return of premium at expiry with
  rate of return?

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Tax Issues - Ownership

• personal
• corporate

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Tax Issues - Deductibility of Premium

• personal - no
• personal or living expense
• corporate - no
• does not meet the test incurred for the purpose
  of gaining or producing income
• typically a capital expense
• corporate - yes?
• group accident and sickness plans
• health and welfare trusts

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Tax Issues - Characterization of Benefit

• personal
• after tax premiums -gt non taxable capital receipt
• corporate
• after tax premiums -gt non taxable capital receipt
  to corporation
• not eligible for capital dividend account
• how to get funds out of company?
• taxable salary
• taxable dividends
• taxable bonus

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Tax Issues - Characterization of Benefit

• Corporate
• corporate-paid premiums -gt taxable benefit to
  employee annually
• proceeds then tax free to employee
• Group Accident and Sickness Plan
• formalities
• deductible premiums -gt no taxable benefit to
  employee annually
• periodic benefit then taxable when received
• what about a lump-sum?

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CI Taxation Conclusion

• No formal CRA ruling as yet
• Uncertainty
• Tax treatment of return of premium benefits is
  subject to interpretation
• Canada Life recommends clients discuss the tax
  implications of a critical illness insurance
  policy with their professional legal and tax
  advisors

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