NewsColony
Image default
Insurance

Deducting Life Insurance Costs: Paragraph 20(1)(e.2) Of Income Tax Act Explained – Tax – Canada – Mondaq News Alerts

To print this article, all you need is to be registered or login on Mondaq.com.

(January 18, 2021, 3:21 PM EST) — The cost of life
insurance is a cost which is usually borne by individuals and is
not something that people think of as a deductible expense.

With numerous deductions for loss from a business (or property)
available in Canada’s tax legislation, it is possible if not
probable that some opportunities will be missed. The opportunities
that may be missed for income deductions naturally go back to some
of the most technical provisions in the Income Tax Act, RSC 1985, c
1 (5th Supp.) (ITA). One of these technical provisions is examined
here: paragraph 20(1)(e.2).

This provision allows a person or business to deduct the
reasonable cost of life insurance, in the event it is used as
collateral in a business financing agreement. When would this be
useful, and why would it be missed? Moreover, what makes this
provision so technical? This series seeks to answer these
questions, clarifying a technical provision in the ITA starting
with a relatively simple example.

When would paragraph 20(1)(e.2) be useful?

A company or one of its business units may have one or more key
persons — perhaps executives or company rainmakers. A key
person may be a technical person like a researcher or a chief
technology officer.

What is common about these people is that their death would
prove to be detrimental to the business. As such, it is commonplace
for a company to buy insurance against the loss of a person who is
integral to its business or who is perhaps difficult or impossible
to replace. This insurance comes in the form of a life insurance
policy, commonly referred to as “key person
insurance.”

Different from “dead peasant insurance” (insurance
purchased by corporations on the lives of low- wage workers —
usually without their knowledge), key person insurance is meant to
mitigate the losses that would take place by a business should a
key person die. It allows the business to use the payout to try to
find a replacement or to give the business an opportunity to get
back on track.

Aside from their direct value to the company, many key employees
have a value to financial institutions which often agree to finance
a company on the basis of their faith in that person and their
value to the business. As part of a financial arrangement based in
part on an individual’s merit, credentials or experience, the
lending institution may require collateral to compensate in the
event something happens to that person.

Key person insurance may then be taken out by the company and
used as collateral in the loan agreement, or an already existing
life insurance policy may be assigned. This will protect the
lending institution against something happening to the individual
whose merit ensures continued loan repayment.

In such a case, paragraph 20(1)(e.2) becomes a valuable tool for
the borrower. The way that it works is that this provision allows
the borrower to deduct from their income, reasonable costs of a
life insurance policy which in turn facilitated the financing with
the lending institution.

From a tax perspective, a life insurance policy assigned to a
financial institution to earn income or one which is specifically
taken out to facilitate a business loan is different from a policy
purchased specifically to mitigate the loss of a key person.

Since the borrowed funds are used to earn income and an interest
in the life insurance has been assigned, the expense of owning life
insurance has changed. Similar to any other reasonable expense used
to earn income, it is deductible when reporting at the end of each
tax year, but only by virtue of paragraph 20(1)(e.2) of the
ITA.

In the case of pre-existing key person insurance which is then
assigned it to a lender, upon the assignment, the purpose of such
insurance changes from a mitigation purpose (one which protects the
company from the losses which occur and the damage which occurs
from the death of a key person) to an income-earning purpose.

This is part one of a two-part series. Part two will discuss why
paragraph 20(1)(e.2) may be missed and what makes the provision
technical.

Originally published by The Lawyer’s Daily.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

POPULAR ARTICLES ON: Tax from Canada

Source: Google | Insurance News

Related posts

Bumbalough Earns Fraternal Insurance Industry Designation – wjle.com

NewsColony

Eagle Life Insurance Company Names Albert as Head of Sales – Yahoo Finance

NewsColony

Types of life insurance – Business Insider

NewsColony

Leave a Comment