Corporate-owned insurance — Valuation Issues Regarding the Deemed Disposition Rules at Death (Subsection 70(5))

Last updated: August 2022

A common question asked by owner-managers who are contemplating the purchase of life insurance is whether the insurance should be owned personally or by their private corporation. Deciding between personal or corporate ownership is properly based on a number of tax and non-tax considerations. For an overview of these considerations, see the Tax Topic, “Ownership of Life Insurance – Planning Considerations”.

This Tax Topic reviews valuation issues involving corporate-owned insurance, specifically, the valuation of shares held by a deceased shareholder for capital gains purposes. Certain other valuation issues are also mentioned.

There are several circumstances when a valuation involving a corporate-owned life insurance policy is required under the Income Tax Act (the “Act”). When a specific income tax provision applies, the tax treatment and valuation is determined under the specific provision. However, when a specific income tax provision does not apply, Canada Revenue Agency (“CRA”) uses general valuation principles to determine the value of a corporate-owned life insurance policy.

CRA has set out these general valuation principles in Information Circular IC 89-3 “Policy Statement on Business Equity Valuations” dated August 25, 1989. The Information Circular outlines the valuation principles, practices and policies that CRA generally considers and follows in the valuation of securities and intangible property of closely held corporations for income tax purposes. Determining the value of shares in a private corporation requires consideration of a number of fundamental factors, including the nature of the business, outlook for the company and the industry, the company’s balance sheet, financial condition, earnings record, goodwill, etc. There are also numerous issues relevant to the valuation of specific shareholdings. The existence of corporate-owned life insurance is one of the relevant issues.

Although this Information Circular applies in determining the fair market value of shares in a corporation, CRA has indicated that the same factors listed in the Information Circular would be used to determine the fair market value of an interest in a life insurance policy in general.

Paragraph 40 of IC 89-3 lists the factors that are considered in determining the value of corporate-owned life insurance:

a) the cash surrender value of the policy;
b) the policy’s loan value;
c) the face value of the policy;
d) the state of health of the insured and his/her life expectancy;
e) conversion privileges under the policy;
f) other policy terms, such as term riders, double indemnity provisions; and
g) the replacement value of the policy.

The result of applying general valuation principles can produce a valuation which is materially different than the cash surrender value of the insurance policy. For example, if the death of one of the shareholders for which corporate life insurance is owned is considered imminent and the general valuation principles apply, the resulting valuation will exceed the policy’s cash surrender value and may approach the total death benefit attributed to the interest in the policy held by the corporation. 

Clearly, valuation in these circumstances is not an exact science, but rather a reasonable estimate based on all known facts. Fair market value is a question of fact and therefore, it is important for taxpayers who are asserting a particular point of view relating to fair market value to appropriately establish the basis for their view. As in any other matter of valuation, it is appropriate to seek the opinion(s) of a valuation professional(s).

Subsection 70(5) of the Act provides that a deceased taxpayer is deemed to have disposed of each capital property (including private corporation shares) for proceeds equal to the fair market value of the property immediately before death. As a result, any accrued capital gain or capital loss will be realized for income tax purposes on the deceased’s final income tax return unless a specific relieving provision applies (for example, subsection 70(6) of the Act under which the property may be transferred on a tax-free rollover to a surviving spouse or spousal trust).

The fair market value of the deceased’s shares in a private corporation must be determined for the deemed disposition rules. If a shareholder’s agreement exists, the terms of the agreement should be determinative of the fair market value of the shares of the deceased shareholder for purposes of subsection 70(5) of the Act provided certain conditions are met. The conditions that must be met for a buy-sell agreement to be considered determinative of value pursuant to subsection 70(5) are contained in paragraph 28 of Information Circular 89-3:

a) The agreement must obligate the estate to sell the shares at death either under a mandatory sales and purchase agreement or at the option of a designated purchaser;
b) The agreement must restrict the shareholder's right to dispose of the shares at any price during the shareholder’s lifetime;
c) The agreement must fix a price for the shares or set out a method for determining the price on a current basis; and
d) The agreement must represent a bona fide business arrangement and not a device to pass the decedents shares to their heirs for less than an adequate and full consideration.

If a buy-sell agreement between non-arm’s length parties meets these conditions, its provisions should be determinative of value, if it also meets the following additional criteria:

a) It is a bona fide business arrangement. In other words, while the parties to the agreement may be related, they must transact as they would at arm's length with strangers;
b) The stipulated price or formula price in the agreement provides full and adequate consideration, and represents the fair market value of shares determined without reference to the agreement at the time that it is executed; and
c) It is a legal and binding contract.

Also, a bona fide buy-sell agreement between non-arm’s length parties will be determinative of value in respect of the sale of the shares by the estate to the surviving shareholders by the promissory note method. (See Question 13 at the 1993 CALU Annual Meeting #9310110, dated May 17, 1993.)  If the agreement is not determinative of value, the CRA position is that on the sale of shares by the estate to a purchaser with whom it does not deal at arm’s length, an adjustment might occur under section 69 of the Act to include the value of the life insurance proceeds in the proceeds received by the estate, thereby increasing the capital gains tax liability to the estate.

And in respect of a deceased shareholder, if the shareholder’s agreement is not determinative of the fair market value of the shares for purposes of subsection 70(5) or if an agreement does not exist, then the question arises as to how a corporate-owned life insurance policy will impact the valuation of the deceased’s shares.

For purposes of determining the fair market value of the shares owned by a deceased shareholder on death under the deemed disposition rules in subsection 70(5), subsection 70(5.3) of the Act specifically provides that the fair market value of a corporate-owned life insurance policy on the life of the deceased shareholder or any person not dealing at arm’s length with the deceased shareholder shall be its cash surrender value. The term “cash surrender value” is defined under subsection 148(9) of the Act to be the cash surrender value stated under the insurance policy, ignoring policy loans, policy dividends (other than paid-up additions) and interest payable on such dividends. CRA has indicated they would look to ordinary valuation principles in determining whether a policy loan would otherwise be considered in valuing the deceased’s shares (Technical Interpretation #2003-0035675).

Subsection 70(5.3) of the Act provides specific rules for valuing a corporate-owned life insurance policy owned on the life of the deceased shareholder and related persons.  It should be noted that subsection 70(5.3) applies to joint and multi-life policies under which the particular individual or a person related to the individual is “a person” whose life was insured. However, these rules do not apply to other corporate-owned insurance policies held on the lives of other insureds (e.g., the surviving shareholders if they are unrelated). Life insurance policies on the lives of any other person insured also represent assets of the corporation and must, therefore, be considered in valuing the deceased’s shares. CRA has indicated in IC 89-3 that it will value corporate-owned life insurance policies on the lives of the surviving shareholders at fair market value, determined in accordance with the factors noted previously.

Therefore, when determining the fair market value of shares owned by a deceased shareholder, corporate-owned life insurance policies on the life of the deceased will be valued based on the cash surrender value of the policies, but corporate-owned life insurance on the lives of any other arm’s length insured will be valued using general valuation principles.  

Subsection 70(5.3) of the Act applies in determining the value of any property (e.g., an interest in a trust or a partnership) not just shares that are deemed disposed of in consequence of a particular individual’s death or as a consequence of the particular individual becoming or ceasing to be a resident of Canada. It applies on a deemed disposition for an alter-ego, joint-partner or spousal trust on the death of the settlor, a spouse or common-law partner (as the case may be) under subsection 104(4) of the Act and for an individual on departure from (or emigration to) Canada (under section 128.1 of the Act). 

Shares held by an alter-ego, joint-partner or spousal trust are deemed to be disposed of at the end of the day on which the settlor, spouse or common-law partner (as the case may be) dies, pursuant to subsection 104(4) of the Act. The fair market value of the shares must be determined at this time. The corporation may have purchased life insurance to provide estate liquidity upon the death of the settlor, spouse or common-law partner. Valuation of the shares at the end of the day on which the settlor, spouse or common-law partner dies will include the value of the insurance policy. Subsection 70(5.3) of the Act provides that the fair market value of such a policy will be deemed to be equal to its cash surrender value immediately before the death, and therefore only the cash surrender value will be included in the valuation of the shares owned by the trust.  This was confirmed in technical interpretation #2010-0390911E5.

The CRA confirmed in technical interpretation #2021-088240, that subsection 70(5.3) of the Act applies where an individual becomes a resident of Canada and holds shares of a corporation that owns a life insurance policy but would not apply if instead the corporation became a resident of Canada.  The CRA stated that subsection 70(5.3) only applies on a disposition of property held by an individual.

Subsection 70(5.3) of the Act is a deemed valuation rule.  Where it applies, it is used to determine what the value of corporate-owned life insurance is for purposes of a particular deemed disposition.  However, it does not allocate that deemed valuation between different parties.  This question is relevant where a policy is co-owned by a corporation and another party (i.e., “shared ownership” or “split-dollar” life insurance).  Also, where “life insurance shares” exist, a question as to where the CSV of a corporate owned life insurance policy tracks to for purposes of the deemed disposition on death becomes relevant.

When a life insurance policy is jointly owned by a corporation and a shareholder pursuant to a split-dollar arrangement under which the corporation owns a fixed death benefit amount, the CRA confirmed in #2020-0842191C6, that subsection 70(5.3) applies to determine the value of the policy for purposes of the deemed disposition of the shareholder’s shares on death.  However, it stated that subsection 70(5.3) “does not specify the allocation of the CSV of the life insurance policy between separate interests or different policyholders in the policy, nor does the provision determine the value of the respective interests held by joint owners of a life insurance policy.”  The CRA could not therefore conclude that the value allocated to the corporation was nil.  The CRA stated that all the relevant facts, circumstances and related agreements would need to be considered in determining the fair market value of the corporation’s interest in the life insurance policy.

Life insurance shares are a special class of tracking shares, the attributes of which, entitle the holder to the death benefit proceeds of a corporate-owned life insurance policy. They are normally, non-voting, non-participating, redeemable at the discretion of the corporation and entitling the holder to a dividend equal to the proceeds of life insurance received by the corporation and payable to the extent of any capital dividend account credit arising from the life insurance proceeds.   At the 2005 APFF Conference, (2005-0138111C6 and 2005-0138361C6) the CRA was asked, in two different scenarios, to comment on the application of subsection 70(5.3) in the context of the death of a 100% common shareholder where life insurance shares with different share attributes existed. In one scenario, the life insurance shares were entitled to be redeemed prior to death for $1 (i.e., not tracking CSV) and in the second scenario, for the CSV of the policy (i.e., tracking CSV).While all the facts and circumstances would need to be considered, the CRA did  comment that generally it would be reasonable to attribute the cash surrender value of the corporate-owned life insurance policies among various classes of shares based on the rights and conditions attached to the shares in the same way as the overall value of the firm would be allocated among the various classes of shares.  In the first scenario this meant that “the value of the common shares immediately before death would take into account almost the entire cash surrender value of the life insurance policy.”  And in the second scenario, due to the share attributes, “it would not be unreasonable to allocate the amount of the policy’s CSV to the insurance shares, immediately prior to death.”  At the 2021 CLHIA CRA Roundtable (#2021-08842291C6 and #2021-0884301C6) the CRA confirmed these prior views, noting that these views are only relevant in the context of subsection 70(5.3) and only where the share attributes are specifically as described in these scenarios.

At the 2008 APFF Conference (2008-0286151C6) CRA was asked to comment on the valuation of life insurance shares that would flow term insurance proceeds to the holder of the share at death. CRA was asked to confirm that immediately before the taxpayer’s death, the fair market value of the life insurance shares, for the purposes of subsection 70(5) of the Act, would equal the life insurance shares’ issue price of $1  and not take into account the value of the life insurance proceeds payable at death, since subsection 70(5.3) of the Act specifies that only the cash surrender value of the policy on the life of the deceased shareholder is to be considered in the valuation of the shares. Again, CRA stated that they cannot express an opinion on fair market value without an exhaustive review of the property to be valued at a given time, however, has agreed to examine requests from taxpayers concerning complex valuation issues.

Corporate-owned insurance continues to be an attractive ownership alternative, particularly in owner-manager business situations. The decision to purchase insurance personally or through the corporation is properly based on the specific facts of each case. However, when analyzing the corporate ownership alternative, the impact of the corporate-owned insurance on the deemed disposition rules at death pursuant to subsection 70(5) should be considered.

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