All About Estates

INSURANCE TRACKING SHARES

If a taxpayer owns shares of a corporation and passes away, he or she is deemed to have disposed of their shareholding at fair market value (“FMV”) unless a tax-free rollover is applied (e.g., rollover to a surviving spouse). The disposition of shares may cause a tax liability. In the circumstance where this shareholding was in the form of a significant shareholding in a privately held corporation, there may be no immediate source of funds to fund the tax liability. One solution to this problem is to plan for the potential liability by having the corporation purchase life insurance on the individual to fund the tax liability or the outright purchase of shares from the estate. However, the FMV of the insurance policy at time of death in the form of its cash surrender value (“CSV”) may be added to the overall FMV of the corporation at time of death, which increases the taxable capital gain on deemed disposition and taxes as a result. It may also be possible that the proceeds of the life insurance may not be distributed as initially intended.

To address this, the corporation may issue preferred shares that track the CSV of the insurance policy but don’t otherwise entitle the shareholder — typically, the successors — to dividends, proceeds on the sale of the business or voting rights. As the CSV of the policy increases, so does the value of the tracking shares. The shares could track both the cash value and death benefit of a policy. If the tracking shares are issued before the policy is acquired, they can be given a nominal value of $1.

At the business owner’s death, the policy’s CSV is attributed to the insurance-tracking shares, not the business owner’s shares. The corporation redeems the insurance-tracking shares and the life policy proceeds flow from the corporation’s capital dividend account (CDA) to the shareholder of the insurance tracking shares on a tax-free basis. I do not believe the new TOSI rules would apply under the circumstances.

Insurance-tracking shares also can be used to equalize an estate for heirs, particularly when some of the beneficiaries of the estate are active in the business while others are not. They could also be used to plan around beneficiaries who are not Canadian residents and may be subject to tax on the receipt of capital dividends.

The tax treatment of these shares is not specifically addressed in the Income Tax Act. Practitioners have been relying on a 2005 technical interpretation to confirm the foregoing. Recently two 2021 technical interpretations (2021-0884291C6 and 2021-0884301C6) confirmed the Canada Revenue Agency’s position that CSV would be allocated between the common shares and the insurance tracking shares based on the rights and attributes of each class, using the same valuation principles that would guide the allocation of the value of other corporate assets.

Happy Reading and stay safe.

About Steven Frye
Baker Tilly WM LLP is a leading, independent audit, tax, and business advisory firm based in Vancouver and Toronto, serving clients across Canada. Drawing on well-trained teams across a variety of disciplines, we ensure the alignment of our professional’s skills and experience with client requirements, resulting in exceptional service and business outcomes.

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