Collateral insurance deduction basics
Life insurance premiums are generally not tax deductible. However, when life insurance is used as collateral security for a loan, the premiums or a portion of them may be deductible for income tax purposes.
The requirements for deductibility are set out in paragraph 20(1)(e.2) of the Income Tax Act:
The policy must be assigned to a restricted financial institution (RFI) in the course of borrowing from the institution.
The assignment must be required by the RFI.
The interest on the borrowed money must be deductible.
The amount deductible is the lesser of the premiums payable and the net cost of pure insurance for the year in respect of the policy “that can reasonably be considered to relate to the amount owing from time to time during the year by the
taxpayer to the institution under the borrowing.”
The case of Emjo Holdings Ltd. v. The Queen, 2018 TCC 97 examines whether and to what extent these requirements were met in a particular situation. The taxpayer, Emjo, had claimed the full amount of life insurance premiums as tax deductions on the basis that the insurance was used as collateral for loans. The CRA reassessed Emjo and denied the deductions. In Tax Court, the Minister of National Revenue argued that the loans were the personal loans of Emjo’s principal shareholders, that Emjo was not liable for the loans and, consequently, the life insurance premiums (approximately $8,600 per year for 2013-2015) were not deductible.
Although the Court found some of these requirements for deductibility were met in one of the years, Emjo’s appeal from the reassessment was dismissed.
Emjo was incorporated in November 2002. Mr. and Mrs. R owned the voting shares equally and had incorporated Emjo to acquire an existing real estate development company, DH Ltd. Before Emjo’s incorporation, Mr. and Mrs. R got a Commitment Letter from an RFI for a term loan of $300,000 and a second loan of $250,000, both to be amortized over 10 years. In addition to the life insurance discussed below, other collateral security for these loans was provided by Mr. R’s parents, Mr. R and Mrs. R, as well as a general security agreement of DH Ltd. The combined balance owing on the two loans by February of 2013 was about $66,000.
The Commitment Letter included the requirement that “The Borrowers agree to carry minimum $500,000 Keyman Life Insurance assigned to the Credit Union.” Emjo purchased a $ 1 million Universal Life policy in 2002 and increased the coverage to $2 million in 2011. Emjo was unable to provide documentary evidence of the assignment but provided a copy of an email from the RFI confirming that this insurance was assigned to them.
The Saskatchewan Immigrant Investor Fund Inc. (SIIF) provided another loan of approximately $2.4 million. This loan was more in the nature of a credit facility that could be drawn down. By the end of 2012 the balance outstanding on this loan was about $417,500. There was also a letter asking for $500,000 of key man life insurance for this facility. The letter expressed that the assignment “is therefore limited to $500,000.” Emjo acquired a term policy for $3 million in 2011 and assigned the policy to the SIIF using the insurer’s forms.
In respect of the first set of loans, the Court concluded that even though the Commitment Letter was addressed to Mr. and Mrs. R, it was adopted by Emjo once it was incorporated. The Court found that Emjo actually borrowed money and assigned the universal life policy as required by the RFI. However, the amount of the premiums that could have been deducted had to be prorated based on the amount of the loan that was outstanding. In the 2013 taxation year the loan amount owing was $66,000 compared to the $2 million of insurance coverage that was in place. The prorated amount would have resulted in a deduction of $150 for that year. For the 2014 and 2015 taxation years the Court found no outstanding loan balance so there could be no collateral insurance deduction for those years.
As for the credit facility from the SIIF, the Court found that it was never fully drawn down. Emjo only borrowed what was required from time to time, and repaid amounts on a rolling basis. Since there was no evidence of any indebtedness for the years in question (2013-2015), it was not possible for the Court to correlate the life insurance premiums paid with the balance due on a loan for any of those years.
This case shows the practical realities of taking the collateral insurance deduction and the importance of keeping good records.