For business owners and shareholders, accessing the cash value held within a corporation’s life insurance policy, such as Whole Life or Universal Life (UL), for personal use can be a strategic financial maneuver. One effective method involves personal loans backed by corporate guarantees. This approach offers several advantages, particularly when a future capital gain event is anticipated. By leveraging this strategy, shareholders can avoid immediate taxation through dividends or salaries and eventually repay the loan at a lower effective rate using the Capital Dividend Account (CDA). This article explores the benefits, implementation steps, and Canada Revenue Agency’s (CRA) position on shareholder benefits in such arrangements.

Why Access Corporately Held Cash Value in Life Insurance Policies Through Personal Loans?

1. Tax Efficiency

One of the primary benefits of this strategy is tax efficiency. By taking a personal loan backed by the cash value of a corporate-owned life insurance policy, shareholders can avoid the immediate tax implications associated with receiving dividends or salaries. This is especially beneficial when a significant future capital gain event is expected. In such cases, accessing funds via a loan can defer taxation and allow the shareholder to benefit from more favorable tax treatment in the future.

2. Leveraging the Capital Dividend Account (CDA)

The CDA is a notional account that tracks certain non-taxable income within a corporation, such as the non-taxable portion of capital gains and proceeds from life insurance policies. When a future capital gain event occurs, the corporation can credit the CDA with the non-taxable portion of the gain. Shareholders can then receive tax-free capital dividends from the CDA, which can be used to repay the loan, reducing the effective tax rate on the accessed funds.

3. Preservation of Corporate Cash Flow

Using personal loans to access corporately held cash value preserves the corporation’s cash flow. This can be particularly advantageous for businesses that require liquidity for operations, investments, or other strategic purposes. The corporation can continue to utilize its cash reserves while the shareholder benefits from immediate access to funds.

4. Maintaining Efficient Taxable Income in Retirement

This strategy can also be particularly useful during retirement years. Instead of drawing down personal income—which might push the retiree into a higher tax bracket or deplete retirement savings—loans backed by the corporation’s life insurance policy can provide the necessary cash for unexpected emergencies or even discretionary spending. The shareholder can then repay the loan slowly over time, ensuring that their annual taxable income remains at an optimal level, minimizing tax liabilities while maintaining financial flexibility.

5. Flexibility and Control

Accessing funds through personal loans provides shareholders with greater flexibility and control over their financial planning. Unlike dividends or salaries, which are subject to immediate taxation, loans offer the ability to manage cash flow and repayment terms more effectively. Shareholders can structure the loan repayment in a way that aligns with their financial goals and tax planning strategies.

6. Circumventing the One-Year Loan Repayment Requirement

According to the Canadian Income Tax Act, a withdrawal designated as a shareholder loan that is repaid within one year from the end of the corporation’s taxation year will not be included in the borrower’s income. Failure to repay within this period results in the loan being included in the recipient’s income retroactively. By using the cash value of a life insurance policy as collateral, this strategy can effectively circumvent the one-year repayment rule. The loan backed by the life insurance policy does not trigger the same immediate repayment obligation, providing more flexibility and potentially better financial terms for the shareholder.

CRA’s Position on Shareholder Benefits

The CRA assesses whether a corporation has conferred a benefit on a shareholder when it guarantees or provides security for a shareholder’s loan. This determination depends on the specific circumstances of each case. The CRA has outlined several key points:

• Arm’s Length and Repayment Ability: No benefit is assessed if the shareholder deals at arm’s length with the corporation and can repay the loan at the time the guarantee is granted.
• Reasonable Fee: When a shareholder pays a reasonable fee to the corporation for granting the guarantee, it typically does not result in a benefit. This fee serves as consideration for the risk taken by the corporation.
• Honouring the Guarantee: If the corporation is required to honour the guarantee, any payments made to the financial institution to discharge its obligation, including any realized security, generally constitute a benefit to the shareholder. However, amounts recovered from the shareholder can reduce this benefit.

NB: The determination of whether or not a corporation has provided a benefit to a shareholder can only be made after reviewing all the circumstances of a particular situation. Therefore, it is advisable to consult with your tax advisors before implementing any strategy described.