Gestion Case

A cautionary tale for Holdco/Opco structures

When a shareholder establishes a holding company/operating company structure, the holding company often owns life insurance coverage on the life of the shareholder that is required for business or estate planning purposes.

Typically, the holding company (Holdco) is also the beneficiary of the policy, and the premiums can be funded with tax-free intercorporate dividends paid to Holdco by the operating company (Opco). The tax results of this structure are relatively straightforward: on the death of the shareholder, the insurance proceeds are received by Holdco and a substantial portion of those proceeds will be credited to its capital dividend account (CDA). The holding company can retain the insurance proceeds or flow part or all of the insurance proceeds to either Opco (as a shareholder loan) or the shareholders of Holdco (as a tax-free capital dividend).

However, there may be circumstances in which it is advantageous to have Opco be the direct recipient/beneficiary of the insurance policy owned by Holdco — for example, when there is a buy-sell agreement with arm’s length shareholders. In this case, Opco will be entitled to the CDA credit and will use the funds for buyout purposes as specified in the agreement. That said, as demonstrated in a recent Tax Court decision, Gestion M-A Roy and 4452712 Canada Inc. v. The King (the “Gestion case”), complications can arise under this structure when Opco directly pays (or reimburses Holdco) for the insurance premiums on policies that are owned by Holdco.

Facts Of The Gestion Case

The Gestion case involved the tax assessment of two different holding companies (“Gestion Roy” and “445 Canada”). Mr. Roy was the controlling shareholder of both companies. Gestion Roy was the majority shareholder of an operating company (“R3D”), with 445 Canada being the majority shareholder of another related operating company (“R3D International”). As part of a shareholders’ agreement involving Mr. Roy and a large number of arm’s length employees of R3D and R3D International, Gestion Roy and 445 Canada collectively acquired six insurance policies on the life of Mr. Roy. R3D was designated as revocable beneficiary under each policy and directly paid the insurance premiums. Also, upon the subsequent surrender of those policies, the cash surrender values were paid to R3D and it declared the income arising from the disposition of those policies.

The Canada Revenue Agency (CRA) assessed Gestion Roy for a shareholder benefit under subsection 15(1) of the Income Tax Act on the basis of R3D having paid the premiums under the policies that Gestion Roy owned. Similarly, the CRA assessed a taxable benefit to 445 Canada for the premiums paid by R3D on the policies that it owned, this time using an “indirect tax benefit” provision since it was not a shareholder of R3D.

The taxpayers appealed these assessments, arguing there were valid business reasons for structuring the life insurance arrangements in this manner. The Tax Court responded that while there may be bona fide reasons for this arrangement, the real question was whether a taxable benefit had been conferred on the taxpayers.

The taxpayers also took the position that despite the holding companies owning the policies, R3D should in effect be treated as the beneficial owner of the policies, since it paid all the premiums under the policies, claimed the proceeds on their surrender, and paid the related taxes. The Tax Court did not accept this argument either, taking the view that the taxpayers were clearly on title as owners, and R3D was merely the beneficiary and could not exercise any contractual rights under the policies.

Finally, the taxpayers took the position that they did not “benefit” from this arrangement as they did not either receive any death benefits or the proceeds arising from the surrender of those policies. The Tax Court once again dismissed these arguments, noting that the taxpayers benefited as they did not have to pay the substantial premiums they were otherwise obligated to pay as owners of these policies.

The Tax Court therefore upheld the CRA’s assessment of taxable benefits to the taxpayers.

Some Observations

It is important to note that the taxpayers have appealed this case, and the Federal Court of Appeal may ultimately overturn the decision. However, based on recent CRA interpretations and the Gestion case, taxpayers should avoid establishing arrangements in which the corporate beneficiary (whether revocable or irrevocable) directly pays the insurance premiums or reimburses the owner of the policy (whether an individual or corporation) for payment of the insurance premiums. In particular, when there is a Holdco/Opco relationship, the safer route would be for Opco to pay dividends to Holdco to assist in the payment of the insurance premiums.

In addition, a number of other issues must be considered when establishing insurance as part of a Holdco/Opco arrangement, including how best to creditor protect the policy and insurance proceeds, what happens to the policy if Opco is sold, what the most tax-efficient way to pay the insurance premiums is, and how rights and interests of other shareholders will be affected by the ownership structures. Implementation of these arrangements often requires a co-ordinated approach involving the client’s tax, legal, accounting, and insurance advisors.