The Income Tax Act1 considers the income earned through a private corporation in the same framework as income earned directly by an individual. To this end, the Act provides that private corporation can pay out non-taxable dividends to its shareholders from its capital dividend account (“CDA”) in order to take into consideration non-taxable amounts realized by it. The life insurance proceeds received by a corporation constitute one of the elements to be included in calculating the CDA. However, Tax authorities have held the view that life insurance proceeds used to repay a creditor cannot be included in the calculation of the CDA and cannot therefore contribute to the payment of tax-free dividends.
Recently, in Innovative Installation Inc. v. R. 2, the Tax Court of Canada rejected this position.
In this case, the appellant, Innovative Installation Inc., borrowed $220,000 from the Royal Bank of Canada (“RBC”). Solely to ensure its financial security and not to meet a prerequisite to obtaining the loan, the corporation acquired insurance from Sun Life Financial on the life of its founder and committed to use that insurance to repay the loan to RBC in the event of his death. The founder did unfortunately die and the insurance proceeds were used to repay the loan from RBC. The appellant included the death benefits in calculating its CDA and elected to declare a $160,000 capital dividend. The Minister assessed the corporation on the basis that the dividend was in excess of the balance of its CDA by an amount of $160,000. In their opinion, the corporation mistakenly included death benefits in calculating its CDA, because, as it is not a beneficiary under the policy, it did not “receive” the death benefits within the meaning of the definition of “capital dividend account” as provided in paragraph 89(1)(d) ITA. The Minister referred to Interpretation Bulletins IT-66R6 and IT-430R3 to argue that the corporation did not receive the insurance proceeds as beneficiary and to affirm that RBC is the real beneficiary under de policy.
The Court needed to determine whether or not there is an obligation by a corporation to be the beneficiary of a life-insurance policy in order to add the proceeds to a CDA and whether or not paying the proceeds directly to the creditor would prevent a corporation from adding the payment to the calculation of its CDA. The court stated that there is no need to be the beneficiary. In its analysis it referred to the terms of the Act and determined that it is unnecessary to go beyond them when they are not ambiguous. The Act requires that the corporation “receives” the proceeds of the life-insurance policy but does not require that the corporation be the beneficiary for the purposes of calculating its CDA. The court also specified that the term “received” does not require the proceeds to be paid directly to the corporation. As this payment was used to pay its debt, it is clearly the company that benefited from the payment of the proceeds.
Therefore, the Court concluded that the corporation legally included the death benefits in the calculation of its CDA and rejected the arguments of the Minister.
This case constitutes an example among others that have been brought before the courts and that have had significant impact on our tax law, which is in constant evolution.