20 May 2011 Roundtable, 2011-0399771C6 - CDA, Innovative Installation case

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: 1) Whether Innovative Installation decision applies to a specific fact situation involving a trust.

Position: 2) No

Reasons: 3) Because of the particularity of group creditor life insurance policies, we are of the opinion that this decision is limited in its application to similar situations involving this type of insurance policy. Consequently, we do not believe that it would apply to the situation described.

CLHIA Round Table

Question 10

Innovative Installation Case

Background

The decision of the Federal Court of Appeal (the FCA) in the case of Her Majesty the Queen v. Innovative Installation Inc. (2010 FCA 285) was rendered in October, 2010. In its decision, the FCA denied the appeal by the Minister of National Revenue (the Minister) from the 2009 trial decision (2009 TCC 580) of the Tax Court of Canada (the Tax Court).

The case involved a group creditor insurance policy issued to the taxpayer's bank by the insurer under which the bank was named beneficiary. Innovative Installation Inc. (the Corporation) paid the premiums. The policy was security for a loan from the bank to the Corporation, but obtaining this insurance was not a condition of receiving the loan. On the death of the insured, who was a key shareholder of the Corporation, the bank applied the proceeds against the Corporation's loan as it was contractually obliged to do.

In its tax return for the year in question, the Corporation added the life insurance proceeds to its capital dividend account (CDA). The Minister reassessed on the basis that the Corporation did not receive the insurance proceeds, as is required by the definition of capital dividend account in subsection 89(1) of the Income Tax Act.

While acknowledging that the insurance proceeds were not directly received by the Corporation, the Tax Court found that they had been constructively received. The economic reality of the situation was that the proceeds had been used to pay off a liability of the Corporation, and that in substance this was the same result as one where the proceeds were directly received by the Corporation and then paid to the bank to repay the loan. Thus the Tax Court held that the Corporation should be permitted to add the proceeds to its CDA.

In denying the Minister's appeal, the FCA agreed with the Tax Court and essentially adopted its reasoning in allowing the Corporation a CDA credit for the insurance proceeds.

Situation

We have a question that relates to the potentially broader impact of this case:

Consider the example of three holding companies (A Co., B Co. and C Co.) that each hold one third of the shares of an operating company (Opco). Insurance is acquired on the lives of the three controlling principals, the proceeds of which would be used to fund a purchase and sale of Opco shares owned by a deceased principal's holding company.

For the sake of creditor protection and administrative simplicity, the parties decide to have the policies held by an inter vivos trust under which A Co., B Co. and C. Co. are non-discretionary beneficiaries. The trust is named beneficiary of the policies. Premiums are paid in agreed upon proportions by the three holding companies by way of contributions to the trust.

Assume that shareholder A, who controls A Co., dies. Pursuant to the trust agreement and shareholders agreement, the insurance proceeds payable on A's death are held by the trustee pending the transfer of A Co's shares of Opco to B Co. and C Co. Immediately upon completion of the transfer of the shares, the trustee distributes the insurance proceeds to A Co., in satisfaction of the purchase price payable by B Co. and C Co., as required under the parties' various agreements.

In this fact situation, the insurance proceeds are not received directly by B Co. and C Co., but are in fact paid on their behalf by the trust to A Co., the vendor under the purchase and sale transactions.

Questions:

Does the CRA agree that, in accordance with the Innovative Installation case, the proceeds were received by B Co. and C. Co., and applied towards their obligation to purchase shares owned by A Co. under the various agreements? Does the CRA also agree that B Co. and C Co. should receive CDA credits equal to their respective portions of the proceeds of the insurance death benefit less their respective portions of the policy's adjusted cost basis?

CRA Answer:

In our view, the Innovative Installation decision did not extend the concept of constructive receipt or create a new, broader meaning of the word "received", under which a taxpayer could be considered as having received an amount to which he is not otherwise entitled under the terms of a life insurance policy. More specifically, in that case, the judge concluded that the proceeds of the policy had been constructively received by Innovative Installation Inc. since the bank was contractually bound by the terms of the group creditor life insurance policy to credit the taxpayer by discharging the balance of the loan.

Because of the particularity of group creditor life insurance policies, we are of the opinion that this decision is limited in its application to similar situations involving this type of insurance policy. Consequently, we do not believe that it would apply to the situation described above.

Catherine Ayotte
(613) 957-8962
May 20, 2011
2011-039977