What a Corporate Contract Leaves on the Balance Sheet

A key person contract leaves the company one of two things while everyone is alive. A term policy of the kind used for a temporary exposure leaves nothing: it has no cash surrender value, so there is no policy value to reach, borrow against or sell. A participating whole life contract leaves a cash surrender value, which belongs to the corporation as an asset. Part of it is guaranteed by the contract, and part comes from dividends the insurer has already paid. The company can reach it by a policy loan, by a loan from an outside lender that takes the policy as security, or by surrender, and each route has a cost and a tax result. How the value appears on the financial statements is the accountant's decision.

The general view here is that term life insurance is the first comparison to make for a key person exposure that has an amount and an end date, and that a participating contract has to earn its higher early premium on a purpose of its own. That is a general view, not a recommendation for any company, which needs that company's figures, its lender's documents and its shareholders agreement. This practice holds an insurance licence and gives no tax, accounting or legal advice: the accountant measures, and a lawyer (in Quebec, a lawyer or notary) drafts. The wider framework for incorporated owners is in the business owners section.

What does key person coverage do, and what can it not do?

Key person coverage is life insurance that a company buys on someone whose death would cost the business money. The company applies, pays the premium and is named as beneficiary. When the person insured dies, the insurer pays the death benefit to the company, at the moment the company may find it hardest to raise money any other way.

It does not replace the person. Money does not by itself shorten the search for someone who can do the work, or transfer the judgement and relationships that person built. Customers who dealt with one person may leave before a replacement is hired, and a lender comfortable with one signature may become less comfortable, whatever cash the company now holds. Coverage pays for time. It does not create any.

Key person coverage is a financing answer to a business problem. The problem itself shrinks with written processes, a second person who knows the accounts, and customer relationships held by the company. An owner who does that work first may find the coverage needed is smaller than the coverage first presented.

Who owns, who pays, who is insured and who receives?

Four roles sit in every key person file, and the tax result follows from how they line up. Write them down before anything else.

Variations exist: a related company can own or receive, a shareholder can own a policy the company pays for, and two parties can share one contract under a written agreement. Each variation changes the tax result, and some create a taxable benefit, as the sections below explain. Which entity should own, pay and receive is for the company's accountant and lawyer to decide together; corporate-owned life insurance sets out the options without ranking them.

What makes someone a key person?

A key person is someone whose absence would measurably damage revenue, financing or continuity, in a way the company could show to a lender or an auditor. Seniority, title and long service answer a different question. Three questions separate the real cases from the assumed ones.

1. Would the company lose revenue that will not come back on its own if this person were gone on Monday?
2. Does a loan agreement, a supply agreement or a customer contract name this person or depend on them?
3. Would the company have to hire, and how long would a competent replacement take to become productive?

A company that can answer with figures has found a key person. A company that cannot has found a valued colleague, and the money may do more good spent on retention or succession. The answers also fix the size of the coverage and the period it is needed: a production manager whose loss would disrupt eighteen months of margin and a founder who holds every major customer are key in different amounts and for different periods.

The label is easy to apply loosely, although the insurer still tests the amount at underwriting and may reduce or decline it. Two pressures push toward more coverage than the figures support. A larger amount enlarges the sale, and this practice is paid by the insurer when a contract is issued, so ask any advisor how they are paid. And an owner may find it awkward to tell a long-serving colleague that the business carries no financial exposure to their absence. The correction is to write each proposed name beside the amount the company would lose and the months over which it would lose it.

How do you size the need?

Size it from the losses, not from a multiple of salary. Then expect the insurer to test the result against its own financial underwriting rules, which can cap the amount it will issue. The worksheet below names each input, where it comes from and the order in which the inputs are combined.

Illustrative example. The figures are assumptions for the arithmetic, not a forecast for any company. Suppose your business would lose $25,000 of contribution margin a month for 8 months, which is $200,000. It would spend $45,000 recruiting and training a replacement. It has a $180,000 loan the lender could call. And it would lose a further $15,000 a month of margin for 4 months after month 8, as personal relationships move or disappear, which is $60,000. Step 4 counts only months 9 to 12, so there is no overlap to subtract. The total need is $485,000. Assume the loan, the largest single item, is scheduled to be repaid over six years, and the replacement is productive well inside that time. The need then falls as the years pass.

The amount is what the coverage should pay, and the horizon is how long the company needs it. A need that declines over six years has a different shape from one that lasts as long as the founder lives, and the shape tells you which coverage to compare first. A lender may also require a minimum amount as a loan condition; check that in the credit agreement separately, because it is the lender's rule.

Who has to take part before a company can insure someone?

The person insured answers the application's questions, may take a medical, and signs. The law also requires a reason to insure another person's life. In Quebec, the Civil Code requires that the policyholder have an insurable interest in that life when the contract is made, or that the person insured consent in writing (art. 2418), and art. 2419 lists who has an insurable interest. Outside Quebec, each province's insurance act sets its own rule on insurable interest and consent. Keep the signed consent with the policy.

Underwriting raises a question of disclosure, and the first rule protects the person insured. Under the federal Genetic Non-Discrimination Act, no one may require a person to take a genetic test, or to disclose the results of one, as a condition of entering into a contract. Beyond that protection, the person insured must answer truthfully. In Quebec, art. 2408 requires the disclosure of every fact known that is likely to materially influence the insurer, not only the facts the printed questions ask about. A misrepresentation can put the coverage at risk.

Two beneficiary points matter in a key person file. If the key person is an employee who holds no shares and the company pays for coverage whose proceeds go to that person's family, our reading is that the tax question becomes a benefit from employment under paragraph 6(1)(a) of the Income Tax Act, not a shareholder benefit. And in Quebec, designating a married or civil union spouse as beneficiary in a writing other than a will, such as the application, is irrevocable unless the designation says otherwise (art. 2449). An irrevocable designation limits what the owner can later change without that spouse's consent.

Why is term life insurance the first comparison for a temporary exposure?

Because an amount over a defined period is the shape term life insurance was built for. A level term policy is designed to cost less in its early years than a participating contract with the same death benefit, because it builds no cash value; matched quotes for your file show by how much. The difference stays in the business, working on payroll, on equipment and on the debt the coverage was bought to protect.

Term also follows the way the exposure behaves. A ten year policy on a production manager ends around the time a successor is trained, and a policy written to the maturity of a credit facility ends when the covenant does. The company stops paying when the exposure stops.

The comparison has limits. Renewing term after its first period can cost far more than the original premium, so a need that outlasts the term costs more than the first quote suggests. Some term contracts carry a conversion privilege, which lets the owner exchange the term for permanent coverage without new medical evidence, depending on the contract and before its deadline; read it at the application. Some participating designs have a limited payment period, which changes the yearly comparison once the payments end. The fair test runs over the whole period the company actually needs, with quotes for the same person insured, the same underwriting class and the same death benefit.

What does a participating contract leave on the balance sheet?

It leaves an asset, and four different figures describe it. Keep them apart, because each one answers a different question.

A term policy has none of these figures. It carries no cash surrender value, so there is no policy value to reach or borrow against. A participating contract with a cash surrender value is an asset whose presentation the company's accountant decides under the standard the company reports under: Accounting Standards for Private Enterprises (ASPE) or International Financial Reporting Standards (IFRS). Under ASPE, the accountant applies the accounting guideline on life insurance contracts with cash surrender value, known as AcG-21. How that guideline measures the asset, and what passes through the income statement each year, is the accountant's work.

Ask the accountant three things before the application: how the policy will be carried, what the yearly entries will look like in the early years, and how a policy loan will be shown. A lender and a buyer will ask too.

Which part of the value is guaranteed?

Part of a participating contract's cash surrender value is guaranteed by the contract, and part is not. The guaranteed cash value schedule, printed in the contract, shows the minimum the insurer must pay on surrender at each policy year if every premium is paid. On top of that, the insurer may declare policy dividends each year. Dividends are not guaranteed, and they can go down.

What happens to a dividend depends on the option the owner chose. Under the paid-up additions option, each dividend buys a small amount of additional paid-up insurance with its own cash value. Once bought, those additions form part of the contract on its terms; it is future dividends that remain uncertain. Other options pay the dividend in cash, apply it to the premium, or leave it with the insurer to accumulate at interest, and each choice changes the values that follow.

Two warnings belong here. An illustration built on the current dividend scale is a projection, not a promise: ask for the guaranteed column, and for the same illustration on a lower scale. And the dividend scale interest rate an insurer publishes is one input to its dividend formula, not the return the corporation earns on its premiums.

How does the company reach the value, and what does each route cost?

There are three routes. Each has a different lender, a different party owed interest and a different tax result.

The policy loan. Under subsection 148(9) of the Income Tax Act, a policy loan is a disposition of an interest in the policy. Subsection 148(1) includes in the corporation's income only the part of the advance above the adjusted cost basis immediately before it, and the loan reduces the basis. The adjusted cost basis is a running total the Act keeps for the policy: premiums add to it, and the net cost of pure insurance, policy loans and withdrawals reduce it. Unpaid interest is added to the balance, depending on the contract, so the debt grows if nothing is paid. Repaying the loan restores the basis within limits, and it can give a deduction under paragraph 60(s) in the year of repayment, limited to amounts previously included in income. Repayment restores borrowing room. It does not reverse tax already reported on the advance.

Illustrative example. Suppose the adjusted cost basis immediately before a $50,000 policy loan is $40,000. The corporation includes $10,000 in income for that year, and the basis after the loan is nil. The corporation owes the insurer $50,000 plus interest at the insurer's rate. These figures are assumptions for the arithmetic; the insurer reports the actual basis and the taxable part.

If the contract ends with a loan outstanding. On a surrender or a lapse, the proceeds for tax are the cash surrender value less the loans owing, and income arises only to the extent those proceeds exceed the basis. The small cheque left after the loan is settled is not the figure that decides the tax. Before surrendering, ask the insurer in writing for the proceeds, the loan settlement, the basis and the expected tax slip, and have the accountant review them. When the loan comes close to the value securing it, check more often than once a year.

The money stays in the corporation. Moving it to a shareholder is a second transaction, such as salary, a dividend or the repayment of a shareholder loan, with its own tax. The shareholder loan and the policy loan covers that step, and how policy loans work covers the mechanics. Interest the corporation pays is deductible only when the borrowed money is used to earn business or property income, and money borrowed to acquire a life insurance policy is excluded. Policy loan interest counts only as the insurer confirms it on CRA Form T2210.

What does the living value cost, and what else could the money do?

The living value costs the premium difference between the participating contract and term coverage for the same death benefit, in after-tax corporate dollars, for as long as the participating premium runs. A participating design is expected to cost more in its early years; how much more comes only from matched quotes for your file, so the worksheet uses letters.

1. T is the yearly term premium for the death benefit the exposure needs, over the period it lasts, including any renewal premiums.
2. P is the yearly participating premium for the same death benefit, over its payment period.
3. P minus T, in each year, is what the living value costs that year in after-tax corporate dollars.
4. Against that, set the guaranteed cash surrender value at each year, and separately the illustrated value, which is not guaranteed.
5. Last, set the same yearly difference spent on the other use the company would otherwise make of the money, priced by the accountant over the same years.

That last line is where the decision is made. The difference could repay corporate debt, fund working capital, buy equipment, or sit in a corporate investment account, and each use has its own tax treatment:

• A corporate investment account is taxed on income as it is earned. A gain is taxed when it is realised, not before. Part of the corporate tax on investment income can be refunded when the corporation pays taxable dividends.
• The small business deduction lowers the tax on active business income up to the business limit. The CRA's T2 guide (page modified 28 May 2026) says the limit shrinks when the corporation and its associated corporations earn $50,000 to $150,000 of passive income, and it is nil above $150,000. The measure is adjusted aggregate investment income, under subsection 125(5.1) of the Income Tax Act. Provinces do not all follow this rule, so the accountant checks yours; retained earnings and the passive income rule explains it.
• In Quebec, Revenu Québec runs its own small business deduction. Its note of 4 May 2026 says the reduction based on hours paid to employees stays in place.
• Income from one person's services, earned through a corporation, can fall under the personal services business rules. Those rules change the whole calculation.
• While a policy stays exempt under section 306 of the Income Tax Regulations, growth inside it is not taxed each year. On our reading, that growth does not add to adjusted aggregate investment income, but a loan, withdrawal or surrender that creates income can. A policy that stops being exempt is deemed disposed of under paragraph 148(2)(d).

None of those rules settles the choice; they describe where each dollar is taxed. A participating contract is life insurance first, bought for its coverage, and its living value is worth paying for only where the company has a purpose for permanent coverage of its own. Ask the accountant to price the uses side by side over the same horizon, in after-tax corporate dollars.

What happens in the early years if the company stops paying?

The early years are where a participating contract is least forgiving. The guaranteed cash value schedule starts low and rises over time, and the schedule printed in the contract shows how low, year by year. A company that surrenders early can get back less than it paid in. That is why a policy should never be bought with money the business will need back soon. A near-term need (a purchase next year, a loan payment, a slow season) belongs in cash or a credit facility, not in a life insurance contract.

If premiums stop, the contract decides what happens. Depending on the policy, the options can include:

• an automatic premium loan, which the insurer advances against the policy to pay the premium, with interest owed to the insurer;
• using dividends toward the premium, where the contract and the dividend option allow it;
• a reduced paid-up policy, with a smaller death benefit and no further premiums;
• surrender, which ends the coverage and can create income to the extent the proceeds exceed the adjusted cost basis.

Ask for each option in writing before applying, with its effect on the death benefit and the cash surrender value at years 1, 3, 5 and 10, and do not count on illustrated dividends to meet a required premium.

Should one contract be sized for both purposes?

Calculate the two needs separately first, then decide the design. The key person need comes from the worksheet above: an amount and a horizon. A permanent need, if the company has one, comes from a different question: how much surplus the company can commit each year, for how many years, without straining working capital, and what permanent death benefit it actually wants. That purpose might be funding a shareholders agreement, paying tax at a shareholder's death, or another reason the company can write down in one paragraph.

With both numbers on paper, ask the insurer for comparable illustrations of two designs: separate policies (term for the key person need, a participating contract for the permanent need) and a single contract designed to meet both. Compare the premiums, the guaranteed values, the death benefit through the key person horizon, and what happens if payments stop. Neither design wins automatically. The design to avoid is a single contract sized by neither calculation, overinsured on one measure and short on the other.

Whatever the design, keep a short memorandum with the policy naming what it is for, prepared with the accountant at the application. A contract described as key person coverage but funded as a capital arrangement raises questions at an audit and in diligence on a sale, and that paragraph answers them.

When does the arrangement create a shareholder or employee benefit?

A benefit question arises when the corporation pays for coverage that benefits a shareholder personally instead of the corporation. The plain case is a corporate-paid policy whose beneficiary is the shareholder's spouse, estate or another person the shareholder chooses, or a policy transferred to a shareholder for less than its value. The Canada Revenue Agency can then include the benefit in the shareholder's income under subsection 15(1) of the Income Tax Act, and the corporation deducts nothing. Writing the arrangement down does not remove the benefit. Being the insured shareholder does not, by itself, create one.

Where the corporation owns the policy, pays the premium and is the beneficiary, when the corporation pays and the shareholder owns explains why no benefit arises, and it walks through the other positions. Two more points carry a cost. Proceeds paid to a spouse are not received by the corporation, so no capital dividend account credit arises. And a related company named as beneficiary of a policy the operating company pays for can raise its own benefit question, which the accountant answers on the actual designations. The difference between key person coverage and coverage that funds a shareholders agreement is set out in key person coverage compared with shareholder coverage.

Settle three things in writing before the application is signed. First, who owns, who pays and who is beneficiary, confirmed by the accountant against subsection 15(1) on the facts as they stand. Second, what the contract is for, in one paragraph kept with the policy. Third, what happens to the contract if the person insured leaves, is bought out, or the company is reorganised; that belongs in the shareholders agreement, drafted by a lawyer (in Quebec, a lawyer or notary).

How does the choice affect the capital dividend account?

The capital dividend account is a notional tax account that a private corporation keeps. When the corporation receives life insurance proceeds because of a death, paragraph (d) of the definition in subsection 89(1) of the Income Tax Act credits the account with the proceeds less the policy's adjusted cost basis immediately before the death. A Canadian resident shareholder does not include a capital dividend paid from the account in income, once the corporation files the election under subsection 83(2) at or before the time the dividend becomes payable. The capital dividend account is the full reference.

The kind of policy changes the credit. A participating contract funded with larger premiums can carry a higher adjusted cost basis for years, and every dollar of basis at death is a dollar that does not reach the account. An insurer's policy loan outstanding at death is deducted from the death benefit, which reduces the amount the corporation receives.

Illustrative example. Assume a $500,000 death benefit received by the corporation, no policy loan and no other entries in the account. If the adjusted cost basis immediately before the death is nil on a term policy, the credit is $500,000. If the basis is $120,000 on a participating contract, the credit is $380,000, and the remaining $120,000 leaves the corporation, when it does, as an ordinary taxable distribution. The basis figures are assumptions: the insurer projects the real basis year by year, and the accountant calculates the balance on the day it matters.

The credit exists only for a private corporation. A capital dividend paid to a shareholder who lives outside Canada is subject to Canadian withholding tax under Part XIII of the Act. A Quebec corporation also elects with Revenu Québec, on form CO-502. Electing more than the account holds carries its own tax, so the accountant confirms the balance first.

Can a premium ever be deductible?

Generally not. Owning a policy through the corporation does not make the premium a business expense. The narrow exception is paragraph 20(1)(e.2) of the Income Tax Act. The CRA's archived interpretation bulletin IT-309R2 (28 February 1995, no longer updated) describes its conditions: an interest in the policy is assigned to a restricted financial institution, the lender requires the assignment as collateral for the borrowing, and the interest on the borrowing is deductible. A lender's request alone is not enough.

When the conditions are met, the deduction is the lesser of the premium and the policy's net cost of pure insurance for the year, and only the share that reasonably relates to the amount owing on the loan counts. An unused line of credit is not an amount owing. On a participating contract, the net cost of pure insurance can be well below the premium, so the deductible part can be small. Ask the accountant to read the loan documents and the insurer's figure for the net cost of pure insurance before any premium is budgeted as deductible.

What if the key person is alive but cannot work?

A key person can be lost without dying. A serious illness or a disability can take someone out of the business for months or for good, and life insurance pays nothing while the person is alive. Coverage for those risks comes in separate contracts. Disability coverage written for a business can pay a monthly amount for a limited period while the person cannot work. Critical illness coverage can pay a lump sum on the diagnosis of a condition the contract defines.

The same worksheet applies, except that the horizon is the period of absence, and the person may come back. The definitions decide everything: what counts as unable to work, the waiting period, how long payments continue, and which conditions qualify. Ask for them in writing before you compare premiums. A long disability can also trigger a buyout under the shareholders agreement, which needs its own funding.

What do a lender and a buyer each see?

A lender sees an asset and coverage on the person the loan depends on, and it may want the policy assigned as security. In a collateral assignment, the corporation still owns the policy. The lender holds a right to be paid from the policy's values or proceeds up to what is owed. Depending on the assignment and the contract, the insurer may require the lender's consent before paying a policy loan or a surrender to the corporation, which can limit the access the company was counting on. When the loan is repaid, the lender releases the assignment and the policy is free of it. The assignment is filed with the insurer through the process the documents set out. In Quebec, ask a Quebec notary or lawyer what security the lender's document creates and how it is released. Ask for the wording at the term sheet stage.

A buyer sees value inside the company and will ask whether it leaves with the seller. A buyer may value the policy differently from its carrying amount, depending on who is insured, whether that person stays, any loan or assignment against it, and the tax on moving it. Taking the policy out before closing is a disposition with its own tax, described in the next section. Cash value inside an operating company can also affect whether the shares meet the asset tests for the lifetime capital gains exemption, one measured at the time of sale and one across a period before it. An exit in ten years describes those tests, and the accountant runs them years ahead of an offer.

What happens when the key person leaves alive?

A key person can leave alive: by resigning, retiring, being bought out or joining a competitor. A term policy in that situation can be cancelled, and the cost stops. A participating contract becomes a decision, and each route has a tax side.

• The company can keep the contract and keep paying. The coverage then insures someone with no connection to the business, and a key person arrangement becomes a corporate capital arrangement the company may never have chosen.
• The company can surrender it. A surrender is a disposition, and under subsection 148(1) the corporation includes in income the amount by which the proceeds exceed the adjusted cost basis; with a loan outstanding, the proceeds are the cash surrender value less the loan.
• The company can transfer it to the departing person. Where the policy goes by gift, by distribution from the corporation, or to someone the corporation does not deal with at arm's length, subsection 148(7) deems the corporation to receive the greatest of the value of the interest, the fair market value of anything paid, and the adjusted cost basis. Any excess over the basis is corporate income. Separately, the person receiving it can have a taxable benefit, as a shareholder under subsection 15(1) or as an employee under paragraph 6(1)(a), measured by what the policy is worth, which can differ from its cash surrender value.

Decide the answer at the outset, write it down with the policy, and have a lawyer (in Quebec, a lawyer or notary) check it against the shareholders agreement. A decision made in advance is a choice. One made under pressure is the expensive kind.

Who this suits, and who it does not

This reasoning suits an incorporated owner who has been shown a participating contract described as key person coverage and wants the drawbacks set out before the application. It suits a company with surplus, a measured exposure and an accountant already in the file, and it applies with most force where the exposure has an end date.

It applies with less force to a company whose exposure has no end date, such as a founder whose relationships the business will depend on for as long as the founder lives. A permanent need is where permanent coverage can earn its premium on the coverage alone. It applies with less force again to a company with no surplus beyond working capital. A premium schedule the company cannot keep up can return less than it cost, and those companies can settle term coverage now and return to the question later.

It does not suit a reader who wants a participating contract presented as a way to grow corporate surplus. Participating whole life insurance is insurance, not an investment, and a corporation that funds one for a living purpose holds value that is low in the early years and can be taxed when it is reached. Those facts do not condemn the contract. They decide which companies it fits.

What should you ask, and who answers?

Each question has an owner. Bring them in this order, before anything is signed.

Answer two questions yourself before the product question. What would this company lose if the person were gone on Monday, as an amount and a number of months? And does it hold surplus it intends to keep for decades, separate from that loss? For the next decisions, see funding premiums from corporate cash flow and funding a buy-sell agreement.