Holding Property in a Corporation and the Contract

An investor has built a portfolio inside a corporation. The properties are there, the mortgages are there, the rent arrives there. The question of where a participating contract should sit arrives with the first proposal, and it is usually answered by whoever is selling the contract. The proposal arrives with the ownership box already filled in more often than not. Nothing about the decision is urgent, and that is precisely why it gets made by default.

It should not be. This page sets out what each choice does, what it costs, and which parts of the question belong to an accountant and not to an insurance professional. It reaches no conclusion, because a conclusion would have to be invented. A conclusion invented on a website is worth nothing against your own filings. Everything below is a list of what to ask and not a list of what to do.

What are the two arrangements?

The corporation owns the contract, or the shareholder does. Two arrangements, and the difference between them is structural and not cosmetic. Everything else on this page follows from which of the two is chosen, and the choice is made once.

Where the corporation owns it, the corporation is the policyowner, pays the premium, holds the accumulated value on its balance sheet, and is normally the beneficiary. The lives insured are usually the shareholders, and the contract becomes a corporate asset like any other. Everything the corporation owns behaves like a corporate asset, including this. The premium leaves the corporation and the value stays inside it.

Where the shareholder owns it, the individual is the policyowner, pays the premium from personal after tax income, holds the accumulated value personally, and names a personal beneficiary. The corporation is not a party to it at all. Nothing crosses between the two, which is the point of the personal version. A personally owned contract is invisible to the corporation's balance sheet and to anyone reading it.

There is a third arrangement that comes up and needs a lawyer and not a website: shared ownership, where the corporation and the shareholder each own a defined interest in the same contract. It exists, it is used, and it is complicated enough that no general description of it is useful. It is mentioned here only so that nobody thinks it was omitted.

What matters for this page is that the first two are genuinely different arrangements with different consequences, and that both are legitimate. Neither is a trick and neither is the default.

What does corporate ownership do?

Four things, and only the first is usually mentioned. Three of the four are rarely raised at the proposal stage.

It funds the premium with corporate dollars. Money inside a corporation has been taxed at the corporate rate and not at your personal rate, so fewer dollars of pre-tax income are consumed to produce the same premium. For an owner whose income comes from the corporation, this is a material difference and it is the argument that leads every presentation. The saving is real and it is not the whole of the comparison. Fewer pre-tax dollars for the same premium is a genuine advantage in a corporation that retains earnings. The size of the advantage depends on the gap between the two rates, and that gap moves with policy.

It credits the capital dividend account on death. When a corporation receives a death benefit on a policy it owns, the amount exceeding the contract's adjusted cost basis is credited to the capital dividend account under section 89(1), and can generally be distributed to shareholders as a capital dividend. That is the mechanism that makes corporate ownership work for estate purposes. That single mechanism carries most of the case for corporate ownership.

It puts the accumulated value on the balance sheet. A lender reviewing the corporation sees it. So does a purchaser reviewing the shares. That visibility is occasionally helpful and occasionally not. Visibility cuts both ways, and which way depends on who is looking.

And it exposes the value to corporate creditors. A contract owned by the corporation is an asset of the corporation, and an asset of the corporation is available to the corporation's creditors in the ordinary way. Creditor exposure is a fact of corporate ownership and not a feature of insurance. Nothing in the contract changes that; it is what corporate ownership means.

What does personal ownership do?

The mirror of the above, with one addition. The mirror is exact, which makes the comparison easier than it first looks.

The premium is paid with personal after tax dollars, which for an owner drawing income from a corporation means more pre-tax income consumed. That is the cost and it is the whole of the cost on the funding side. More pre-tax income for the same premium, and that is the entire cost. For an owner who draws a salary anyway, the difference is smaller than it first appears. An owner drawing a full salary already pays personal tax on that income before the premium is written.

The accumulated value sits outside the corporation. It is not on the balance sheet, a purchaser of the shares does not see it, nor available to the corporation's creditors. The protection of personal assets from a creditor is a separate question, governed by provincial law and the identity of the beneficiary, and it is a question for a lawyer and not an assumption. Protection from creditors is a legal question with a provincial answer. Designating a beneficiary correctly is a legal step with provincial rules behind it.

The death benefit is generally received tax free by a named beneficiary and passes outside the estate. No capital dividend account, no election, no filing, no waiting for a corporate distribution. Simplicity has a value that is easy to underrate until an estate is being administered. An estate settled without an election is an estate settled faster. Beneficiaries receive money and not a process.

And nothing about the contract complicates a future share sale, which is the addition, and which leads to the next section.

What does the passive income rule do?

It reduces the small business deduction as passive investment income rises, and it is the reason this question is not purely about insurance. This is the part of the question that has nothing to do with insurance at all.

Section 125(5.1) of the Income Tax Act reduces a corporation's business limit where its adjusted aggregate investment income exceeds a threshold. A corporation carrying on an active business and also holding investments can therefore find that the investments cost it access to the small business rate on its active income. The threshold and the mechanics are set out in the provision itself. Nothing about this calculation is discretionary; it falls out of the return.

Two consequences follow for a landlord. Rental income earned in a corporation is generally passive and not active, which is the starting point. And accumulating assets inside a corporation, whatever form they take, can have an effect on this calculation that has nothing to do with insurance. Both consequences are arithmetic and not opinion. A corporation holding only rental property sits in a different place from one that also trades. An operating company that also holds buildings carries both sets of consequences at once.

Where a corporation holds rental property and no active business, the calculation is different from one where an operating company also holds property. Which of those you have, and what the numbers do, is a question with an exact answer that a CPA produces from your own filings. Nothing on this page substitutes for that. Your own filings answer this in an afternoon. Two hours of a CPA's time settles it for the year.

What does a share sale change?

It raises the lifetime capital gains exemption question, and passive assets are what decide it. The exemption is the largest number in many owners' plans, and it is conditional.

The exemption applies to the disposition of qualified small business corporation shares, and qualification depends on tests about the proportion of the corporation's assets used in an active business, measured at the time of sale and over the preceding period. Assets that are not used in an active business count against those tests. The tests are technical and they are applied to facts and not intentions. Qualification is measured over a period and not on a single day. Time in that state is what qualification is measured over, so a late correction may not correct anything.

A corporation holding a large accumulated value, or a large amount of anything passive, can therefore fail to qualify when the owner comes to sell. The remedy is usually planning done years in advance and not a transaction done at the last minute, which is why this belongs in the conversation at issue. Planning done in year three is worth more than planning done in year ten. The remedy is almost always a sequence started early and not a transaction done late.

For an investor whose corporation holds only rental property, the exemption may not have been available in any case, and the point is less sharp. For an investor whose corporation carries an active business alongside the properties, it can be the single most valuable item in the plan. Knowing which you are is the first question. The first question is the cheapest one to answer and the one most often skipped. Owners who do not know which case they are in should find out before anything else.

How does a lender read a corporate contract?

As an asset with a value and a claim attached to it. Lenders are not impressed or alarmed by a contract; they price it.

A lender reviewing a corporation's financial statements sees the accumulated value as an asset. Depending on the lender and the file, that can support an application, and it can also raise questions about why capital is sitting in a contract and not in the business or the properties. Questions from a lender are better answered before they are asked. Two lenders can look at the same statement and reach different conclusions. Ask the question of your own lender and not of a general description of lenders.

A lender can also take an assignment of the policy as collateral for a corporate loan, which is an ordinary arrangement. That assignment is a legal step with consequences for the beneficiary designation and for what the corporation can do with the contract while the loan is outstanding, and it is read before signing and not after. An assignment changes what you can do with your own contract. An assignment is a contract with a lender, and it is read the same way any contract is read.

The practical instruction is the same one this section gives everywhere. Tell the lender what is in the file before they find it, and ask how they treat it. The answers vary by institution and a general answer is worse than no answer.

What should be settled before a proposal is signed?

Five questions, and none of them is an insurance question. Five questions, and every one of them is about your business and not about a product.

How you take income from the corporation, salary, dividends or a mix, because that decides how much a personal premium actually costs you in pre-tax terms. Salary and dividends are taxed differently in your hands, and the difference is the real cost of a personal premium.

The presence of an active business alongside the properties, because that decides whether the passive income rule and the exemption question matter at all. An operating company and a holding company face different questions here.

What the exit plan is: a share sale, an asset sale, a transfer to family, or holding until death. Each produces a different answer and the plan is allowed to change, so the question is what you believe today. Plans change, and the current one is still the right input. Writing the current plan down is what makes it possible to notice when it has changed.

Who your creditors could be, and how you feel about the value being reachable by them. Creditor exposure is a matter of fact and not of feeling, but the tolerance is yours.

And what the family arrangement is: who the beneficiary should be, whether other shareholders are involved, and whether a shareholders' agreement exists that already says something about insurance. An existing shareholders' agreement may already have answered part of this.

Bring the five to an accountant, with the corporation's last two years of statements, before an application is signed. Ownership set correctly at issue costs nothing. Ownership corrected later is a transfer, and a transfer is a disposition. An hour with an accountant, once, and the decision is settled for the life of the contract.

What does the general treatment look like elsewhere on this site?

The corporate ownership question is not unique to landlords, and the general treatment of a corporately owned contract sits with the business owners section, which deals with an operating business and not a property portfolio. What this page adds is the landlord's version of it: rental income is generally passive, the assets are real property and not receivables and equipment, and the exit is often a property sale and not a share sale.

Those differences change the emphasis and not the mechanics. The capital dividend account works the same way. The transfer rules work the same way. The passive income calculation works the same way and lands differently because the income is different. Same rules, different facts, different weight. Reading both pages together gives the whole picture and not half of it.

An investor reading both pages gets the mechanism from one and the application from the other, which is how the two are meant to be used. One page gives the mechanism and the other gives the application.

Who this applies to

Any investor whose properties sit in a corporation and who is being offered a participating contract, which is an increasingly common combination. Corporate landlords are more common each year and the question follows them.

It applies with the most force to an investor whose corporation also carries an active business, because the passive income rule and the exemption question both bite there and neither is obvious from inside. Neither issue is visible from inside the business without someone checking. An accountant sees this combination often and can price the effect quickly.

It applies to an investor planning to sell the corporation and not the properties, since that plan is the one most affected by what accumulates inside. What accumulates inside is what a purchaser is buying. A share sale magnifies every decision made inside the corporation over the preceding years.

It applies less to an investor holding properties personally, for whom the question does not arise, and less to an investor who has already had this conversation with a CPA and holds a written recommendation. Anyone in the second group should check that the recommendation is still current, because the rules in this area have moved more than once. For a personal holder the question simply does not arise. For a personal holder the question simply does not arise, and that simplicity is worth something.

The arrangement as a whole is described on the real estate investors page, and what the contract does at death is set out in the tax at death on a rental portfolio.