Budget 2016 proposes changes for the Capital Dividend Account (CDA). In addition to the changes outlined in the recent “Changes to the Capital Dividend Account” post, there is another important change that we would like to highlight as it will affect many clients.
Background
The Capital Dividend Account is a cornerstone of effective succession and estate planning for business owners. The CDA tracks non-taxable amounts that can be distributed from the corporation to its shareholders on a tax-free basis in the form of Capital Dividends. This includes the non-taxable portion of capital gains, as well as the proceeds from a life insurance policy. In regards to insurance, the resulting credit to the CDA is equal to the death benefit proceeds less the corporation’s Adjusted Cost Base (ACB). For example, if a policy had a $1million death benefit and a $100,000 ACB, the resulting CDA credit would be $900,000 [death benefit – ACB].
Old Rules
For a number of planning reasons, it often makes sense to separate the owner and the beneficiary of a corporate-owned policy. For example, where a holding company is the owner and payor of a policy with an operating company as the beneficiary. We will often recommend this structure when structuring buy/sell agreements between corporate shareholders. Owing and funding the insurance contracts at the holdco level is useful to protect policy cash values from creditors, while also allowing each shareholder the flexibility to fund their policies at varying levels (term vs. permanent). As an added benefit, this structure also resulted in a 100% credit to the CDA of the operating company. Prior to the amendments proposed in the budget, the CDA credit received by a private corporation was only reduced by its ACB in the policy. Splitting the owner and beneficiary meant that the beneficiary had no ABC in the policy, resulting in 100% credit to the CDA.
New Rules
Under the new rules, the credit to a corporation’s CDA will be reduced by the policyowner’s ACB, regardless of who owns the policy. It’s also important to note, that where there are multiple corporate beneficiaries under a policy, the CDA credit to each corporation will be reduced by the entire ACB of the policyowner. For example, HoldCo. owns a $1million policy with a $100,000 ACB. OpCo 1 and OpCo 2 are equal beneficiaries of the policy. The resulting CDA credit for each corporation would be only $400,000 [($1,000,000 x 50%) – $100,000 ACB].