CORPORATE OWNED LIFE INSURANCE — PROBATE TAX ISSUES?

The tax rules governing the valuation of corporate-owned life insurance, for purposes
of determining the fair market value (FMV) of private company shares on a shareholder’s death¹,
are well established. Subsection 70(5.3) of the Income Tax Act (the Act) provides that in valuing the shares ofthe corporation, the FMV of any corporate-owned life insurance on the life of that shareholder (or thelife of certain non-arm’s length persons) is deemed to be the cash surrender value (CSV) of the policy immediately before death.

For example, assume Ms. A owns all the shares in Opco. Opco owns a $1-million life insurance policy
on Ms. A’s life. Ms. A passes away and at that time the CSV of the policy on her life is $50,000. In
determining the FMV of her shares for purposes of the deemed disposition rules on death, only the
policy’s CSV ($50,000) should be considered. In other words, the death benefit payable under the policy
is not relevant in determining the FMV of Ms. A’s shares in Opco.

The Canada Revenue Agency has also indicated that the terms of a buy-sell agreement that determine the
value of shares on the death of a shareholder may displace the rule in subsection 70(5.3) and govern
share value on death. For example, if an agreement specifies a valuation formula for determining
the purchase price of shares on the death of a shareholder, the value determined by that formula
could govern the determination of the FMV of the deceased’s shares for purposes of the Act.²

Determination of Probate Fees/Taxes

It might be assumed that a similar approach to valuing corporate-owned life insurance would be
taken in determining the FMV of shares in a private corporation for probate tax purposes.³

That is, only the CSV of a corporate-owned policy on the shareholder’s life would be relevant in determining
the value of shares in that corporation for probate tax purposes. However, a recent court action in Ontario
signals that this assumption may not necessarily apply in the probate context.⁴

The facts leading up to the Crichton court action are as follows: Mr. Greaves was the sole shareholder
of three private corporations that were the owners and beneficiaries of life insurance policies insuring
his life. Mr. Greaves passed away and the shares of these three corporations became part of his estate.
The estate trustees applied for and were granted probate.⁵

Estate administration tax was paid based on the estimated value of the estate, including the
shares in the three private corporations. However, in determining the value of the shares, the insurance
proceeds payable to the corporations were not included. The estate trustees also provided an
undertaking confirming they would file a sworn statement of the actual value of the estate once
it was determined and pay any additional estate administration taxes.

There was a question of whether the value of the life insurance policies should increase the FMV of the
three corporations for probate tax purposes, which would result in higher estate administration taxes
payable by the estate. The Ministry of Finance (the Minister) offered to provide the estate trustees with an
advanced tax ruling on this issue. However, this offer was declined and instead the estate trustees brought
an application to the Ontario Superior Court seeking a determination of whether life insurance proceeds
payable to private corporations should be included in the value of the shares for purposes of calculating
Ontario estate administration taxes.

The Minister opposed this motion on the basis that there is a separate mechanism for taxpayer objections
and appeals under the Estate Administration Tax Act (EATA).⁶ The Minister argued that the proper way for the estate trustees to deal with this issue would be to self-assess (that is, take a position on value)
and then wait until the Minister had assessed the tax payable by the estate. Only at this stage should
the Court be engaged in considering the estate’s appeal from such an assessment. The estate trustees
challenged the Minister’s position on the basis that the Court has an inherent jurisdiction to deal with
functional gaps in legislation, such as in this present case where there has been no assessment, objection,
or appeal that would engage the legislated objection/appeal procedures.

CALU Request for Interpretation

Upon learning about this issue earlier in 2021, and prior to the release of this court decision, CALU had
written to the Minister seeking its views on whether an insurance death benefit received by a corporation
on the death of a shareholder should be included in valuing the deceased’s shares for purposes of the
estate administration tax.

CALU also asked the Minister to consider the situation where there is a buy-sell agreement that is triggered
by the death of a shareholder, and there is a formula in the agreement for determining the value of the
deceased’s shares. We requested the Minister’s views on whether the share value calculated by such a formula would be determinative of the value of the deceased’s shares for estate administration tax purposes.

The Minister has now responded to CALU’s request for an interpretation. The Minister indicated that it
was not the government’s policy to provide a binding interpretation regarding an unidentified client or
situation. However, it was prepared to provide some general information that might be of assistance in
understanding the administration of the EATA.

The Minister’s response went on to state that the estate administration tax is payable on the value
of the estate of a deceased if an estate certificate is applied for. Value of the estate means the value of all
assets belonging to the deceased at the time of death, and not just assets for which probate is required.
In the situation where the deceased owned shares in a corporation at the time of death, the value of
those shares will need to be included in the value of the estate. The FMV of the shares needs to be determined by the estate representative (and their accountant) and documentation evidencing the value produced if requested by the Minister.

Some clarification is required in relation to the Minister’s response to CALU’s request for an
interpretation, as it may appear to suggest that all assets owned by the deceased must be included in the
value of the estate for estate tax purposes. However, Ontario specifically recognizes the use of secondary
wills.⁷ Certain types of property that don’t require probate to be administered⁸ by the executors are
typically included in a secondary will. The secondary will does not require probate and therefore no estate taxes are payable on property included in it._⁹

Conclusions

Neither the court decision in Crichton nor the Minister’s response to CALU’s request for an
interpretation provide any certainty relating to the issue of the valuation of corporate-owned
life insurance in determining Ontario estate administration taxes. There is also the broader
question of whether similar interpretive issues could arise in other high probate tax jurisdictions such as
British Columbia and Nova Scotia. As noted above, one way to avoid this issue in British Columbia
and Ontario would be to have a secondary will governing the corporate shares, which does not
require probate or the payment of estate taxes on the value of the corporate shares. Having a
buy-sell agreement between the shareholders that specifies the FMV of a deceased’s shares may also
be determinative of the value of those shares for Ontario estate tax purposes. The FMV of fixed
value preference shares (such as those issued under an estate freeze) would also not be influenced by
future growth in the value of corporate assets resulting from the receipt of life insurance proceeds.

This issue will continue to be monitored. In the meantime, the potential for increased estate taxes
should be considered by Ontario clients and their professional advisors when contemplating the
purchase of corporate-owned life insurance. ©

Kevin Wark, LLB, CLU, TEP, is a tax advisor for CALU. He can be reached at kevin.wark@calu.com. Reprinted with
permission from CALU.

1 As required under subsection 70(5).
2 Refer to paragraphs 17-31 of Information Circular IC 89-3
dated August 25, 1989.
3 Ontario levies an estate administration tax that is generally
equal to 1.5% of the value of estate assets above a very low
threshold.
4 Crichton v. Ontario (Minister of Finance) 2021 ONSC 8012.
Herein referred to as “Crichton”.
5 In Ontario this is referred to as a Certificate of Appointment
of Estate Trustees with a Will.
6 S.O. 1998, C. 34. Section 4.6(2) of the EATA incorporates by
reference the appeals process under the Ontario Retail Sales
Tax Act, R.S.O 1980, c. R.31.
7 The other province is British Columbia.
8 The secondary will would typically include the testator’s
personal property and shares of a private corporation.
9 https://www.ontario.ca/page/estate-administration-tax.
In circumstances where there is an Ontario estate with
a secondary will, the estate executors would apply for a
Certificate of Appointment of Estate Trustee with a Will
Limited to the Assets Referred to in the Will. Only assets
included in that specific will be included in the value of the
estate.