While life insurance is generally considered a personal expense and therefore not something business owners can get tax deductions on, there is a provision under the Income Tax Act that defines some exceptions.
“Paragraph 20(1)(e.2) of Canada's Income Tax Act permits a taxpayer to deduct life-insurance premiums from business income only if the expense satisfies three conditions,” wrote David Rotfleisch, tax lawyer at Rotfleisch & Samulovitch P.C., in a recent commentary.
According to Rotfleisch, a deduction may be applied if a “restricted financial institution” acquired an interest in a life-insurance policy in the context of a loan transaction. Additionally, the lending institution — a bank, a credit union, a trust company, or an insurance company, for example — must have specified life insurance as collateral for the loan. Finally, the borrower may otherwise deduct the loan’s interest from taxable income.
“In short, you may deduct life-insurance premiums if a bank or similar financial institution required you to put up life insurance as collateral for a loan, and you obtained the loan to finance your business,” he said.
However, when a business owner voluntarily puts up life insurance as collateral, and it wasn’t a condition for the loan, the insurance premiums cannot be deducted. Rotfleisch cited Norton v. The Queen, 2010 TCC 62, where the Tax Court of Canada denied a taxpayer’s deduction for insurance costs because they couldn’t prove that the lending institution required life insurance as collateral.
Life insurance used as collateral for private loans, he emphasized, isn’t eligible for premium tax deductions. “Moreover, the deduction is available only if the life-insurance company is obligated to pay the insurance proceeds to the lending institution,” he said.
Paragraph 20(1)(e.2) also specifies that the allowable deductions must be capped at a certain amount, which is the least of three values: the premiums actually paid, the “net cost of pure insurance” — essentially the premium minus any savings component that may be included in the policy — and the portion of the premium that reasonably relates to the outstanding portion of the loan.
“In addition to carving out the personal aspects of the insurance cost, like any savings component, these criteria match the tax treatment of insurance costs with that of interest expenses,” Rotfleisch said. “[A]s the taxpayer pays down the principal, the deduction available for insurance costs, like that available for interest expenses, will decrease.”
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