Photo Credit: CRA

TAX TIP Watch out for offshore leveraged insured annuity schemes

Saturday, 29 August 2020 12:02.PM

The Canada Revenue Agency (CRA) is warning Canadians about getting involved in tax schemes involving leveraged insured annuity plans. Promoters, including tax representatives and tax preparers, are claiming that taxpayers can extract tax-free earnings from corporations or claim large insurance expenses using a leveraged insured annuity provided by supposed offshore insurers.

What are tax schemes?

Tax schemes are plans and arrangements that go against the Income Tax Act. They deceive taxpayers by promising to reduce taxes. Such schemes may promise large deductions or tax-free income.

What is a leveraged insured annuity?

A leveraged insured annuity (LIA) involves a limited recourse (or no risk) loan that is fully secured by a life insurance policy and an annuity. The loan is generally repayable on the death of any life insured under the policy. The life insurance policy, the annuity and the loan are heavily interdependent, would not have been issued on a stand-alone basis and do not make commercial sense from the perspective of the purchaser, the provider or the individual being insured if the intent of the policy is in-fact insurance. These LIAs are generally issued by offshore entities. Although this communication piece highlights offshore arrangements, similar concerns can arise with respect to domestic arrangements with the same or similar characteristics.

The LIA was designed to provide multiple tax benefits, including an increase in a private Canadian corporation's capital dividend account on the death of any life insured under the life insurance policy, a deduction for premiums and interest expense on the loan.

In 2013, new rules for LIAs were enacted to deny these unintended benefits, as well as to improve the integrity and fairness of the tax system. However, LIAs are still promoted.

How does a LIA scheme work?

In general, private Canadian corporations are using LIAs to distribute corporate earnings tax free to individual shareholders in the form of loan repayments or tax-free capital dividends. This is generally accomplished by the corporate taxpayer investing in an annuity and a life insurance policy issued by a so-called offshore insurer on the life of one (or more than one) insured individual (including, in some cases, the lives of arm's length individuals). Key features of LIA schemes include:

- Limited-recourse loans advanced to participants by offshore lenders. These loans are on the condition that participants agree to acquire a life insurance contract and an annuity to pay the premiums under the life insurance contract issued by a supposed offshore insurer,
- The principal and interest (which is capitalized) owing on the limited-recourse loan is repayable out of the life insurance policy's death benefit, and
- The life insurance contract and the annuity are assigned to an offshore lender to repay the limited-recourse loan on death.

In many cases, the corporate taxpayer increases its capital dividend account by the amount of the death benefit and then distributes corporate assets tax free to its shareholders despite no value in respect of the death benefit having been added to its capital dividend account (i.e., it was used to repay the limited-recourse loan).

In other cases, individuals acquire a LIA to obtain a large life insurance premium expense and an interest expense to reduce their taxable income.

Why is this a scheme?

Funds circle into and out of Canada to avoid Canadian income tax.

The products do not make commercial sense and would not have otherwise been issued in the absence of other interdependent contracts.

The CRA has found that promoted leveraged insured annuities abuse the capital dividend increase for life insurance, other tax provisions and the new LIA rules.

Your actions may have serious consequences

Through increased audits of promoters, improved intelligence gathering and strengthened communication with taxpayers, the CRA continues to identify and shut down tax schemes.

The CRA reviews leveraged insurance products, including LIAs, to determine whether they are valid insurance products or just vehicles for a tax advantage. The CRA has also identified LIAs where the general anti-avoidance rule (GAAR) will be used to deny the tax benefit sought.

In the event the CRA finds these purported insurance products to be invalid, participants, and those who promote and sell them, face serious consequences, including third-party civil penalties for promoters and gross negligence penalties for participants.

What can you do?

The CRA encourages all Canadians to seek an independent second opinion from a reputable tax professional on important tax matters.

If you suspect tax evasion, you can report it online at Canada.ca/taxes-leads or by contacting the Informant Leads Centre at 1-866-809-6841. The CRA will act to protect your identity. Also, you may give information anonymously.

You are welcome to correct your tax affairs through the Voluntary Disclosures Program: Canada.ca/taxes-voluntary-disclosures.

For more information on tax schemes, please go to Canada.ca/tax-schemes.

SOURCE: Canada Revenue Agency

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