The taxable policy gain is calculated by subtracting the Adjusted Cost Basis (ACB) of the policy from the proceeds of disposition, which in this case is the Cash Surrender Value (CSV). The formula is: Taxable Gain = CSV – ACB. The ACB itself is calculated by taking the total premiums paid and subtracting the cumulative Net Cost of Pure Insurance (NCPI). The NCPI represents the mortality cost or the pure cost of the insurance protection component of the policy over its lifetime. It is subtracted because it is considered an expense for the coverage received and not part of the investment basis.

First, we calculate the ACB:
\[ ACB = \text{Total Premiums Paid} – \text{Cumulative NCPI} \]
\[ ACB = \$110,000 – \$30,000 = \$80,000 \]

Next, we calculate the taxable policy gain using the calculated ACB and the given CSV:
\[ \text{Taxable Policy Gain} = \text{CSV} – \text{ACB} \]
\[ \text{Taxable Policy Gain} = \$105,000 – \$80,000 = \$25,000 \]

Therefore, the amount that must be reported as income for tax purposes is $25,000.

Under the Income Tax Act of Canada, when a life insurance policy is disposed of through surrender, the policyholder may realize a taxable gain. This gain is not treated as a capital gain; instead, it is fully included in the policyholder’s income for the year of disposition and taxed at their marginal tax rate. The concept of the Adjusted Cost Basis is crucial for determining this gain. The ACB represents the policyholder’s net investment in the contract. By subtracting the NCPI from the premiums, the calculation correctly isolates the investment portion of the premiums from the portion that paid for the death benefit coverage. Failing to subtract the NCPI would incorrectly inflate the cost basis and understate the taxable gain. It is the responsibility of the life insurance company to calculate this policy gain and report it to both the policyholder and the Canada Revenue Agency on a T5 slip. An agent must understand this calculation to provide accurate advice regarding the tax consequences of surrendering a policy.

The calculation to determine the taxable policy gain upon the surrender of a life insurance policy is as follows:
First, calculate the Adjusted Cost Basis (ACB) of the policy. The ACB is the total premiums paid minus the total Net Cost of Pure Insurance (NCPI).
\[ \text{ACB} = \text{Total Premiums Paid} – \text{Total NCPI} \]
Using the figures provided:
\[ \text{ACB} = \$80,000 – \$30,000 = \$50,000 \]
Next, determine the proceeds of disposition. In the case of a full policy surrender, the proceeds of disposition are equal to the Cash Surrender Value (CSV).
Proceeds of Disposition = \$110,000
Finally, calculate the policy gain, which is the proceeds of disposition minus the ACB. This gain is the amount subject to taxation.
\[ \text{Policy Gain} = \text{Proceeds of Disposition} – \text{ACB} \]
\[ \text{Policy Gain} = \$110,000 – \$50,000 = \$60,000 \]
The resulting policy gain of \$60,000 is fully taxable as ordinary income to the policyholder in the year the policy is surrendered.

Under the Income Tax Act of Canada, when a life insurance policy is disposed of during the lifetime of the life insured, any resulting gain is subject to income tax. A disposition includes events like a full surrender for the policy’s cash surrender value. The taxable amount is calculated as the policy gain. This gain is determined by subtracting the policy’s Adjusted Cost Basis from the proceeds of disposition. The ACB is a crucial figure representing the policyholder’s cost for tax purposes; it is not simply the total premiums paid. It is calculated by taking the sum of all premiums paid into the policy and subtracting the cumulative Net Cost of Pure Insurance. The NCPI represents the mortality charges or the pure cost of insurance protection over the life of the policy. In this scenario, the proceeds of disposition are the cash surrender value received. The difference between this amount and the calculated ACB constitutes the policy gain. This gain must be reported as income and is taxed at the policyholder’s marginal tax rate. It is not treated as a capital gain.

The calculation to determine the taxable policy gain upon the surrender of a life insurance policy is as follows. First, the Adjusted Cost Basis (ACB) of the policy must be calculated. The ACB is the total premiums paid less the total Net Cost of Pure Insurance (NCPI).
Given:
Total Premiums Paid = $50,000
Total NCPI = $18,000
Cash Surrender Value (CSV) = $45,000

Step 1: Calculate the Adjusted Cost Basis (ACB).
\[ \text{ACB} = \text{Total Premiums Paid} – \text{Total NCPI} \]
\[ \text{ACB} = \$50,000 – \$18,000 = \$32,000 \]

Step 2: Calculate the Policy Gain. The policy gain is the amount by which the CSV exceeds the ACB.
\[ \text{Policy Gain} = \text{Cash Surrender Value (CSV)} – \text{Adjusted Cost Basis (ACB)} \]
\[ \text{Policy Gain} = \$45,000 – \$32,000 = \$13,000 \]

The resulting policy gain of $13,000 is fully taxable as income to the policyholder in the year of disposition.

When a life insurance policy with an investment component, such as a universal life policy, is disposed of through surrender, a specific tax calculation is required. The Income Tax Act dictates that any gain realized from this disposition is to be included in the policyholder’s income for that year. The gain is not treated as a capital gain, which would have a preferential inclusion rate, but rather as regular income, subject to the policyholder’s marginal tax rate. The key to this calculation is determining the policy’s Adjusted Cost Basis, or ACB. The ACB represents the policyholder’s cost for tax purposes. It begins with the total premiums paid into the policy. From this total, the cumulative Net Cost of Pure Insurance is subtracted. The NCPI represents the mortality cost, or the pure cost of the death benefit protection provided each year. Subtracting the NCPI ensures that the policyholder is not taxed on the portion of their premiums that paid for insurance coverage, but only on the investment growth element within the policy. The final policy gain is the proceeds of disposition, which is the cash surrender value, less this calculated ACB.

The core of this scenario revolves around an agent’s professional responsibility and duty of care when collaborating with other professionals, such as an accountant, on behalf of a client. The primary concept is that a life insurance agent’s duty is to their client, not to other advisors. While the accountant’s advice on tax matters is valuable, the agent is the expert on the insurance product and its application. The agent must ensure the recommended insurance strategy is suitable and that the client fully understands all associated risks and benefits.

In this case, the accountant is focused on maximizing the Capital Dividend Account (CDA) credit. The CDA is a notional account for Canadian-controlled private corporations that tracks certain tax-free surpluses. The death benefit from a corporate-owned life insurance policy, less its adjusted cost basis (ACB), is added to the CDA, allowing the corporation to pay tax-free capital dividends to its shareholders. While maximizing this is a valid goal, it should not be pursued at the expense of the primary purpose of the insurance, which is to fund the buy-sell agreement effectively and securely. An aggressive or overly complex strategy might invite scrutiny from the Canada Revenue Agency (CRA) or fail to function as intended under pressure.

The agent’s professional and ethical obligation is to conduct independent due diligence. They must analyze the accountant’s proposal, compare it with standard and potentially more robust strategies like a corporate share redemption agreement, and present a balanced view to the client. This includes clearly articulating the potential downsides, complexities, and risks of the proposed plan. The agent must ensure the client is making a fully informed decision, rather than simply deferring to the accountant or the agent. This upholds the agent’s duty of care and the principle of providing suitable recommendations based on a comprehensive needs analysis, which goes beyond a single tax objective.

The calculation for the credit to the Capital Dividend Account (CDA) is determined by subtracting the adjusted cost basis (ACB) of the life insurance policy from the total death benefit received by the corporation. In this scenario, the death benefit is \( \$1,000,000 \) and the policy’s ACB is \( \$150,000 \). Therefore, the CDA credit is calculated as follows: \[ \text{CDA Credit} = \text{Death Benefit} – \text{ACB} \] \[ \text{CDA Credit} = \$1,000,000 – \$150,000 = \$850,000 \]

When a Canadian Controlled Private Corporation (CCPC) is the beneficiary of a life insurance policy, the death benefit proceeds are received by the corporation entirely tax-free. This influx of cash increases the corporation’s assets. However, the tax treatment of the subsequent distribution of these funds to shareholders is governed by the rules of the Capital Dividend Account. The CDA is a notional account, meaning it is not a separate bank account but a running tally maintained for tax purposes. It tracks various tax-free amounts received by the corporation, with the primary source often being the tax-free portion of life insurance proceeds. The amount credited to the CDA is specifically the death benefit minus the policy’s adjusted cost basis. This credit then allows the corporation’s directors to declare and pay a capital dividend to its shareholders. For the shareholders, a capital dividend is received completely free of personal income tax. The portion of the death benefit equal to the ACB simply increases the corporation’s cash and retained earnings but does not contribute to the CDA balance and cannot be distributed as a tax-free capital dividend. The status of the insured individual, whether they are a shareholder or simply a key employee, does not alter this calculation or the eligibility for the CDA credit.

The foundational legal principle at issue is insurable interest. For a life insurance contract to be valid, the policyowner must have an insurable interest in the life of the person being insured at the time the policy is issued. In personal insurance, this is presumed for close family members. However, in a commercial context, insurable interest must be based on a reasonable expectation of pecuniary or financial advantage from the continued life of the insured, and a corresponding financial loss from their death or disability.

In this scenario, BuildRight Inc. is the proposed policyowner and Dr. Thorne is the life insured. Although Dr. Thorne is not an employee of BuildRight Inc., a clear financial relationship exists. BuildRight Inc. has invested significant capital into the joint venture, the success of which is critically dependent on Dr. Thorne’s unique expertise. The collapse of the joint venture due to Dr. Thorne’s death or disability would cause a direct and quantifiable financial loss to BuildRight Inc. Therefore, BuildRight Inc. has a valid pecuniary interest. This financial dependency must be clearly demonstrated and documented for the insurer during the underwriting process. Furthermore, under Canadian common law, it is an absolute requirement that the person whose life is to be insured, in this case Dr. Thorne, must provide their written consent for the insurance to be placed on their life. Without this consent, the policy would be void from inception, regardless of the existence of a valid insurable interest.

The scenario describes a criss-cross buy-sell agreement, a common business succession strategy. In this arrangement, the shareholders personally own life insurance policies on each other, rather than the corporation owning the policies. When Amira passes away, the policy that Ben owns on her life pays the death benefit directly to him as the named beneficiary. Under Canadian tax law, life insurance death benefits paid to an individual beneficiary are received entirely tax-free. Therefore, Ben receives the full amount of the proceeds without any tax liability.

The corporation itself is not a party to the insurance contract; it is neither the owner nor the beneficiary. As a result, the corporation’s Capital Dividend Account, or CDA, is not impacted. A credit to the CDA is only generated when a corporation receives a life insurance death benefit. Since the corporation did not receive the proceeds, no CDA credit is created.

Following the terms of the buy-sell agreement, Ben is now obligated to use the tax-free insurance proceeds he received to purchase Amira’s shares from her estate. This transaction allows for a smooth transfer of ownership. For Amira’s estate, the sale of the shares to Ben is a disposition. This may trigger a capital gain, which is calculated based on the difference between the sale price and the Adjusted Cost Base of the shares. The primary tax event for the estate is the deemed disposition of the shares at fair market value upon Amira’s death, which is reported on her final tax return.

The capital dividend account (CDA) is a notional account available to Canadian-controlled private corporations (CCPCs) that tracks certain tax-free surpluses. One of the primary credits to the CDA comes from the proceeds of a life insurance policy received by the corporation upon the death of an insured person. The amount of the credit is calculated as the total death benefit received minus the adjusted cost basis (ACB) of the policy. In this scenario, the calculation is: \[ \text{CDA Credit} = \text{Death Benefit} – \text{ACB} \] \[ \text{CDA Credit} = \$1,000,000 – \$150,000 = \$850,000 \] This \( \$850,000 \) can be paid out to the shareholders as a tax-free capital dividend. The primary purpose of key person insurance is to indemnify the corporation for the financial losses incurred from the death of a key employee, such as lost revenue or the cost of hiring and training a replacement. The corporation, as the policyowner and beneficiary, has the legal right to decide how to use the proceeds. The agent’s professional and ethical duty is to the client, which is the corporation, not the individual shareholders. In this situation, the agent must provide accurate information regarding the insurance policy’s implications, including the creation of the CDA credit. However, the agent must not direct the corporation’s business decisions or take sides in a shareholder dispute. The most appropriate and ethical course of action is to explain the available options and their consequences, and then strongly advise the corporation’s current director to seek specialized legal and accounting advice to navigate the business decision and the conflicting interests of the shareholders. This upholds the agent’s duty of care and competence while respecting the boundaries of their professional expertise.

The logical path to the correct conclusion is as follows. First, identify the insurance structure: the corporation owns the policies and is the beneficiary. Second, trace the funds upon death: the tax-free death benefit is paid to the corporation, not the surviving shareholder. Third, analyze the corporate impact: the corporation’s assets increase by the amount of the death benefit. The net proceeds (death benefit minus the policy’s adjusted cost basis) create a credit to the corporation’s Capital Dividend Account (CDA). Fourth, analyze the buy-sell execution: for the buyout to happen, the corporation must use these funds to redeem the deceased shareholder’s shares from their estate. This is a share redemption, not a purchase by the surviving shareholder. Fifth, evaluate the consequence for the surviving shareholder: because the corporation is now worth more (due to the influx of insurance cash) and the deceased’s shares have been removed, the surviving shareholder’s original shares now represent 100% of a more valuable company. This increase in the fair market value of the survivor’s shares creates a large, unrealized capital gain. This gain will be subject to tax when the surviving shareholder eventually sells their shares or upon their own death. This outcome defeats a primary goal of a properly structured criss-cross buy-sell agreement, which is to facilitate the transfer of ownership without creating a large, new tax liability for the survivor. The correct structure for a criss-cross agreement involves each shareholder owning and being the beneficiary of a policy on the other shareholder’s life.

A criss-cross buy-sell agreement is designed to allow surviving shareholders to purchase the shares of a deceased shareholder directly from the deceased’s estate. The most efficient way to fund this is for each shareholder to personally own and be the beneficiary of a life insurance policy on the other shareholder. Upon a death, the surviving shareholder receives the insurance proceeds tax-free and uses that personal cash to buy the shares from the estate. In the scenario presented, the corporation itself owns the policies and receives the proceeds. When the corporation uses these funds to buy back or redeem the deceased’s shares, it is a corporate redemption, not a criss-cross purchase. The value of the corporation increases by the amount of the insurance proceeds received. Consequently, the value of the surviving shareholder’s existing shares increases substantially. This creates a significant accrued capital gain on those shares. This future tax liability for the surviving shareholder is the primary and most detrimental flaw of this structure, as it undermines the tax-efficient succession intended by the agreement. While the death benefit does create a credit to the Capital Dividend Account, allowing the corporation to potentially pay out tax-free dividends, this does not negate the adverse capital gains consequence for the surviving shareholder’s personal tax situation.

The legal instrument in this scenario is a collateral assignment of a life insurance policy. When a policy is collaterally assigned to a lender for a loan, the lender becomes an assignee with a priority claim on the death benefit proceeds. However, this claim is not for the entire death benefit. The assignee’s entitlement is strictly limited to the amount of the outstanding debt, including any accrued interest, at the time of the insured’s death. The insurance company is obligated to first pay the assignee the amount required to extinguish the debt. Any remaining portion of the death benefit is then paid to the beneficiary designated in the policy. The collateral assignment does not cancel the beneficiary designation; it simply establishes the lender’s claim as having priority over the beneficiary’s claim.

From a tax perspective, under the Income Tax Act of Canada, the death benefit proceeds from a life insurance policy are generally received tax-free by the recipient. This principle applies to the entire death benefit payout. Therefore, the portion of the proceeds paid directly to the lending institution to satisfy the outstanding loan is received by the lender on a tax-free basis. Similarly, the remaining balance of the death benefit paid to the designated beneficiary is also received entirely tax-free. The character of the funds as a tax-free life insurance death benefit is maintained for all parties receiving a portion of the proceeds.

The calculation for the credit to the Capital Dividend Account (CDA) is determined by subtracting the Adjusted Cost Basis (ACB) of the life insurance policy from the death benefit received by the corporation. In this scenario, the death benefit is $1,200,000 and the policy’s ACB is $250,000.
The CDA credit is calculated as:
\[ \text{CDA Credit} = \text{Death Benefit} – \text{Adjusted Cost Basis (ACB)} \]
\[ \text{CDA Credit} = \$1,200,000 – \$250,000 = \$950,000 \]

When a corporation is the beneficiary of a life insurance policy, the death benefit is received by the corporation tax-free. However, the full amount of the proceeds cannot be distributed to shareholders as a tax-free dividend. The Income Tax Act allows for the tax-free portion of the proceeds to flow through the corporation to its shareholders via the Capital Dividend Account. This tax-free portion is calculated as the total death benefit minus the policy’s adjusted cost basis. The resulting amount, in this case $950,000, is added to the corporation’s CDA balance. The corporation can then elect to pay this amount out to its shareholders as a capital dividend, which is received completely tax-free by the shareholders. This mechanism is a cornerstone of funding corporate buy-sell agreements, as it provides tax-efficient liquidity to redeem a deceased shareholder’s shares from their estate, ensuring a smooth transition of ownership while minimizing the tax burden on the surviving shareholders. The amount equal to the ACB, which is $250,000, remains within the corporation as part of its general capital and if distributed, would be treated as a taxable dividend, unless other tax-free accounts are available.

The logical deduction process to determine the outcome is as follows. The primary goal of the insurance strategy is to fund a buy-sell agreement using the Capital Dividend Account (CDA). The credit to the CDA is calculated as the life insurance death benefit received by the corporation, minus the Adjusted Cost Basis (ACB) of the policy at the time of death. The agent’s recommendation was for an aggressively funded policy. Aggressive funding, particularly in a Universal Life policy, leads to a rapid increase in the cash surrender value (CSV). The ACB of a policy is directly influenced by the premiums paid and the CSV; a higher CSV generally results in a higher ACB over time. Therefore, a higher ACB at the time of death reduces the total credit to the CDA. This means a smaller portion of the death benefit can be paid out to the surviving shareholder as a tax-free capital dividend to purchase the deceased’s shares. The remaining funds needed would have to be paid as a taxable dividend, undermining the tax efficiency of the strategy.

The Capital Dividend Account is a special notional account available to Canadian Controlled Private Corporations (CCPCs). It allows the corporation to track certain tax-free surpluses, including the non-taxable portion of capital gains and the proceeds of a life insurance policy. When a corporation is the beneficiary of a life insurance policy, it can add the amount of the death benefit minus the policy’s Adjusted Cost Basis (ACB) to its CDA. The corporation can then pay this amount out to its shareholders as a tax-free capital dividend. The ACB of a life insurance policy is essentially its tax cost, calculated as the total premiums paid less the cumulative Net Cost of Pure Insurance (NCPI). An agent’s recommendation to aggressively fund a policy, while potentially beneficial for asset accumulation, directly increases the policy’s ACB. In a scenario where the primary goal is to maximize the tax-free payout via the CDA for a share redemption, this strategy is counterproductive. It reduces the CDA credit, thereby limiting the amount of tax-free capital available to the surviving shareholder and potentially creating an unintended tax liability. This represents a failure to align the product recommendation with the client’s stated primary objective.

The core legal principle at play is material misrepresentation within the contestable period of a life insurance contract. Under Canadian common law, insurance contracts are based on the doctrine of utmost good faith (uberrimae fidei). This imposes a strict duty on the applicant and policyowner to disclose all material facts to the insurer. A fact is material if, had it been known, it would have influenced a prudent insurer’s decision to accept the risk, set the premium, or establish policy terms.

In this scenario, the undisclosed medical condition is a material fact. The death occurred eighteen months after the policy was issued, which falls within the standard two-year contestability period. During this period, the insurer is entitled to investigate the statements made in the application. Upon discovering a material misrepresentation, the insurer has the right to treat the contract as void from the very beginning (void ab initio). The legal remedy for this is rescission of the policy.

When a policy is rescinded, the insurer’s sole obligation is to return all premiums that were paid. They are under no obligation to pay the death benefit. The fact that the cause of death was unrelated to the misrepresented condition is legally irrelevant. The breach of utmost good faith occurred at the time of application, which invalidates the entire contract, regardless of the subsequent cause of the claim. The agent’s failure to probe further could expose them to an Errors and Omissions claim from the client, but it does not change the insurer’s right to rescind the policy.

The core issue revolves around the agent’s duties, specifically the principle of utmost good faith (uberrimae fidei), which applies to all parties in an insurance contract, including the agent. The agent, Kenji, acts as an intermediary and owes a primary duty to the insurer to disclose all material facts relevant to the risk being underwritten. A material fact is any information that could influence a prudent insurer’s decision to accept the risk or determine the premium.

In this scenario, the information Kenji discovered regarding Ben’s actual role within InnovateForward Inc. is highly material. The justification for a key person policy, and especially its face amount, is based on the quantifiable financial loss the business would suffer upon the death of that key individual. If Ben’s role is less critical than stated by Amara, the insurable interest may be significantly lower than the $2 million applied for. Proceeding with the application without revealing this discrepancy would constitute a failure in the agent’s duty to the insurer. It would facilitate a potential material misrepresentation by the applicant, which could lead the insurer to void the policy in the future, even if a claim arose.

While an agent has a duty of service and confidentiality to the client, this duty does not override the legal and ethical obligation to ensure the underwriting process is based on truthful and complete information. The agent’s responsibility is to present all known material facts to the underwriter, who will then make the final assessment. Therefore, Kenji’s professional and ethical obligation is to communicate his findings to the insurer’s underwriting department for their consideration. This action upholds the integrity of the underwriting process and fulfills his duty of utmost good faith to his principal, the insurance company.

The agent’s liability stems from a breach of the professional duty to advise as mandated under the Civil Code of Quebec. This duty, often referred to as the obligation d’information et de conseil, is more extensive than simply avoiding misrepresentation. It requires a representative to provide the client with all the necessary information to make an enlightened decision. For a complex product like Universal Life insurance, this includes not only explaining the policy mechanics but also clearly and explicitly highlighting the associated risks. In this scenario, the agent correctly described how the policy functions but failed to adequately warn the client about the specific and material risk that poor investment performance could lead to the depletion of the cash value and potential policy lapse. The agent’s responsibility is to ensure the client understands the potential negative outcomes, not just the potential benefits. The fact that the client is a business owner does not negate the agent’s duty, as the agent is the expert in the insurance product. The failure to provide a sufficient warning about a foreseeable, material risk constitutes a professional fault, making the agent liable for the consequences of this omission. The core issue is not a misstatement of fact, but an inadequate fulfillment of the advisory role, which is a central tenet of professional practice in Quebec.

The central issue in this scenario is the proposed beneficiary designation. InnovateNext Corp., as the proposed policyowner, has a clear insurable interest in its key person, Dr. Aris Thorne. The financial loss the corporation would suffer upon his death is the basis for this interest, making the policy itself valid. However, the purpose of key person insurance is to provide the corporation with funds to mitigate the financial impact of losing the key employee. These funds are intended to be used for purposes such as recruiting a replacement, covering lost revenue, or reassuring creditors and investors.

By designating Thorne Holdings Inc., an entity owned by the insured’s spouse with no direct business relationship to InnovateNext Corp., as the beneficiary, the policy proceeds would bypass the corporation entirely. This arrangement diverts a corporate asset, the death benefit, to a third party. This could be interpreted as an inappropriate transfer of value out of the corporation, potentially to the detriment of the corporation’s other shareholders or its creditors. Such a structure could be challenged in court as a fraudulent conveyance or an oppressive action against minority shareholders.

An agent’s professional and ethical duty of care requires them to recognize the potential legal and ethical ramifications of such a request. While the agent is not expected to provide legal or tax advice, they must identify red flags. The most appropriate action is to advise the client that the proposed structure is highly unusual and has potential legal consequences. The agent must recommend that the principals of InnovateNext Corp. consult with their own independent legal and accounting professionals to validate the structure’s legitimacy before the application is submitted. Proceeding without raising this concern would be a breach of the agent’s professional duties.

The legal determination of the death benefit recipient hinges on the fundamental principle of policy ownership. In this scenario, Innovatech Dynamics Inc., a corporation, is the legal owner of the key person life insurance policy. As the owner, the corporation possesses all contractual rights associated with the policy, including the absolute right to name and change the beneficiary. The policy was issued in Alberta, a common law province, meaning the Alberta Insurance Act and common law principles govern the contract.

Lucien, despite being the individual whose life is insured, is not a party to the insurance contract in terms of ownership rights. He is the subject of the insurance, but he does not control it. His attempt to alter the beneficiary designation through his personal will is legally ineffective. A will can only dispose of assets that are part of the testator’s personal estate. The life insurance policy and its proceeds are an asset of the corporation, not of Lucien personally. Therefore, the proceeds are not part of his estate to be distributed.

The fact that Lucien’s will was executed under the Quebec Civil Code does not alter the outcome. The governing law for the insurance contract is the law of the province where the contract was made and issued, which is Alberta. The provisions of the Quebec Civil Code regarding testamentary dispositions cannot override the established contractual rights of a corporate policy owner under Alberta’s common law framework. Consequently, the original beneficiary designation naming Innovatech Dynamics Inc. remains valid and enforceable. The insurer is legally obligated to pay the death benefit directly to the corporation.

The core of this scenario revolves around a corporate-owned life insurance policy used to fund a buy-sell agreement. When a shareholder dies, the corporation receives the life insurance death benefit. Under the Income Tax Act, this death benefit is received by the corporation tax-free. A crucial secondary effect is the creation of a credit to the corporation’s Capital Dividend Account (CDA). The amount of the CDA credit is calculated as the total death benefit proceeds minus the Adjusted Cost Basis (ACB) of the policy. The corporation can then declare and pay a capital dividend to its surviving shareholders from the CDA. These capital dividends are received entirely tax-free by the shareholders. This mechanism is a fundamental advantage of using corporate-owned life insurance for succession planning. An insurance agent’s professional responsibility, specifically the duty of competence, requires them to have a thorough understanding of these complex tax implications and to explain them clearly to the client. Failing to advise the client on the existence and function of the Capital Dividend Account constitutes a significant professional lapse. It means the client is unaware of a key benefit of the strategy and may not utilize the tax-free withdrawal, potentially leading to adverse tax consequences and demonstrating a failure by the agent to provide complete and competent advice.

The calculation for the Capital Dividend Account (CDA) credit is as follows:
\[ \text{CDA Credit} = \text{Life Insurance Death Benefit} – \text{Adjusted Cost Basis (ACB) of the Policy} \]
\[ \text{CDA Credit} = \$2,000,000 – \$150,000 = \$1,850,000 \]
The correct process involves the corporation receiving the death benefit, crediting its CDA by this amount, and then paying a tax-free capital dividend to the surviving shareholder, who then uses those funds to complete the purchase from the deceased’s estate.

In Canada, when a Canadian-controlled private corporation (CCPC) is the beneficiary of a life insurance policy, the death benefit proceeds are received tax-free by the corporation. However, the key to unlocking the value for the shareholders lies in the Capital Dividend Account (CDA). The CDA is a notional account that tracks tax-free amounts received by a corporation, which can then be distributed to shareholders as tax-free capital dividends. The amount credited to the CDA from a life insurance policy is the total death benefit minus the policy’s adjusted cost basis. An agent’s professional and ethical duty of care extends beyond the initial sale and into the claims process. It is crucial for the agent to provide competent guidance to ensure the insurance strategy functions as intended. In a criss-cross buy-sell agreement funded by corporate-owned insurance, the intended mechanism is for the surviving shareholder to receive funds personally in a tax-efficient manner to purchase the shares from the deceased’s estate. The proper procedure is for the corporation to receive the proceeds, make the CDA election, and pay a capital dividend to the surviving shareholder. Alternative methods, such as a direct corporate share redemption from the estate or treating the proceeds as a shareholder loan, can lead to unintended and adverse tax consequences, defeating the purpose of the carefully structured plan.

The calculation for the credit to the corporation’s Capital Dividend Account (CDA) is determined solely by the corporate-owned Key Person policy. The formula is the death benefit received by the corporation minus the policy’s Adjusted Cost Basis (ACB).
CDA Credit = Key Person Death Benefit – Policy ACB
CDA Credit = \($500,000 – $50,000\)
CDA Credit = \($450,000\)

The criss-cross buy-sell agreement funding is a separate transaction that occurs outside the corporation. The \($750,000\) death benefit is paid directly to the surviving shareholder, Ben, as he is the owner and beneficiary of the policy on Anika’s life. These funds do not flow through the corporation and therefore have no impact on its Capital Dividend Account.

This scenario involves two distinct insurance strategies running in parallel. The first is a corporate-owned Key Person policy. When the insured person dies, the corporation receives the death benefit. For tax purposes, the amount of the death benefit in excess of the policy’s adjusted cost basis is added to the corporation’s Capital Dividend Account. This account allows the corporation to pay out tax-free capital dividends to its shareholders. In this case, the corporation receives \($500,000\), and with an ACB of \($50,000\), the credit to the CDA is \($450,000\). The second strategy is a criss-cross buy-sell agreement funded by personally-owned life insurance. Under this structure, each shareholder owns a policy on the other’s life. The surviving shareholder receives the death benefit personally and tax-free. These funds are then used, as per the buy-sell agreement, to purchase the deceased shareholder’s shares from their estate. This transaction ensures a smooth transfer of ownership but is external to the corporation’s own financial accounts, meaning it does not affect the CDA.

The proceeds from a corporate-owned life insurance policy are received tax-free by the beneficiary corporation. A specific mechanism within the Income Tax Act allows for the tax-free portion of these proceeds to be distributed to the corporation’s shareholders. This is accomplished through the Capital Dividend Account (CDA). The CDA is a notional account, not a real bank account, that tracks various tax-free amounts received by a private corporation. When the corporation receives the life insurance death benefit, an amount equal to the death benefit minus the policy’s Adjusted Cost Basis (ACB) is credited to the CDA. For example, if a one million dollar death benefit is received on a policy with an ACB of fifty thousand dollars, a credit of nine hundred and fifty thousand dollars is made to the CDA. The corporation can then elect to pay this amount out to its shareholders as a capital dividend. When a shareholder receives a capital dividend, it is entirely tax-free in their hands. This process is a key feature of using life insurance for funding buy-sell agreements and for estate planning within a corporate structure. It allows for the efficient transfer of value from the corporation to the shareholders without incurring personal or corporate income tax on the insurance proceeds.

1. Calculate the credit to the Capital Dividend Account (CDA):
\[\$1,000,000 \text{ (Death Benefit)} – \$150,000 \text{ (Policy ACB)} = \$850,000 \text{ (CDA Credit)}\]
2. Calculate the deemed dividend on the share redemption:
\[\$1,000,000 \text{ (Redemption Price)} – \$10,000 \text{ (Share PUC)} = \$990,000 \text{ (Deemed Dividend)}\]
3. Calculate the capital gain or loss for the estate:
The proceeds of disposition for capital gains purposes are reduced by the deemed dividend.
\[\text{Proceeds for Capital Gains} = \$1,000,000 \text{ (Redemption Price)} – \$990,000 \text{ (Deemed Dividend)} = \$10,000\]
\[\text{Capital Loss} = \$10,000 \text{ (Proceeds for CG)} – \$100,000 \text{ (Share ACB)} = (\$90,000)\]

When a Canadian corporation is the beneficiary of a life insurance policy, the death benefit proceeds are received by the corporation tax-free. These proceeds create a credit to a notional account called the Capital Dividend Account, or CDA. The amount of the credit is the death benefit minus the policy’s adjusted cost basis. In this case, the CDA credit is eight hundred fifty thousand dollars.

The buy-sell agreement requires the corporation to use these funds to redeem the deceased shareholder’s shares from their estate. When a corporation redeems its own shares, the amount paid to the shareholder in excess of the paid-up capital of those shares is considered a deemed dividend under the Income Tax Act. Here, the deemed dividend is nine hundred ninety thousand dollars.

The corporation can then make an election to treat a portion of this deemed dividend as a tax-free capital dividend, up to the available balance in the CDA. Therefore, the estate receives eight hundred fifty thousand dollars as a tax-free capital dividend. The remainder of the deemed dividend is treated as a taxable dividend.

For capital gains purposes, the proceeds of disposition received by the estate are reduced by the amount of the deemed dividend. This is a crucial rule to prevent double taxation. The proceeds are therefore only ten thousand dollars. When compared to the estate’s adjusted cost basis for the shares of one hundred thousand dollars, this results in a capital loss of ninety thousand dollars, which can be used to offset other capital gains.

The calculation for the Capital Dividend Account (CDA) credit is the life insurance death benefit received by the corporation minus the adjusted cost basis (ACB) of the policy. Assuming a death benefit of $1,000,000 and an ACB of $50,000 for the policy on Anika’s life:
\[ \text{CDA Credit} = \text{Death Benefit} – \text{Adjusted Cost Basis (ACB)} \]
\[ \text{CDA Credit} = \$1,000,000 – \$50,000 = \$950,000 \]

This scenario describes a common but complex business succession funding strategy. The buy-sell agreement is a criss-cross agreement, meaning the surviving shareholder is obligated to purchase the shares from the deceased shareholder’s estate. However, the life insurance policies are owned by and payable to the corporation. This creates a specific financial and tax pathway. When the corporation receives the death benefit from the policy on Anika’s life, the proceeds are received tax-free. The amount by which the death benefit exceeds the policy’s adjusted cost basis creates a credit in a notional account called the Capital Dividend Account. This account allows the corporation to pay out dividends, known as capital dividends, to its shareholders without those dividends being included in the shareholders’ taxable income. In this case, the corporation can declare a capital dividend and pay it to the surviving shareholder, Wei. Wei receives these funds tax-free and can then use them to fulfill his obligation under the criss-cross agreement to purchase Anika’s shares from her estate. This structure is an effective way to extract funds from the corporation for the purpose of the buyout. It is critical to understand that the funds are not paid directly to the surviving shareholder from the insurer, nor are they automatically taxable income to the corporation. The CDA is the specific mechanism within the Income Tax Act that facilitates this tax-free flow-through to the shareholder.

The legal determination of the death benefit recipient hinges on the principles of policy ownership and beneficiary designation, which are fundamental to insurance law. In this scenario, Innovatech Dynamics Inc. is the registered owner of the life insurance policy on Amara’s life. As the policy owner, the corporation holds all contractual rights, including the right to name the beneficiary and the right to receive the policy proceeds upon the death of the life insured. The corporation designated itself as the beneficiary. Therefore, upon Amara’s death, the insurer is contractually obligated to pay the death benefit directly to Innovatech Dynamics Inc.

A person’s will can only govern the distribution of assets that form part of their personal estate at the time of death. Since the corporation is the owner and beneficiary of the policy, the death benefit proceeds are paid directly to the corporation and do not flow into or form part of Amara’s personal estate. Consequently, the clause in Amara’s will attempting to direct these specific proceeds to a testamentary trust is legally ineffective. The will has no authority over an asset it does not control. The proceeds received by the corporation create a credit to its Capital Dividend Account (CDA), equal to the death benefit minus the policy’s adjusted cost basis. This allows the corporation to pay out a tax-free capital dividend to its remaining shareholder, Ben, to facilitate the purchase of Amara’s shares from her estate under the terms of the buy-sell agreement.

The calculation for the Capital Dividend Account (CDA) credit is determined by subtracting the policy’s Adjusted Cost Basis (ACB) from the death benefit proceeds.
Death Benefit = $2,000,000
Adjusted Cost Basis (ACB) = $150,000
CDA Credit = Death Benefit – ACB
\[ \$2,000,000 – \$150,000 = \$1,850,000 \]

Under the Income Tax Act of Canada, when a corporation is the beneficiary of a life insurance policy, the death benefit proceeds are received by the corporation tax-free. However, the distribution of these funds to shareholders is governed by specific rules. The amount that can be added to the corporation’s Capital Dividend Account is the total death benefit less the policy’s adjusted cost basis at the time of the insured’s death. This resulting amount, once credited to the CDA, can then be paid out to the corporation’s shareholders as a tax-free capital dividend. Any amount paid out to a shareholder that exceeds the available balance in the CDA would be treated as a regular taxable dividend and subject to personal income tax. An agent’s professional responsibility includes providing accurate information about the features and tax implications of the products they recommend. In this situation, the agent has an ethical duty to correct the client’s misunderstanding to prevent significant, unforeseen tax liabilities and to ensure the strategy functions as intended. This duty of care is a cornerstone of professional practice and is essential for maintaining client trust and avoiding potential liability for providing incorrect advice.

The calculation to determine the credit to the corporation’s Capital Dividend Account (CDA) is based on the life insurance proceeds received less the adjusted cost basis (ACB) of the policy.
Life insurance death benefit received by the corporation = $1,200,000
Adjusted Cost Basis (ACB) of the policy = $250,000
The formula for the CDA credit is:
\[ \text{CDA Credit} = \text{Life Insurance Proceeds} – \text{Adjusted Cost Basis of Policy} \]
\[ \text{CDA Credit} = \$1,200,000 – \$250,000 = \$950,000 \]

Under the Income Tax Act (Canada), when a private corporation is the beneficiary of a life insurance policy, the death benefit is received by the corporation on a tax-free basis. However, the distribution of these funds to shareholders has specific tax implications. A special notional account, the Capital Dividend Account (CDA), is used to track certain tax-free amounts received by the corporation. The amount credited to the CDA from life insurance proceeds is the total death benefit minus the policy’s adjusted cost basis. This resulting amount can then be paid out to the corporation’s shareholders as a capital dividend, which is received entirely tax-free by the shareholders. This is a significant advantage in corporate tax and estate planning. It is a critical professional responsibility for a life insurance agent to understand this mechanism. However, the agent’s role is to explain the concept and the amount of the potential CDA credit. The agent must not provide tax or legal advice. Instead, they must strongly recommend that the client engage the corporation’s professional accountant and legal counsel to ensure the proper corporate resolutions are passed and the correct election form (Form T2054) is filed with the Canada Revenue Agency before paying the dividend.

The transaction is structured as a criss-cross buy-sell agreement, where each shareholder owns a life insurance policy on the other. Upon Amara’s death, Ben, as the beneficiary of the policy on her life, receives the \(\$1,000,000\) death benefit. In Canada, life insurance death benefits paid to a named individual beneficiary are received entirely tax-free. Ben then uses these personal, tax-free funds to purchase Amara’s shares from her estate for their Fair Market Value, which is \(\$1,000,000\).

For tax purposes, the cost of an asset for the purchaser is the amount they paid to acquire it. This cost establishes the asset’s Adjusted Cost Basis (ACB). In this case, Ben paid \(\$1,000,000\) for the shares. Therefore, the ACB of the block of shares he acquired from Amara’s estate is \(\$1,000,000\). This is a critical outcome of the criss-cross arrangement. It provides Ben with a “stepped-up” basis in the newly acquired shares, which is significantly higher than Amara’s original ACB of \(\$100,000\). This high ACB is advantageous for Ben, as it will reduce the amount of capital gains tax he would have to pay if he sells these shares or the entire company in the future. This structure avoids the complexities of the Capital Dividend Account, which is associated with corporate-owned life insurance, and the deemed dividend rules under section 84.1 of the Income Tax Act, which do not apply to this type of share purchase between an individual and an estate.

The taxable policy gain is calculated when a disposition of a life insurance policy occurs. A disposition includes events like a full surrender, maturity, or, as in this case, when a policy loan exceeds the policy’s Adjusted Cost Basis (ACB). The ACB represents the policyholder’s cost for tax purposes and is generally the total premiums paid minus the cumulative net cost of pure insurance (NCPI). When a policy loan triggers a deemed disposition, the amount of the loan is considered the proceeds of disposition. The taxable policy gain is then calculated using the formula: \[ \text{Policy Gain} = \text{Proceeds of Disposition} – \text{Adjusted Cost Basis (ACB)} \] In this specific scenario, the proceeds of disposition are the policy loan amount, which is $110,000. The policy’s ACB is given as $85,000. The transaction triggers a taxable event because the loan amount is greater than the ACB. The calculation is as follows: \[ \$110,000 \text{ (Proceeds)} – \$85,000 \text{ (ACB)} = \$25,000 \text{ (Taxable Policy Gain)} \] This calculated gain of $25,000 must be reported by the policyholder as regular income on their tax return for the year in which the loan was taken. It is not a capital gain and is taxed at the policyholder’s marginal tax rate. The fact that the loan is less than the Cash Surrender Value is irrelevant for determining the amount of the taxable gain in this specific type of deemed disposition.

The calculation for the surviving shareholder’s new Adjusted Cost Base (ACB) is as follows:
Initial ACB of surviving shareholder’s original shares = $75,000
Purchase price of deceased shareholder’s shares (funded by insurance proceeds) = $1,500,000
New total ACB for the surviving shareholder = Initial ACB + Purchase Price of New Shares
\[ \$75,000 + \$1,500,000 = \$1,575,000 \]

In a criss-cross buy-sell agreement, each shareholder personally owns a life insurance policy on the other shareholder. When one shareholder, in this case Kenji, passes away, the surviving shareholder, Fatima, receives the life insurance death benefit directly from the insurance company. This receipt is tax-free to Fatima. She then uses these funds to purchase Kenji’s shares from his estate at the agreed-upon price, which is the fair market value. The primary tax consequence and advantage of this structure for the surviving shareholder is the impact on the Adjusted Cost Base of their total holdings in the company. The amount Fatima pays for Kenji’s shares, which is $1,500,000, is added to the ACB of her original shares. This results in a significant “step-up” in her total ACB for the corporation. This is highly advantageous because when Fatima eventually sells her shares or upon her own death, the higher ACB will result in a much lower capital gain, thereby reducing her future tax liability. This method is distinct from a corporate redemption model, where the corporation owns the policy and buys back the shares. In that case, the surviving shareholder’s personal ACB does not increase, although the corporation would gain a credit to its Capital Dividend Account.

When a corporation is the beneficiary of a life insurance policy on a key shareholder, the death benefit is received by the corporation tax-free. A significant portion of this death benefit creates a credit to the corporation’s Capital Dividend Account (CDA). The amount credited to the CDA is the total death benefit received minus the policy’s adjusted cost basis (ACB). This CDA balance can then be used by the corporation to pay tax-free capital dividends to its shareholders.

In the context of a shareholder agreement, this insurance is very often structured to fund a buy-sell provision. The purpose is to provide the corporation with the necessary cash to redeem or purchase the shares from the deceased shareholder’s estate. This ensures a smooth transition of ownership, provides liquidity to the estate, and protects the surviving shareholders and the business itself.

An agent’s professional and ethical duty extends beyond the sale of the policy. Upon the death of the insured, the agent’s role is to ensure the client understands how the proceeds can be used to fulfill the original intended purpose. While the creation of a CDA credit is a powerful tax advantage, it is a mechanism to an end, not the end itself. The agent must not provide specific legal or tax advice. Instead, the agent’s primary ethical responsibility is to remind the surviving shareholder of the plan’s original objective, which is typically funding the buy-sell agreement, and strongly recommend they consult with the corporation’s legal and accounting professionals. These professionals will ensure the share redemption is executed correctly according to the shareholder agreement and that the CDA is used appropriately to facilitate this transaction in a tax-efficient manner, respecting the rights of all parties, including the deceased’s estate.