The words Canada Revenue Agency have the tendency to make any of us a little nervous when it comes to debts owed and tax collection. More so since the Canada Revenue Agency (CRA) maintains certain powers under the Income Tax Act (also known as the “Act”) to collect tax debts from property that has been transferred to a non-arm’s length person, such as a spouse, child or sibling. Where these rules apply, the recipient of the property becomes liable for the tax debts of the deceased to a maximum of the fair market value of the transferred property.
Although this liability rule has been challenged many times, the CRA has continued to attempt to apply it through a number of court cases over the years. The most recent case, a 2020 Tax Court of Canada decision in Dreger v. The Queen, involved a life income fund (LIF) under which the deceased had named his two daughters as beneficiaries. The deceased had tax debts at the time of his death and the CRA sought to collect these debts from the LIF proceeds paid to the daughters.
The daughters made an interesting argument that they were no longer related to their father, and therefore not liable for his tax debts, because he was deceased. However, the Tax Court was not convinced by this argument and similar to the many other court cases throughout the years, ruled in favour of the CRA.
Given these case outcomes, there has been some serious concern when it comes to life insurance proceeds – can the CRA really seize the proceeds payable to the beneficiary of a deceased policy owner? The good news is that the CRA cannot confiscate the proceeds from life insurance to satisfy the deceased’s tax debt – here are the reasons why:
- The Act refers to the “transfer” of property to a non-arm’s length person. However, life insurance proceeds are not transferred to a beneficiary in the same way that, for example, a RRIF or RRSP is transferred to a beneficiary. When it comes to insurance proceeds, the payment is made from the insurance company rather than the deceased, and involves funds to which the deceased would not have been entitled to while alive.
- The rules in the Act are designed to preserve the deceased’s estate so that taxes can be collected from that estate upon death. However, if a beneficiary is named, the proceeds bypass the estate.
- Previous Tax Court decisions strongly indicate that life insurance proceeds are not subject to the same rules that applied in Dreger and similar cases.
There continues to be a strong argument that insurance proceeds paid to a non-arm’s length beneficiary cannot be accessed by the CRA to satisfy tax debts of the deceased. Unlike other registered plans and assets that do not have the same level of defence, life insurance is protected.
As suggested above, it is important to distinguish between insurance proceeds paid to a named beneficiary versus those paid to the estate. Where the estate is the beneficiary of a policy, the proceeds will be vulnerable to all creditors, including the CRA. Yet another reminder why it’s crucial to designate a specific beneficiary on a policy whenever possible.
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