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November 25, 2011

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You might be wondering about the recent newspaper articles and emails proclaiming that the “10-8” or “9-7” insurance plans are not subject to the “general anti avoidance rule” (GAAR). What exactly does this mean?

The GAAR is a broad anti-avoidance provision in the Income Tax Act.  At its most general, the GAAR will tax income even if the specific provisions of the Income Tax Act will not tax that income. The GAAR applies transaction or series of transactions that are undertaken to get around the tax rules in a manner unintended by the Income Tax Act and does not have a business purpose. It is not uncommon for the Canada Revenue Agency (CRA) to make statements to the effect that a particular tax plan may be subject to the GAAR.  These statements are sometimes an attempt to dissuade taxpayers from taking advantage of a particular tax plan the CRA does not like by putting a “chill” on the plan.  This is what happened with the “10-8” or “9-7” insurance plans.

The “10-8” or “9-7” insurance plans are essentially leverage life insurance plans.  There is a life insurance policy that includes an investment account and a loan secured by the policy.  The amount of the loan is approximately equal to the balance in the life insurance policies investment account.   The “10-8” or “9‑7” refers to the interest on the loan and the rate of return on the investment account, respectively.  Why would someone pay 10% to earn 8%, or pay 9% to earn 7%?  The answer, and the reason the CRA does not like the “10-8” or “9-7” insurance plans, is because the loan is structured to have the interest tax deductible and the earnings are tax-free if paid out on death.

The CRA has attempted to put a chill on the “10-8” or “9-7” insurance plans. They have done this by making statements to the effect that these plans may be offensive under the GAAR and by sending out questionnaires to taxpayers that had invested in these plans.  As individuals, we have little ability to push back against the CRA without fear of repercussion or incurring substantial professional fees.

In fall 2009 and spring 2010 the CRA took their campaign one step further. They demanded a number of insurers who had issued policies under the “10-8” or “9-7” plans to provide the names, social insurance numbers and policy information of all customers. The CRA pushed against entities that could afford to push back.  BMO Life Assurance Company, Industrial Alliance Pacific Insurance and Financial Services Inc. and RBC Life Insurance Company pushed back and ended up in court to stop what was clearly a fishing expedition by the CRA.

At trial the CRA was required to reveal internal documents about its “10-8” or “9-7” insurance plan initiative.  The CRA documents revealed:

  • The “10-8” or “9-7” insurance plans may have a high interest rate, but it is not a GAAR issue if the amount is determined to be reasonable.
  • It may be difficult to convince the Court that the series of transactions that is the “10-8” or “9-7” insurance plan is an avoidance transaction.
  • The investment return may be untaxed, but that is not inconsistent with the object, spirit and purpose of the Income Tax Act.
  • Given the GAAR may not apply to the “10-8” or “9-7” insurance plans, the Income Tax Act should be amended or something that is the mandate of parliament, not the CRA.
  • The Department of Finance had refused to consider proposing to parliament an amendment to the Income Tax Act to address what the CRA had perceived as abuses.
  • The CRA decided to undertake a limited number of targeted audits. They did this to put the insurance industry on notice that they were concerned about the trend to develop insurance products that take advantage of the preferential tax treatment offered under the Income Tax Act.

The Court found the CRA’s target audits and the fishing expedition intended to send a message to the industry not valid for enforcement purpose and not permitted under the Income Tax Act.  The CRA is not, however, precluded from undertaking a fishing expedition in order to enforce the Income Tax Act.  A peripheral result was evidence that the CRA does not think the “10-8” or “9-7” insurance plans offend the GAAR. This is not to say the CRA has given a stamp of approval to the “10-8” or “9-7” insurance plans.  There remains the possibility the CRA may yet challenge the “10-8” or “9-7” insurance plans under the GAAR.  Just because the CRA’s GAAR committee thinks such plan may survive a GAAR challenge does not mean the CRA will give up. There is also the risk the CRA may challenge such plans using the argument the interest rate on the loan is not reasonable, and therefore not deductible under the Income Tax Act.

– comment by Tom Morton, Partner

If you have any questions regarding GAAR, contact Tom Morton

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