Nervousness creeps in whenever the Canada Revenue Agency (CRA) reaches out on issues bordering on debts owed and tax collection. The Canada Revenue Agency (CRA) is empowered under law, particularly the Income Tax Act (the “Act”), to collect tax debts. Therefore, they oversee the collection of tax debts on properties transferred to someone you have a relationship with (non-arm’s length persons). Such persons may include your sibling, child, or spouse. In such cases, the tax debts of the deceased are transferred to the beneficiary – up to a maximum of the fair market value of the property they received.
Despite numerous challenges against this liability rule, the CRA has continued its enforcement in several court cases over time. For example, in the 2020 case of Dreger v. The Queen. Here, the deceased, who had tax deaths before his demise, named his two daughters as beneficiaries of his Life Income Fund (LIF). The CRA sought to retrieve these debts from the LIF proceeds the deceased’s daughters receive.
In their argument, the daughters told the court they were no longer related to their deceased father in his death. Hence, the liability for his tax debts should not be transferred to them. Unfortunately, the Tax Court failed to uphold this argument and instead ruled against it. Instead, it granted the request of CRA to collect these debts from the daughters. That is just one of the many court cases with a similar outcome over the years.
This trend has raised serious concerns about life insurance proceeds. Is the CRA legally right to seize proceeds payable to the beneficiary of a deceased policy owner? Fortunately, they cannot! The CRA is not allowed under the law to confiscate the proceeds from life insurance, to use the same to satisfy the tax debt of the deceased. And that is because;
- According to the Act, the confiscation is only applicable to the “transfer” of properties to a non-arm’s length person. But the transfer of life insurance proceeds to the beneficiary does not follow the same process as, say, RRSP or RRIF transfers. In the case of insurance proceeds, the beneficiary receives the payment directly from the insurance company and not the deceased. Furthermore, the policyholder would not have been entitled to these funds if alive.
- The Act is structured to preserve the deceased’s estate, ensuring that taxes are collected from the estate after the owner’s demise. However, if a named beneficiary exists, the proceeds go straight to them and not the estate.
- Based on the previous Tax Court decisions, it can be strongly deduced that the rules applied in Dreger v. The Queen (and similar cases) do not apply to life insurance proceeds.
We have continued to see substantial arguments against CRA’s use of insurance proceeds paid to a non-arm’s length beneficiary to satisfy the tax debts of the deceased. Life insurance, however, does not fall into the same category as other registered plans and assets. Therefore, it has a higher level of defence and is thus protected.
To reiterate, insurance proceeds paid to the estate are different from those paid to a named beneficiary. According to Ottawa Certified Financial Planners, all creditors, including the CRA, can access the proceeds when the estate is the beneficiary. That is why policyholders must designate a particular beneficiary at their earliest convenience.
If you are still unclear about any aspect of this discussion, please reach out to your Ottawa CFP for professional guidance.
