Back at the December 2008 Canadian Tax Foundation Conference, the CRA announced it was preparing to audit loans secured with life insurance policies, also known as 10/8 plans.
At the November 2010 CTF conference in Vancouver, Wayne Adams, director general of the income tax rulings directorate of the CRA, said the agency was still reviewing its analysis and a formal announcement of their position could be made as soon as late January. It’s now February, and there’s been no announcement. The industry is hoping it will come soon and significantly reduce the level of uncertainty that surrounds these leveraged-loan insurance plans.
The name “10/8” comes from the way the plan is structured. A client purchases an insurance policy with a guaranteed 8% rate of return. Meanwhile, that policy is used as collateral to borrow up 100% of the cash-surrender value of the policy at a 10% interest rate, often from the same insurance company.
While this seems counterintuitive, the CRA’s taxation rules currently allow the interest payments to be deducted if the proceeds of the loan are used to generate income. Deducting the interest would reduce the after-tax cost of borrowing from 10% to approximately 5.5% if the taxpayer were in the highest marginal tax bracket.
This strategy is best suited for high-income, highly taxed individuals who qualify for life insurance, are willing to take risks and be highly leveraged, and have access to high rate-of-return investment opportunities. But with the entire strategy contingent on the deductibility of the interest payments, it’s no wonder the industry is eagerly awaiting a pronouncement from the CRA.