The Canada Revenue Agency (CRA) is cautioning Canadians about the use of critical illness insurance in financial arrangements that may be structured to avoid taxes.
Critical illness insurance provides a lump-sum payment to policyholders if they are diagnosed with a specified serious illness, such as cancer, heart attack or stroke, and is generally intended to help cover medical costs, lost income or expenses during recovery.
The CRA said some arrangements misuse these insurance products for tax purposes, which can misrepresent the nature of the coverage and lead to significant tax consequences. The agency has previously issued warnings on similar schemes, including Offshore Disability Insurance Plans and Offshore Leveraged Insured Annuities.
These schemes often rely on limited recourse loans, where the lender’s recovery is restricted to the insurance policy itself. If the borrower defaults, the lender cannot claim other assets.
The arrangements are typically promoted by companies or individuals, sometimes including offshore entities. A common setup involves a shareholder borrowing funds from a lender linked to the promoter, transferring the money to their corporation, and using it to purchase a critical illness insurance policy, often from an offshore provider. The corporation records the shareholder loan as a liability, allowing tax-free withdrawals. The loan’s security can cancel the shareholder’s repayment obligation, creating a circular flow of funds.
The CRA has noted that these insurance products frequently do not meet the standards of valid policies. They are used primarily to support tax avoidance rather than provide legitimate insurance coverage.
Participants in these schemes, including promoters and advisors, may face penalties, court fines, and jail time. The CRA can reassess participants to deny tax benefits and may impose third-party penalties. Enforcement actions have been taken when insurance-based arrangements are found to be non-compliant.
Finally, the CRA advised taxpayers to seek independent advice from a qualified tax professional before entering complex insurance arrangements and to be cautious of schemes that use insurance products to reduce taxes through unconventional or circular financial structures.
