If you have participated in what's become known as a "10-8 insurance plan," you may be able to breathe a sigh of relief after a recent decision of the Federal Court to restrict the Canada Revenue Agency's ability to hunt you down, at least for now.
The 10-8 plan is an insurance leveraging strategy sold primarily to high-net-worth investors which involves two elements: a life insurance policy that includes an investment component and a corresponding loan, secured by the life insurance policy, in an amount equal to the balance of the investment account within the policy.
The term "10-8" comes from the interest rates associated with each element, as the investor pays 10% interest on the loan but receives an 8% return on the investment in the life insurance policy. The benefit under a 10-8 is that 8% interest credited to the policy by the life insurance company is tax-exempt as part of a life insurance policy while the 10% interest payable on the corresponding loan, which is typically used to invest in a pool of securities or mutual funds, is tax-deductible since the loan proceeds are being used to produce investment income, reducing the cost to a mere 5.5%, assuming a 45% marginal tax rate.
Sounds too good to be true, right? That's what the CRA was likely thinking when it received an Advanced Income Tax Ruling Request (ATR) in 2007 from an insurance company seeking guidance from the CRA on its proposed 10-8 plan and whether it complied with the Income Tax Act.
The ATR was reviewed by the CRA's General Anti-Avoidance Rule ("GAAR") Committee, whose role is to assess whether GAAR, a special provision which allows the CRA to attack a tax plan that technically complies with the law but is viewed to be abusive, should be applied.
The committee concluded that the 10-8 plan "was likely in compliance with the Act and did not believe that the GAAR could be successfully applied."
Since then, the CRA has stated at least half a dozen times in various public tax forums that it was reviewing 10-8 plans, despite the fact that its internal documents suggested the plans "comply with the letter of the Act, if not with its spirit."
Regardless, other CRA documents reveal the CRA decided to "send a message to the industry" by refusing to respond to the ATR and to do an "audit blitz" of several insurers, including RBC Life, Industrial Alliance and BMO Life.
To this end, the CRA was required to appear before a Federal Court judge in several ex parte applications under the "unnamed persons" rule in order to obtain "all information and documents relating to (the insurance companies') 10-8 plan holders, including names and social insurance numbers." The purpose of this rule is to limit unauthorized fishing expeditions by the CRA.
Based on CRA affidavits, the Court granted ex parte orders that would have forced the insurance companies to hand over their client lists for audit. The insurance companies refused and went back to the court to have these orders cancelled.
But the court concluded the CRA affidavits did not make a "full and frank disclosure - of all material facts" and, in particular, the CRA did not disclose the very material fact that its internal documents suggest the 10-8 plans actually comply with the letter of the Act.
As a result of the CRA's "incomplete disclosure" in the ex parte applications, the orders previously issued were cancelled and the insurance companies will not have to hand over their 10-8 client lists to the CRA.