The tax treatment of insurance versus mutual fund commissions
by Jamie Golombek
Do you provide life insurance solutions to your clients? If so, chances are that you operate your life insurance practice through a personal corporation.
The advantages of doing so can be substantial. For example, the ability to access low corporate tax rates and defer personal tax on the income earned by leaving it in the corporation until it's paid out can result in a significant tax-deferral advantage.
In addition, the ability to have your spouse and children (over the age of 18) own shares of the corporation provides a significant opportunity for income splitting through the payment of dividends.
Finally, assuming the corporation qualifies as a small business corporation at the time of sale, you may be able to exempt the first $500,000 of capital gains from tax using the lifetime exemption.
Mutual fund commissions
Of course, the ability to flow insurance commissions through a personal corporation is very different from the ability to assign your mutual fund commissions to a corporation. The reason for this is that provincial securities law across Canada currently prohibits advisors to register as incorporated salespersons and, therefore, the licence to sell securities must be held individually.
The Mutual Fund Dealers Association's (MFDA) Rule 2.4.1, "Payment of Commissions to Non-Registered Entities", prohibits the payment of mutual fund commissions to personal corporations. That being said, late last year, the securities commissions of four provinces - British Columbia, Saskatchewan, Ontario and Nova Scotia - have extended a previously issued exemption suspending the rule's enforcement until December 31, 2008, effectively allowing mutual fund commissions to be paid to personal corporations in those four provinces.
However, just because the commissions can be physically paid to an advisor's corporation does not necessarily mean that the corporation has "earned" those commissions for tax purposes.
Wallsten v. the Queen
The discussion of commissions paid to corporations came to the forefront over six years ago with the release of the Wallsten decision (Wallsten et al v. The Queen, 2001 DTC 215) decision.
In Wallsten, an insurance salesperson redirected commissions that he earned personally to his own corporation. The Canada Revenue Agency (CRA) took him to court arguing that the commissions should be taxed in his hands personally and could not be redirected to his corporation since the contract to earn the commission income was between Mr. Wallsten and the insurance company.
Mr. Wallsten was successful and won his case. The court said that the assignment of commissions to his corporation was allowable under tax law, notwithstanding that it was a violation of the contract that Mr. Wallsten had with the insurance company.
Shortly after that decision, the CRA stated that they did not accept the decision as they believe that it was wrongly decided. Specifically, the CRA stated that "if insurance agents ... (or) ... mutual fund salespersons ... are legally, whether contractually or by statute, precluded from assigning their commissions to a corporation, then the commission income must be reported by the individuals and cannot be reported through a corporation, regardless of the documentation provided".
Since then, the CRA has somewhat relaxed its position. In various technical interpretations released in the past five years (see, for example, 2006-0176531I7 released last April), it acknowledged that it may be possible to have the mutual fund commissions assigned to your corporation, particularly in a province, such as Ontario, where the MFDA rule discussed above is not being enforced.
But mere assignment is insufficient, as the CRA has stated: "whether or not the corporation is actually carrying on the business is a question of fact, normally supported by adequate documentation".
Boutilier v. the Queen
A recent tax case (Boutilier v. the Queen, 2007 TCC 96) involving a Halifax advisor who had his mutual fund trailing commissions paid to his numbered company drives home this concern.
The CRA reassessed him arguing that the commissions should be taxed in his hands personally maintaining that "the transfer of the fees to the corporation was simply a scheme to artificially reduce (his) income. He remains beneficially entitled to those fees. The corporation was essentially a receptacle for the flow of revenue with dividends from the corporation flowing back into (his) account".
The judge agreed and found that the transfer was specifically caught by an anti-avoidance rule of the Income Tax Act that was designed to prevent the avoidance of tax that could result when a right to income is transferred between parties that don't deal at arm's length, including one's personal corporation.
Essentially the question boiled down to who "beneficially earned" the trailer fees, the corporation or the advisor? The judge concluded, based on the facts of the case, that it was indeed the advisor who beneficially earned the trailers.
That being said, the judge did leave the door open for other cases, specifically saying that "given the right set of circumstances, a company could be engaged in the active business of providing services to earn trailer fees".