As an example, if you own a private corporation that needs a loan, your bank may require insurance on your life as collateral, particularly in the case where the corporation has few hard assets and its value is largely dependent upon your effort and expertise. If your corporation pays the premiums on the insurance, it can normally deduct the premiums.
However, the amount of the deduction is limited to the “net cost of insurance in respect of the year” under the policy. The net cost of insurance is determined using actuarial principles set out in the Income Tax Regulations. In general terms, it uses mortality assumptions and is meant to approximate the cost of the pure life insurance coverage under the policy for the taxation year.
The deduction is also limited to the amount that “can reasonably be considered to relate to the amount owing from time to time during the year” under the loan. For example, if the life insurance coverage under an assigned policy is $1 million and the amount owing under the loan throughout the taxation year is $400,000, the amount deductible is limited to 40% of the lesser of the premiums payable and the net cost of pure insurance under the policy for the year.
The CRA states that it is not necessary that the insurance policy be taken out at the time of borrowing. An assignment of an existing policy is acceptable for these purposes.