Are key person insurance premiums tax deductible in Canada?

Whether the premiums on a life insurance policy a business holds are deductible is a tax question, and the Income Tax Act answers it through general limits and a specific rule for policies assigned as collateral for a loan. This page sets out those provisions with their conditions. It does not decide how any particular policy is treated, and no source used here defines key person insurance, so the rules are described for life insurance premiums a business pays.

The general limits in section 18

Section 18(1)(a) says that, in computing income from a business or property, no deduction is made for an outlay or expense except to the extent it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property. Section 18(1)(b) denies a deduction for, among other items, an outlay, loss or replacement of capital, or a payment on account of capital, except as expressly permitted by Part I of the Act.

The collateral-assignment rule in section 20(1)(e.2)

Section 20(1) allows certain listed deductions despite section 18(1)(a), (b) and (h), in computing income from a business or property, to the extent they are applicable to that source. Paragraph 20(1)(e.2) allows the least of three amounts for a life insurance policy, other than an annuity contract or LIA policy. The first is the premiums payable by the taxpayer for the year, if an interest in the policy is assigned to a restricted financial institution in the course of a borrowing, the interest on the borrowing is deductible (or would be but for listed provisions), and the institution requires the assignment as collateral. The others are the net cost of pure insurance for the year (other than for a period after 2013 during which the policy is a 10/8 policy), as determined under the regulations, and the portion of the lesser amount that can reasonably be considered to relate to the amount owing under the borrowing.

What the CRA’s archived bulletin adds

The CRA’s archived bulletin IT-309R2 says the taxpayer seeking the deduction must also be the policyholder, and that the deduction applies if all of its stated conditions are met, including that the restricted financial institution requires the assignment as collateral for the borrowing. The bulletin is archived, so the rule above rests on the Act itself. For how collateral assignment works, see assignment of life insurance.

What to ask your accountant

Ask whether your policy was assigned to a lender, whether the lender required it, whether the business is the policyholder, and how the net cost of pure insurance applies. Do not assume a premium is deductible or not deductible until your accountant has looked at the policy and the loan documents. For the lender side, see whether lenders require key person insurance.