By: Florence Marino B.A., LL.B., TEP | Vice President, Tax & Estate Planning
Where a shareholders’ agreement or life insurance was in place at the relevant time, shares of a private company could be “grandfathered” from the stop-loss rules at subsections 112(3)-(3.2) of the Act. If shares are grandfathered, post-mortem planning involving a redemption of the shares would not be limited by the “50 % rule” allowing any amount of CDA to be used on a redemption of the shares.
The gem here is: no tax to the deceased and no tax to the estate on the redemption if there is sufficient CDA to redeem the grandfathered shares.
At the June 2025 STEP National Conference in the Post-Mortem Planning 301 session a reminder of the rules for CDA stop-loss grandfathering was presented. The session encouraged gathering and retaining information about pre-existing insurance, any shareholders’ agreement(s) and share reorganizations with a view to maintaining the position that the shares are grandfathered when the time comes.
With this encouragement in mind, we thought we’d provide a technical primer and a practical perspective on this hidden gem.
Two routes to grandfathered shares
Grandfathering may exist where shares owned on April 26, 1995 are disposed of:
- pursuant to a written agreement entered into before April 27, 1995, or
- a corporation was a beneficiary of an insurance policy on April 26, 1995 on the life of the taxpayer or the taxpayer’s spouse and a main purpose of the policy was to fund a redemption, acquisition or cancellation of the shares.
A share that has been acquired in exchange for another share under sections 51 (share conversions), 85 (rollovers), 86 (share-for-share exchanges) or 87 (amalgamations) are deemed to be the same share for purposes of the grandfathering rule relating to existing insurance, but not for grandfathering because of an existing agreement.
Existing agreement route
This route to grandfathering is more limited. Effectively, to be assured that the shares remain grandfathered on the sole basis of an existing agreement, it would have to have been left undisturbed, and the shares disposed of must be the original shares governed by the agreement. This may not be practical or possible.
In Income Tax Technical News #12 (the ITTN), dated February 11, 1998, the CRA confirmed that grandfathering because of an existing agreement will apply if the agreement “is not altered or modified in any way.” It also contemplated that parties to an existing agreement may revise the terms of their relationship by a separate agreement so that the existing agreement remains unchanged. However, if the separate agreement is considered to cancel, nullify or replace the existing agreement grandfathering would be lost.
Over the years many technical interpretations asked for guidance on specific types of changes to existing agreements. In general, most if not all of the changes were considered to be fatal. The list of fatalities includes:
- Adding a new shareholder to the existing agreement (#2005-0145111E5);
- A separate agreement for a new shareholder could work but would have to leave the existing agreement unchanged and cannot nullify, cancel or replace the existing agreement (#2005-0136041E5);
- Amendments requiring the corporation to purchase insurance to fund a redemption and to make a capital dividend election on redemption (#2000-0005075);
- Allowing for the payment of eligible dividends on a share redemption (#2007-0241981C6);
- Amendments to the buy-out price or terms, or any material change to the agreement even if it had no impact on the buy-sell provisions (#9621950 – 1996 Ontario Tax Conference).
If grandfathering is potentially available under both routes, the taxpayer may choose to rely on the existing insurance route so that amendments to the agreement can be made. 2005-016129R3 is an example of a ruling that ensured the amendment of an existing agreement would not impact grandfathering of the shares resulting from the existing insurance. In the absence of a ruling, the existing agreement (prior to any amendment) is excellent evidence of the purpose of the insurance, so hang on to it!
Existing insurance route
This route to grandfathering is more flexible. In addition to the share exchange rule noted above, grandfathering extends to shares owned by a trust on April 26, 1995 which are subsequently distributed to an individual who was a beneficiary of the trust on that date and later redeemed from their estate, their spouse or a spousal trust (provided that the existing insurance was on the relevant life).
Also, the insurance that was in place on April 26, 1995, need not be the actual insurance used on the ultimate redemption. The insurance can be renewed, converted, replaced or added to. This was confirmed in the Explanatory notes to the coming into force legislation and several subsequent CRA technical interpretations (e.g. #2005-0124311). A subsequent change in owner or beneficiary of a policy that gave rise to grandfathered shares is not necessarily fatal (#9916175).
The Explanatory Notes also confirmed that the shares being disposed of do not have to be shares of the corporation that is the beneficiary of the policy. For example, Opco could be beneficiary of a policy that contemplated the redemption of shares of Holdco on death of the shareholder of Holdco.
Where insurance was in place on April 26, 1995 the primary inquiry is: Is it reasonable to conclude that on April 26, 1995 that “a main purpose” was to fund a redemption. “A” does not mean “THE” so there can be several purposes that were being served by the insurance. “Main” usually means important, key, major but the word “a” tones this down. The determination must be made at the specific point in time – a snapshot on April 26, 1995. The “reasonable to conclude” language imports an objective standard – would a reasonable person conclude, based on whatever evidence there is, that a main purpose of the insurance was to fund a redemption of shares?
Evidence
The onus is on the taxpayer to prove their shares are grandfathered. In the ITTN and several technical interpretations (e.g. #2001-0066195) the CRA suggested evidence of the purpose of insurance could be found in documents issued by the insurance company, corporate records such as minutes or resolutions of the corporation, correspondence from legal or accounting advisors or any correspondence relating to the issuance of the policy.
Insurance advisors may have plain language explanations of share redemption and loss carry back planning that were presented to the client in the process of placing insurance coverage or may have records relating to insurance that existed at the relevant time which may have been cancelled or replaced.
Practically speaking, when a policy is applied for and issued, normally, the rationale for the purchase is communicated during the underwriting process to justify the amount of coverage and confirm the ownership and beneficiary of the policy. Often, in addition to the application which itself forms part of the contract, a cover letter by the insurance advisor may accompany the application. It would explain to the underwriter, what the purpose of the insurance is. Sometimes during the underwriting process, the insurer may independently seek to verify the existence, value and ownership of a business by asking external vendors to verify information, interview the applicant and receive a report (known as an inspection report) of their findings. This correspondence may be on file along with the policy application and contract with the insurer.
As noted above an existing executed shareholders’ agreement contemplating redemption is excellent evidence even if the agreement is not being relied on for the purpose of grandfathering. Even an unexecuted agreement or drafts may evidence the purpose of the insurance. Often insurance is placed in anticipation of a shareholders’ agreement being signed.
Where there have been share reorganizations, retaining information about the original grandfathered shares and tracing through these transactions is required. In the context of complex transactions such as butterflies, where a ruling would normally be obtained, assembling and providing the evidence of grandfathered shares would allow the ruling to specifically address the preservation of grandfathered status. See #2022-0923451R3 for such a ruling.
30 years is a long time
Obviously contemporaneous evidence of the purpose of the insurance is the most helpful. Does that evidence still exist? What can be done now to substantiate and preserve the position that the shares are grandfathered?
For those practitioners who are encouraging their clients to model out their post-mortem plan, ask if they had insurance 30 years ago to be used in whole or in part to redeem shares from their estate or if they had a redemption buy-sell agreement at that time.
It starts there. You don’t know if you don’t ask.
FOOTNOTE:
This publication is protected by copyright. Tompkins Insurance is not engaged in rendering tax or legal advice. TOMPKINSights contains a general discussion of certain tax and legal developments and should not be construed as tax or legal advice.
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