Insurance: What does the tax man say about it?

• Author: Neilson, Hugh

Insurance is complex enough--what happens when it intersects with our tax system?

We have good news...

Under the Excise Tax Act, insurance is a financial service, making it exempt from GST. If we only had to address the GST, this would be a simple, short article. However...

And we have bad news!

The interaction of insurance with the income tax system is not as straightforward. Various types of insurance carry different, sometimes surprising, income tax implications. Two broad-based questions arise:

1. Is tax relief available for insurance premiums?

2. Do insurance benefits attract an income tax cost?

A third issue arises when employers provide insurance to employees--do employees pay taxes on these benefits?

Property Insurance

The income tax implications of property insurance typically align with the other income tax issues related to that property. Insurance is a cost of owning property. As such, if the property is used for personal enjoyment (e.g. a home, vacation property or personal vehicle), the premiums are also personal and generate no tax relief. However, if the property is used to generate income (e.g. a rental property, business premises or a vehicle used to earn income), the premiums are deductible from that source of income. Some property has mixed use (e.g. real estate with mixed rental and personal use, or a personal vehicle sometimes driven for business). The insurance (like the other costs) must be apportioned between income-earning and personal use (e.g. based on time used personally versus for rental; based on business and personal distance driven).

If the property is damaged, related insurance benefits will offset the costs of repairs. The insurance proceeds will be taxable or non-taxable on the same basis as the repairs themselves. But what if the property is not repaired? The insurance proceeds would generally reduce the cost of the underlying property because part of the property was "disposed of".

If the property was destroyed, the insurance proceeds are the sale proceeds. Again, the tax treatment will follow the nature of the property. Where the proceeds exceed the property's cost, a capital gain will result. This may mean taxes are payable, even if the property was used entirely for personal use. This might happen where a building is insured at its replacement cost, which is greater than its original purchase price. The proceeds could mean a significant gain, especially if the property has appreciated over many...