A closely held Canadian corporation purchases a term life insurance policy on a key employee, paying the premiums. The corporation is the named beneficiary. The key employee dies, and the corporation receives a $1,000,000 death benefit. The corporation's adjusted cost basis (ACB) in the policy was $0. How is this death benefit treated for tax purposes at the corporate level in Canada?

Question: A closely held Canadian corporation purchases a term life insurance policy on a key employee, paying the premiums. The corporation is the named beneficiary. The key employee dies, and the corporation receives a $1,000,000 death benefit. The corporation's adjusted cost basis (ACB) in the policy was $0. How is this death benefit treated for tax purposes at the corporate level in Canada?

Answer options:

• The $1,000,000 death benefit is fully taxable as income to the corporation.
• The $1,000,000 death benefit is received tax-free by the corporation.
• The $1,000,000 death benefit increases the corporation's capital dividend account by $1,000,000. ✅ The $1,000,000 death benefit increases the corporation's capital dividend account by the amount of the death benefit minus the ACB in the policy.

Correct answer: The $1,000,000 death benefit increases the corporation's capital dividend account by the amount of the death benefit minus the ACB in the policy.

Explanation: When a Canadian corporation is the beneficiary of a life insurance policy on an employee (or shareholder), the death benefit received, less the Adjusted Cost Basis (ACB) of the policy, increases the corporation's Capital Dividend Account (CDA). This allows the corporation to pay out tax-free dividends to its Canadian resident shareholders up to the amount of the CDA credit.