My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Monday, May 30, 2016

Financial Ethical Wills - For Estate Planning and Managing Family Wealth


Last week, you read about the benefits of an ethical will. These wills are a way for you to share your personal beliefs, spiritual values and hopes for the future with your family. Today you will discover how some people are using ethical wills, to set forth their financial principles and values.

As a parent, a financial ethical will can help you accomplish one or all of the following:
  1. Allow you to explain your estate planning
  2. Assist your family in maintaining the wealth you created
  3. Provide your family guiding principles of how to conduct business
  4. Set forth how you hope your monetary legacy is to be used 
  5. Discuss your philanthropy values and principals.

Estate Planning - Explaining Your Decisions


As you may have read in my blog titled One Big Happy Family - Until We Discuss the Will, I am a proponent of family meetings to discuss your estate planning (or at least parts of it). Given that many people are uneasy with having a family meeting to discuss money and inheritances, an ethical will provides you the opportunity (albeit after you have died) to clarify for your family your thinking and decision making process in respect of your estate planning.

However, be mindful; if the objective in writing your ethical will is to be positive and motivating, you may need to consider whether the clarity you wish to provide to your family relating to your estate planning decision making process, is in keeping with this objective.

Business - An Ethical Will Provides Guidance for a Family Business


Given the tremendous failure rate of second and third generation businesses (only 30 percent of all family-owned businesses survive into the second generation and only 12 percent will be survive into the third generation), an ethical will can be used to convey the guiding principles of your family business, and even set forth the challenges and opportunities you foresee for the company going forward.

In his article "Reintroducing the Ethical Will: Expanding the Lawyer’s Toolbox", written for the American Bar Association, author Scott E. Friedman provides the following insightful comment:

“In contemplating the scale and variety of intra-family conflict, we have come to the conclusion that many such conflicts are, in part, attributable to the death of a leader who had not thought to clearly transfer his or her intentions, wishes and wisdom to the surviving family members. Lacking direction and the benefits gleaned from a legacy of insight and wishes passed on by the patriarch or matriarch, surviving children often become absorbed in the negative emotions of selfishness, resentment and jealousy, which all inevitably leads to trouble for the business”.

Thus, any guidance and direction you can provide to your children may be invaluable as they try to navigate through the issues of succession of a family business.  

Philanthropy - Setting the Tone for Family Giving


You can use an ethical will to ensure your philanthropic values are carried forward by your children. Here is a quote taken from an article by Eric L. Weiner, Ph.D. written for the practice management section of the Financial Planning Association, in which a parent said the following:

“I would love to see you become responsible members of the community and philanthropists. To that end, I have set up a donor-advised fund as the main conduit for our philanthropic interest. This fund will give you and possibly your children the ability to make grants to worthy causes. I want portability so that you can direct grants to your own communities, as well as to national and international interests”.

Alternatively, instead of setting up a charitable fund, you could just encourage philanthropy by speaking to the importance of charity in your ethical will and hope you lead by example and your children follow in your charitable footsteps.

Ethical wills provide you with a tool to impart both your spiritual and financial values and beliefs and principles to your children. You may therefore, wish to consider using an ethical will in addition to the traditional Last Will and Testament.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, May 23, 2016

Ethical Wills


Wills are typically matter-of-fact documents, as they have to be drafted to withstand legal challenges. Wouldn’t it be nice to have a “softer” complementary document, letter or even a video, in which you can express the following?

1. Your values

2. Your hopes for your family

3. Explain the decisions made in your will

4. Provide for or ask for forgiveness

Today, I will discuss such a will, commonly known as an ethical will.

What is an Ethical Will?


According to Wikipedia, “the ethical will is an ancient document from the Judeo-Christian tradition. The original template for its use came from Genesis 49:1-33”. These wills were designed to pass ethical values from one generation to the next. Modern day ethical wills had been adapted and modified and they remain excellent conduits to ensure our ethics, morals and standards are passed down and on record.

While ethical wills have typically been used to pass personal values to your family, some people are now using ethical wills to include financial issues and/or provide business guidance and values to second generation business owners. I will discuss these “wealth” wills next week.

The website for Celebration of Life, a company that helps people with their legacies, suggests you may include some of the following in an ethical will:

  • important personal values
  • important spiritual beliefs
  • hopes and blessings for future generations
  • life lessons
  • love
  • forgiving others and asking for forgiveness

Shae Irving, J.D. suggests you may also want to include the following in an ethical will:

  • family history
  • cultural and personal beliefs
  • reasons for charitable and personal financial decisions
  • personal stories about items of property left to inheritors
  • how you would like to be remembered after death

When Do You Present an Ethical Will?


Ethical wills can be written and presented literally anytime from cradle to grave. You can write such a document when your son or daughter gets married, has their first child, or as a statement at the end of your life; but in no way are you limited to such occasions.

Most ethical wills are written as end of life statements and can be shared while alive or after you pass away. I would suggest that most people would prefer to have their ethical will shared after they pass away as it avoids confrontation; although personally, I think there is something to be said for explaining decisions and setting forth your values and beliefs in person.

Ethical wills are very personal documents and no two, will be the same. Should you wish to write such a document, the discussion and considerations above, should give you a good start on writing your ethical will.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, May 16, 2016

What Small Business Owners Need to Know - Severance Costs Can be Expensive


When I meet with my clients to review their financial statements, I typically have an agenda of various topics I wish to discuss with them. One topic I like to review is their staffing situation. We typically analyze "accountant numbers" such as staffing costs as a percentage of sales, but I also like to review other employment related issues such as whether the client has updated employment contracts and have they entered into consulting contracts (employee vs independent contractor issues).

Once on this topic, clients often want to discuss their severance cost obligations with respect to (a) dismissing an employee (b) downsizing if their business fell off and (c) obligations should they sell the business? Since those issues are way beyond my skill-set, I refer them to their employment lawyer.

Since I thought you may wish to know the answers to these questions, I asked Stephen Shore of the firm Sherrard Kuzz LLP, an employment and labour law firm, if he could provide his expertise on the severance issue.

Stephen kindly agreed to write a blog post on The Top 5 Severance Issues for Business Owners in Ontario. Before I turn it over to Stephen, please note that; employment law can vary significantly from province to province and the below commentary is limited to Ontario. The commentary is also general in nature. You should seek employment law counsel in your own province that addresses your specific situation. With all these caveats out of the way, let's get to Stephen's post.

The Top 5 Severance Issues for Business Owners in Ontario
By Stephen Shore, Sherrard Kuzz LLP, Employment & Labour Lawyers


The following are in my professional opinion the top 5 severance issues for business owners in Ontario.

1. Obligations on Termination – How much will I owe?


The “cost” of terminating an employee will depend on many factors, including the following:
  1. Is there a valid employment agreement?
  2. How long has the employee been with the company?
  3. How old is the employee?
  4. How much did s/he make?
A business owner who has not pro-actively considered the cost of termination is often surprised by the size of the “bill”. On the other hand, those who plan ahead achieve two extremely valuable objectives: (1) lower cost and (2) cost-certainty.

The easiest and most straight-forward way to achieve these objectives is through the use of a written employment agreement which defines the terms and conditions of employment, including what happens on termination. Properly drafted and executed, an employment agreement can limit an employee’s entitlement upon termination to the minimum amount set out in the employment standards act (roughly one week per year of service). Without an employment agreement, that amount can be upwards of one month per year of service, and even higher. That can amount to a very big financial difference, particularly if the employee has been with the company for many years.

An employment agreement may also be used to secure other significant protections such as non-solicitation and confidentiality obligations.

A business that operates without written employment agreements leave itself vulnerable to the will of the employee-friendly courts. This is not a desirable place to end up.

The most prudent approach is to have all employment contracts prepared by experienced employment counsel, and reviewed periodically, to ensure the language used is and continues to be enforceable. Employment contracts should not be attempted without professional assistance.

2. Employment Standards Act Requirements – Do I owe statutory severance pay?


The Employment Standards Act (“ESA”) sets the minimum (floor) for what an employee is owed upon the termination of employment.

There are two (2) categories of potential payment under the ESA: “termination pay” and “severance pay”. Though the general public tends to use these terms interchangeably, “termination pay” and “severance pay” are not the same.

Under the ESA, an employee is entitled to advanced “notice” of termination, which notice can be given in the form of “working notice”, “pay in lieu of notice” (“termination pay”) or a combination of both.

“Severance pay” is owed to an employee regardless whether the employee is entitled to “termination pay”, but is only owed to an employee who has greater than five (5) years of service and whose employment is terminated by an employer with a payroll greater than $2.5 million dollars.

In calculating whether the 2.5 million dollar payroll threshold is met, an employer must look at: (i) the aggregate wages of employees in the fiscal year prior to the severance, and (ii) the product of the total wages of employees during the four (4) weeks prior to the termination multiplied by 13. If either amount exceeds 2.5 million the threshold is surpassed and the employee is entitled to “severance pay” in addition to whatever “notice” to which the employee is entitled.

3. Temporary Lay-off vs Termination – Am I permitted to lay-off an employee for a period of time?


Many business owners are surprised to learn that – at law – an employer does not have the right to “lay-off” an employee for any time period, regardless whether there is a good reason or however short the period of time. The act of “laying off” can be treated by the employee as the termination of his or her employment and a wrongful dismissal suit may follow.

That being said – the “right” to lay-off an employee can be introduced into an employment relationship through an employment contract or practice. That is to say, an employer and employee can agree in a written employment agreement (or, in the case of a unionized workplace, a collective agreement) that an employee can be laid-off without triggering a termination. Alternatively, if the employee has experienced lay-off on several previous occasions without complaint, then it may be implied that, through practice, the right to do so has been introduced into the relationship.
It is important to note that even where the right to “lay-off” has been introduced into the employment relationship, the “lay-off” must comply with the provisions of the ESA which sets limits on the length of time a temporary lay-off may last and requires certain employee entitlements to continue during a period of layoff (i.e., group benefits). Once again, a lay-off provision should not be attempted without professional assistance.

4. Mass Termination – Are there special rules for a major restructuring event?


Yes – there are special rules which apply when fifty (50) or more employees are being terminated in a four (4) week period.

These special rules are subject to exceptions and qualifications, and legal advice should be sought in every case of a potential mass-termination. That said, the ordinary consequence of a mass-termination is an increased advance-notice requirement or, failing that, an increased liability for ESA “termination pay”. The amounts are as follows:
  1.  For 50 – 199 terminated employees: At least 8 weeks’ notice
  2.  For 200 – 499 terminated employees: At least 12 weeks’ notice
  3. For 500 or more terminated employee: At least 16 weeks’ notice
In addition to the increased notice / “termination pay” requirements, an employer who carries out a mass-termination has reporting and posting requirements imposed by the Ministry of Labour (Ontario) which, if ignored, can have enormous financial impacts.

A mass-termination event is a very sensitive event which imports significant regulatory obligations. An employer is well advised to seek expert assistance well in advance of a potential occurrence.

5. Termination Meeting – How do I tell someone their employment is being terminated?


In carrying out a termination meeting, an employer is expected to be respectful, fair and compassionate. The failure to do so could result in significant damages.

This does not mean an employee is entitled to an explanation, justification or discussion concerning the merits of the decision to terminate. Rather, it requires an employer avoid being harsh and insensitive by, for example, publicly humiliating the employee or terminating the employee on his/her birthday or holiday.

The communication in the meeting should be direct and firm. The employee should be provided with an original signed copy of the termination letter.

Other best practises would be to have a second company representative present to take notes. The meeting should be held towards the end of the working day (if possible) or at a time when the employee would be able to leave without encountering his or her colleagues. Following the meeting, the employee should be permitted to retrieve personal belongings and security should be on-hand and utilized only if required. It is sometimes appropriate to offer the employee transportation home (i.e., taxi).

Once the termination meeting is complete, access to email and electronic records should be discontinued and a communication should be sent to other employees advising that the employee is no longer with the company.

Additional considerations may apply where the termination is for cause, where an offer of settlement is being made or where other factors are involved (e.g., unionized environments, mass-terminations, etc.). Professional advice is always recommended to ensure all legal and technical aspects of the termination are covered.

Stephen Shore is an experienced employment and labour lawyer, representing employers. Stephen regularly writes for a variety of employment and labour law publications and speaks on his areas of expertise. Please feel free to contact him directly at 416.603.6264 or by e-mail at sshore@sherrardkuzz.com. Sherrard Kuzz LLP is one of Canada’s leading employment and labour law firms exclusively representing the interests of management. Recognized nationally and internationally, this team is consistently named among Canada’s Top 10 Employment and Labour Boutiques (Canadian Lawyer®), Canada’s Leading Employment & Labour Law Firms (Chambers Global®) and as Repeatedly Recommended (Lexpert®).

The above blog post is for general information purposes only and does not constitute legal or other professional advice or an opinion of any kind. Readers are advised to seek specific legal advice regarding any specific legal issues.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. 

Small Business Owners - Get on my Mailing List


If you are an owner-manager and/or a shareholder in a corporation and have not signed up for my corporate mailing list, please email me at bluntbeancounter@gmail.com.

I will be sending out specific mailings on matters of importance to small business owners and I am considering, depending upon the interest, holding a roundtable for small business owners who are in the Toronto area. Now that tax season is over, I will start the mailings shortly.

Thanks to the many readers who have already signed up.

Monday, May 9, 2016

Capital Gains Reserves

Last year, I asked you, my readers, for some topics you would like me to write about. One reader suggested I discuss the subject of the capital gains reserve and tax planning around the reserve. As they say, better late than never. Today I will discuss the machinations of the capital gains reserve and some planning, especially in respect of the sale of a cottage to other family members.

The reader, who asked the question, stated that his 65 year-old spouse was going to sell a rental property and wondered if it made income tax sense to transfer half the property to their son before the sale. I will address that question later in the post.

What is the Capital Gains Reserve?


The Income Tax Act ("The Act")  contains a provision [subparagraph 40(1)(a)(iii)] that allows you in general, to claim a capital gains reserve where all of the proceeds from a sale of capital property (typically real estate or shares in a corporation) will be not be received in the year of sale. To make a claim you must file form T2017 – Summary of Reserves on Dispositions of Capital Property with your income tax return.

The Act states that at least one-fifth of the capital gain must be reported in the year of sale and each of the following four years (where the gain arose because of a transfer to your children of certain farm property, fishing property or shares of an Small Business Corporation, you typically can claim a ten year reserve).

Thus, the maximum reserve for each year is as follows:

Year of sale - 80%
2nd Year - 60%
3rd Year - 40%
4th Year - 20%
5th Year – nil

I say maximum, because the reserve is calculated each year based on the following formula:

The lesser of:

a) capital gain x amount payable after the end of the year / total proceeds of disposition

b) One-fifth of the total capital gain x 4 minus the number of preceding taxation years ending after the disposition

For example. If you sold your rental property for $1,000,000 and had a capital gain of $540,000 and you receive $400,000 upfront and will be paid a $150,000 for the next four years, your reserve would be as follows:

Year 1 – lesser of:

a) $324,000 ($540,000 x $600,000/$1,000,000)
b) $ 432,000 (4/5 x $540,000)

Thus, the reserve would be $324,000 for year one and you would report a capital gain of $216,000 ($540,000-$324,000)

Year 2 – lesser of:

a) $243,000 ($540,000 x $450,000/$1,000,000)
b) $324,000 (3/5 x $540,000)

Thus, the reserve would be $243,000 for year two and you would report a capital gain of $81,000 ($324,000 yr. 1 reserve -$243,000 yr. 2 reserve).


Strategies and Considerations for Using the Capital Gains Reserve



Family Transfers


I mentioned earlier that the reader had asked about whether his wife should gift the property to her son before the sale to reduce the family income tax bill. Unfortunately, as I have discussed several times on the blog, transfers of property to family members result in a deemed disposition (sale) at the property’s fair market value (if the transfer is to your spouse, there is an automatic tax-free transfer unless you file an election opting out of the automatic rollover). So if the reader’s wife was selling her property for a $1,000,000 and transferred it to her son before the sale, she would be deemed to have sold the property for $1,000,000; the same consequence as if sold to an arm’s length buyer.

Timing of Repayment


What the reader's wife and anyone selling a property where the proceeds are paid over time need to understand is that you must ensure you leave yourself with enough funds to pay the income tax liability (i.e. the 1/5 required gain each year). That is typically not an issue; however, if you have a long term of repayment, say 10 or more years, this can become problematic. Therefore, for both business and income tax purposes, you will typically want full payment of your proceeds within five years.

Cottages

One of the most challenging assets to tax plan for is a family cottage. I wrote a three-part series on this topic, which you can find under my favourite posts on the right hand side of this page, under the topic, "Family Cottage".

Where you wish to sell your cottage to your children, you may want to consider allowing them at least five years to repay the purchase price and tailor the purchase terms to the capital gains reserve.

If you plan to gift the cottage to your children, you will have a deemed disposition at the cottages fair market value as discussed above and you will have to report the capital gain and pay the related tax in the year of gift. Consideration should be giving to selling the cottage to your children for promissory notes which you may or may not forgive in your will. However, by selling, subject to advice by your accountant, you may be able to utilize the capital gains reserve to defer the tax on the gain for up to five years. [If your child is married, you should consult a family law lawyer before gifting or selling property to your child].


Capital Gains Guide


You may find it useful to review the CRA’s T4037 Capital Gains Guide

You should always obtain professional advice before the sale of any property; especially one is which you hope to use the capital gains reserve, as the legislation is complex. However, when used properly, the reserve can smooth your income tax liability over as many as five years.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, April 18, 2016

Rock On

Over the years, I have often suggested, probably to the point of ad nauseam, that I think you should make a Bucket List (A list of things to do before you die. Comes from the term "kicked the bucket"). I keep preaching this point because I’ve seen too many people never get to do the things they dream of, due to financial, health or age related reasons.

Personally, over the last eight or so years, I have crossed off multiple items from my Bucket List. For some of the more ambitious items on my list, such as my safari to Africa and playing golf at Pebble Beach, I have posted blogs detailing my experiences. One adventure on my list I did not recount was a golf trip I took last year to Ireland. It was an awesome trip and on a cold blustery typical Irish golf day, my friends and I and maybe only ten other people watched Dustin Johnson play a practice round for the British Open.

Bucket list items need not be extravagant trips. My list included watching a baseball game at Wrigley field and taking guitar lessons (which resulted in tennis elbow and quickly derailed my guitar playing to the relief of my families ears). The most recent item crossed of my list, was a visit to the Rock & Roll Hall of Fame (“RRHF”) in Cleveland. My wife took me for my birthday.

During my jaunt to Cleveland, I also attended a Cleveland Cavalier game in which Lebron James was his usual magnificent self (the game happened to be a throwback night to celebrate the 1976 Cavalier team, so the Jumbotron included a video clip of the current Cavs players dressed in 1970’s attire with a Soul Train motif in which many of them danced to the amusement of the crowed). The dancing is caught on this YouTube video. If you remember Soul Train and know some of the Cavs players, you will enjoy this video.

If following celebrity chefs is your thing, you’ll appreciate that we finished off our Cleveland experience with an awesome dinner at Michael Symon's restaurant called Lola’s.

Anyways, before I fall off my Soap Bucket - get it, soap box :) here’s a quick summary of the RRHF.

The Rock and Roll Hall of Fame



The first thing that strikes you about the RRHF is the structure itself. The building was designed by I. M. Pei, one of the world’s most famous architects. It is a really beautiful building.

While I thoroughly enjoyed my time at the RRHF (I was there for over 6 hours) and would recommend it to any music/rock fan, I can’t say there is one overall thing that stood out to me. It was a well- balanced combination of exhibits, video clips and interactive displays. My wife and I were struck by how disruptive rock and roll was to the “establishment”, both at its beginnings and again in the late 60’s and early 70’s.

The first floor of the exhibit was my favourite. It included among various exhibits:

(1) a gallery dealing with the Roots of Rock

(2) an Elvis exhibit (not really my thing)

(3) a Cities and Sounds exhibit which I really enjoyed (I have always personally been especially intrigued by the San Francisco scene of the late 60’s)

(4) a Dick Clark American Bandstand video retrospective (just so interesting seeing many rock stars as they were just coming on the scene)

(5) a legends of Rock exhibit that included clothing/costumes, pictures, video’s on such greats as the Beatles (see picture below), Rolling Stones, Jimi Hendrix, Doors, U2, David Bowie etc.

We enjoyed the colorful and historical guitars and instruments exhibited throughout the floor and the outfits/costumes worn from everyone from Led Zeppelin, to the Beatles, to even the black dress worn by Stevie Nicks on the Rumours album (yes like every teenage guy back then, I had a crush on Stevie).

There were also several fun interactive exhibits such as the one where you discover who inspired your favourite artists. There was also a new Graham Nash exhibit on while we were there.

The second floor provides a historical backdrop to how rock and roll began. Have you ever thought of all those one-hit-wonders you listened to when you were a kid? We had a blast on the second floor which hosted an interactive exhibit where you can search from A-Z for your favourite ones. You forget many of these songs until you see them listed. You then wonder why one only hit?

The third and fourth floors have such things as glass panels with the signatures of inductees and a Pink Floyd: The Wall exhibit. But, I must admit, I spent much of my time on these floors watching film footage and video that tell the story of the inductees and provide musical highlights of the induction ceremony concerts. For example; we watched a concert in which Stevie Wonder played with B.B. King, John Legend, Sting and Jeff Beck, which I really enjoyed.

My timing was a bit off, as I just missed a Herb Ritts rock portrait exhibit that ended the week before and had gotten rave reviews. The next exhibit unfortunately was under construction.

If you are a music fan, especially a rock fan, you’ll want to add the RRHF to your bucket list. You will not be disappointed by the venue or the exhibits.

Bloggers Note: I will not be posting again until May 9th. I have also disabled the ability to comment on this or any prior blog post. I apologize, but I am too busy during tax season to answer the various questions and comments I receive.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, April 11, 2016

What Small Business Owners Need to Know - Shareholder Agreements

If you are starting in business with another individual, your accountants and lawyers will likely suggest that you draft a shareholder agreement. However, since many small businesses are started by family and/or friends with limited funds, the idea of paying a lawyer to draft a shareholder agreement is usually not at the top of the priority list for two reasons:

123RF Stock Photo Copyright: Andrew Grossman

1. The cost of drafting the agreement.

2. Why Worry? Since the shareholders are family or friends, everything will work out because - well, we are family and/or friends, so what could go wrong? 

Consequently, shareholders of many small businesses may go several years before they decide it is time to engage a lawyer to draft a shareholder agreement. Typically the two catalysts to action are:

1. The business has become profitable enough that the shareholders want to ensure if something were to happen to them, their family is well provided for.

2. There is some shareholder friction.

In today’s post, I will discuss two key areas that should be considered/included in any shareholder agreement, whether drafted at the outset of the establishment of the business or years after the business has begun. As many agreements are over 25 pages, please keep in mind I am touching on maybe 30-50% of what is required in a typical shareholder agreement and providing an accountants take on a legal document. I am not a lawyer. If you need an agreement, you must obtain proper legal advice and should get moving on the project, as most agreements take many months to be hammered out.

Key Considerations in a Shareholder Agreement


The two issues I am going to discuss in this post are:

1. Share Transfer Provisions

2. Death Provisions

Share Transfer Provisions


Share transfer provisions in a shareholder agreement provide some order to the often “unorderly” process of third party share sales, unsolicited share offers, shareholder exits and shareholder power struggles.

The most common provisions included in a shareholder agreement are:

1. Right of First Refusal

2. Shotgun

3. Piggyback

4. Drag-along

Right of First Refusal


In order to protect one shareholder from selling to an unwanted or undesirable third party, shareholder agreements typically contain a Right of First Refusal provision.

These provisions typically state that the existing shareholders have the option to match a third party offer made to any of the other shareholders and to purchase the shares of the selling shareholder themselves, on the same terms and conditions as offered by the third party. Minority shareholders, depending upon their financial situations, may be somewhat prejudiced by these provisions.

A related shareholder agreement provision is a Right of First Offer. Under this provision, a shareholder does not need a hard third party offer and can just state the terms on which they wish to leave the company and if the other shareholders do not take them up on the offer, they can sell to a third party on those terms.

Shotgun


A shotgun provision allows one of the shareholders to offer the other shareholders a price and the terms under which they are prepared to either purchase the other shareholder’s shares or sell their shares to the other shareholders. In theory, this will result in a fair price, since the shareholder triggering the shotgun, does not know if they will be selling or buying.

Once the offer is made, the other shareholders must decide whether they wish to buy the offered shares or sell their own shares on the same terms and conditions presented.

While this provision is often useful in shareholder disputes, where one shareholder has more resources than another, they may be dictating the end result of the shotgun, since the shareholder with less finances will not have the resources to fund the purchase of the shares and will be forced to sell.

Piggyback


A common share provision used to protect minority shareholders is a “piggyback” right. This provision protects a minority shareholder from being excluded by the majority shareholders, where they wish to sell their shares to a third party, but have not included the minority shareholder as part of the deal for one of many possible reasons.

A “piggyback” right typically allows a minority shareholder to sell some of their shares to the third party purchaser under the same terms as the majority shareholders.

Drag-along


As noted above, a “piggyback” provision protects minority shareholders where they are excluded from a sale by the majority shareholders. A drag-along provision is a clause that allows the majority shareholder to drag-along the minority shareholder whether they like it or not, where the majority shareholders want to sell and the purchaser wants 100% ownership with no minority owners.

These provisions will often have a minimum price to protect the minority shareholders from selling at a price they consider too low and/or apply only after they had the opportunity to purchase the departing shareholders shares (which in many cases is not practical given their resources).

Death Provisions


It is very important that any shareholders' agreement consider the death and disability of any of the shareholders. I briefly want to discuss one issue that can arise upon the death of a shareholder; that being the flow-through of the capital dividend account to the spouse or estate of the deceased shareholder.

Typically shareholder agreements require all shareholders to obtain life insurance with the corporation being the beneficiary. The idea is that if one shareholder were to die, the insurance is sufficient to allow the corporation to redeem the deceased shareholders shares at their fair market value, subject to a valuation. It should be noted, that life insurance proceeds generally are added to the corporations capital dividend account and can be paid as a tax-free dividend.

The requirement to redeem the deceased shareholder’s shares generally allows the surviving spouse to receive most of the redemption funds tax-free (via the capital dividend) and the remaining shareholders to obtain control of the corporation, with minimal cash outflow, since typically the insurance covers most if not all of the redemption price payable to the spouse or estate.

The reason I have mentioned all this is; that while most agreements have a clause regarding the redemption of the deceased shareholder’s shares and the requirement for the shareholders to obtain life insurance, I have seen on several occasions no mention that the funds used to redeem the shares must be paid from the capital dividend account ("CDA") caused by the insurance (Nowadays, many lawyers do not specifically reference the CDA, but have a clause requiring the redemption to be made in the most tax efficient manner for the vendor). 

Without this clause, the corporation can use the life insurance proceeds to redeem the shares, but keep the capital dividend for itself and its remaining shareholders. While most people would not try and take advantage of such a missing provision, where the shareholders and their families have not got along, the surviving shareholder could try and “stick-it” to the estate of the deceased shareholder without a clear provision.

Marital Breakdown


Many shareholders do not consider that a marriage breakdown by one shareholder can significantly impact the other shareholders. As this post is too long as it is, I will quickly point you to an interesting article published by Jordan Dolgin Do Family Law Clauses in Shareholder Agreements Really Matter? that discusses this topic.

My post today just touches on just a couple points you need to consider in drafting a shareholder agreement. If you have a corporation and do not have such an agreement, I suggest you contact your lawyer and get to work promptly on drafting such.

Bloggers Note: I have disabled the ability to comment on this or any prior blog post. I apologize, but I am too busy during tax season to answer the various questions and comments I receive.

The above blog post is for general information purposes only and does not constitute legal or other professional advice or an opinion of any kind. Readers are advised to seek specific legal advice regarding any specific legal issues.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Small Business Owners - Get on my Mailing List


If you are an owner-manager and/or a shareholder in a corporation and have not signed up for my corporate mailing list, please email me at bluntbeancounter@gmail.com.

I will be sending out specific mailings on matters of importance to small business owners and I am considering, depending upon the interest, holding a roundtable for small business owners who are in the Toronto area. I will start the mailings in May.

Thanks to the many readers who have already signed up.

Monday, April 4, 2016

Reporting the Capital Gains on Your 2015 U.S. Stock Sales

Last year I wrote a blog post titled Foreign Exchange Translation on Capital Gains and Dividends. The article noted that the Canada Revenue Agency (“CRA”) expects you to use the Bank of Canada noon rate or other acceptable exchange rate in effect at the time of purchase and sale for any capital transaction.

To be clear; this means that when you purchase a stock you must translate it at the date of purchase and again at the date of sale [i.e. if you purchased 50 shares of Johnson & Johnson for $80 when the foreign exchange rate is $1.10, your cost for Canadian purposes is $4,400 (50 x $80 x $1.10)]. If you sold the J&J shares later in the year for $90 and the FX rate was $1.45, your proceeds are $6,525 (50 x $90 x $1.45) and your capital gain to report is $2,125 ($6,525-$4,400).

The trouble is, many financial institutions just provide you capital gains summaries based on your U.S. purchase and sale price. If you then multiply that gain by the average foreign exchange rate for 2015 ($1.2787), your capital gain is wrong.

This is a huge issue for 2015, where the U.S. dollar strengthened significantly against the Canadian dollar. You really need to go back and translate your purchases and sales at the FX rate in effect at that time. The same holds for sales of U.S. real estate or any other U.S. capital property.

The above was recently re-enforced when a client of mine advised me of the following:

My client informed me that a certain financial institution was very proud of themselves this year for coming up with a new Realized Capital Gain report and had sent him an email to tell them how wonderful they are.

However, he noted the trouble was they were only reporting capital gains in the original currency, USD.

My client said, “I would bet that many taxpayers are just taking that USD number and converting it to Canadian at the sale date and calling that the gain. Given the big drop in the CAD$ in recent years, they are, of course, under-reporting grossly. There is no warning on the report, not to do this”. He suggested I write another blog post on this topic and hence, today's topic.

When he calculated his capital gain using the rates in effect at the time of purchase and sale, he emailed me to tell me the gain was $35,000 higher than if he had just taken the U.S. gains on the report and used the CRA's average rate for 2015.

It is very important to ensure you translate your capital gains at the actual purchase and sale prices in 2015, or you may be severely under reporting your capital gains.

Bloggers Note: I have disabled the ability to comment on this or any prior blog post. I apologize, but I am too busy during tax season to answer the various questions and comments I receive. 

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.