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 BDO. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. My posts are blunt, opinionated and even have a twist of humour/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, May 18, 2020

The Business Owner’s COVID Contemplation

As I track the headlines, stay up to date on the many new government programs, and advise my clients during this pandemic outbreak, I find myself coming back time and again to its impact on business owners.

Almost no industry is unscathed from COVID-19, but the business owner has had a herculean assignment. They have been tasked with keeping their business afloat (where possible) through typical or ingenious ways, while being asked to keep as many employees on payroll as possible, while watching their retirement dreams delayed or diminished before their eyes.

In today’s post, I bring you the analysis of Jeff Noble. Jeff is a colleague of mine at BDO, where he specializes in helping family enterprises, private companies, and not-for-profits transition their organization through their business lifecycle. During this time of COVID-19, Jeff’s thoughts on adopting an investment mindset are especially valuable for any business owner contemplating the future.

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By Jeff Noble

Entrepreneurs are a risk-taking bunch. Creative, innovative and ambitious, they invest, re-invest and double down in their business. They give up liquidity in exchange for higher returns.

For the past decade, our private company and family enterprise clients enjoyed an unprecedented time of growth and financial success. Markets were bullish. Global and Canadian economies grew. Business valuations escalated. Capital was inexpensive and available for expansion, acquisition, and innovation. Lifestyles expanded as consumers accumulated goods and used services. The value of homes soared.

Then came COVID-19. It stunned the economy and battered the markets. Everywhere. All at once.

The COVID contemplation


Business owners remember ‘BC’—before coronavirus—and are anxious to reach ‘AC’—after coronavirus. Many are using this time to consider the intentional, strategic decisions they must make not just now but also after the outbreak ends. These decisions are based on a ‘COVID contemplation’ and are happening in real time. These choices will affect life, family and future. To master this COVID contemplation, ask yourself these questions:
  • How do I keep my family safe, healthy, happy, fulfilled, and independent?
  • How do I keep myself happy and fulfilled?
  • Should I continue investing in my business or sell it?
  • Do I monetize part—or all—of my business and redeploy the capital?
  • Do I sell and divide the proceeds among my heirs and successors?
  • How do I create and build a better, more valuable business?
  • Do I look for acquisition opportunities and accelerate my growth?


Adopt an investment mindset


Going forward, private company owners should use an investment mindset when considering how to grow their wealth. By adopting this investment mindset, the owner takes into account not just their business but rather the entire family net worth.

The investment mindset considers the unique wealth dynamic of private company owners—where every success depends directly on the success of the business. This dependency creates risk and threatens the finances, lifestyle, and the very livelihood of private company owners and their families.

Just as investment counsellors work to create diversified wealth portfolios, business owners can adopt this practice with the objective of avoiding the risks associated with business concentration. The ultimate scorecard is not your margin or topline or even your bottom line. The ultimate scorecard is the change in the value of your business from year to year. Does this trend in valuation and outlook for the future justify your ongoing investment?

Appreciate the importance and impact of purposefully shifting risk away from the operating business towards other non-related investments. For many entrepreneurs, this focus on balancing liquidity and risk will be a strategic change of mindset. For example, there may be ways to unlock and release value from the corporate balance sheet and deploy that capital outside the business to develop a separate wealth stream, optimize working capital, and continually work to increase cash flow for investment in and out of the business. Regularly monitor the value of your business as you would any other investment. The objective is to create stronger, more stable balance sheets for your business and for your family. Use this goal as a filter when investing to decide where the best investment is for your family’s money.

This means integrating the company into the total family wealth portfolio. This family wealth portfolio consists of all tangible assets, includes the operating business (or businesses) and such things as home, vacation property, investment portfolio, life insurance, savings, and even high-value collections such as jewelry, art, cars, and boats. This emphasis puts balanced wealth creation ahead of lifestyle—creating diversified, de-risked family enterprise wealth and multiple income streams. Ultimately, you and your family will be better protected from economic volatility and shocks to your business.

6 strategies for your business and your family wealth

  1. Seek out alternative and supplementary revenue streams. For example, look at online sales, new customer segments, acquisitions, or alliances with a complementary business.
  2. Reduce supplier concentration. Look for new suppliers who can provide your current or similar goods and services—or for new suppliers to provide new or complementary goods and services.
  3. Take an objective, unbiased look at your business model—how you make a margin. Examine businesses that operate in different sectors, and adapt practices that could improve your model.
  4. Establish a level of return you want to make on your invested capital. Be sure to include a ‘risk premium’ over and above the actual and opportunity cost of that capital. Then, when looking to invest in your business—capital, equipment, buildings, people—understand the return that investment will generate. If that return does not match or exceed your objective, consider a different investment outside of your business.
  5. Work through your balance sheet. Look for ways to remove capital. These could include recapitalization with leverage or selling some equity to a third party or to management or family successors. With this capital now removed from your business, work with professional advisors to find investments that balance risk against your operating business.
  6. Enhance your business. Critically look at your business weaknesses and opportunities with the assistance of an expert. Look for ways to enhance your businesses value through technology, more professional management, new or reduced product lines or any number of ways to ultimately make your business more attractive to a buyer down the road. I often partner with my colleagues at BDO who specialize in enhancing the value of a business.
COVID-19 devastated the economy. It will recover. Some businesses may not survive. Many others will manage through. We expect the best of these will be well positioned to thrive in the post-crisis economy. Entrepreneurs will continue to work hard, innovate, and be creative. Those who view their business through an investment lens will create true, sustainable wealth for their families and generations to come.

Jeff Noble is a senior consultant and family enterprise advisor in the BDO Advisory Services practice. He can be reached at jnoble@bdo.ca, or by phone at 905-272-6247.

For more on how to respond, adapt, and move forward from COVID-19, check out the BDO collection of resources.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Monday, May 4, 2020

Alter Ego Trusts and Joint Partner Trusts – An Example

Way back on March 9th, I posted a guest blog post by Katy Basi on the basics of Alter Ego Trusts and Joint Partner Trusts. Who would have thought it would be 8 weeks later before I was able to publish Part 2 of this excellent series by Katy?

In Part 2, Katy uses an example situation to reflect the benefits of these trusts and some of the complicated tax issues that can arise when utilizing these trusts. I thank Katy for her excellent blog posts.
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By Katy Basi

Our previous blog provided a simplified explanation of Alter Ego Trusts (AETs) and Joint Partner Trusts (JPTs) and set out some pros and cons of using these types of trusts. The following is a sample fact situation illustrating why and how an AET or JPT can be useful – your advisors would be able to let you know if you are a good candidate for this type of planning.

Let’s take the example of John, a 72-year-old debt-free widower with two adult children. John owns his home in Ontario, having a value of $1.2 million, and he is planning to live in his home for the remainder of his life (he will leave his home feet-first, in his words). He also owns a non-registered portfolio of listed stocks and bonds worth $600,000 (cost base is $350,000) and a $500,000 RRIF. John sits down with his advisors (investment counsel, accountant and estates lawyer) and they all recommend that he set up an AET. Why?

In John’s case, this recommendation relates to the 1.5% estate administration tax in Ontario (aka probate tax) that would otherwise be payable on the value of John’s home and investment portfolio upon his death. Having an AET created to be the new owner of these assets results in a probate tax savings of approximately $27,000, so the recommendation is certainly worthy of consideration – who doesn’t like to save on taxes? John’s RRIF cannot be transferred to the AET, but he has named his two children as equal beneficiaries of the RRIF. As a result, there will be no probate tax on the RRIF as long as at least one of his children survives him.

As noted in our prior blog, an AET can be created when the settlor (John in our example) is 65 years of age or older. An AET is a living trust, meaning that it is created while John is alive (as opposed to a testamentary trust, which would usually be created in John’s will, taking effect only upon his death). John can transfer assets to the AET without triggering capital gains tax on these assets, unlike the result with other living trusts. Upon John’s death, the assets owned by the AET are deemed by the Income Tax Act (the “ITA”) to have been disposed of by the AET at fair market value, potentially triggering capital gains tax at that time (but no probate tax).

An AET is subject to income tax at the highest marginal tax rate. Hence, as a practical matter, while John is alive the net income earned by the AET on the investment portfolio (after expenses are deducted) would usually be paid or allocated to John by the AET by the end of every calendar year. John would then include this income in his tax return, allowing John’s marginal tax rate to apply (the AET deducts the income allocated to John in its tax return, leaving the AET with no income after the allocation). If John does not need the after-tax income, he can gift it to the AET if desired. The net result is that John effectively pays the tax on the investment income in the same manner as before the creation of the AET – the paperwork is just more complex.

John and his advisors must consider the income tax that will be triggered by John’s death in determining whether an AET is helpful. Thankfully, an AET is permitted to claim the principal residence exemption (unlike most other types of trusts), so any capital gain accrued on John’s home that is triggered by John’s death will not create a tax obligation (provided that the AET’s tax return is prepared and filed properly – professional accounting advice is a necessity here). However, the AET will be taxable on the capital gain triggered on the investment portfolio. Capital gains are only half taxable, but the taxable half of the capital gain will be taxed to the AET at the highest marginal tax rate (53.53% in Ontario). John’s RRIF is fully taxable upon his death, but the RRIF is included in John’s terminal return (the personal tax return filed for John from January 1 of John’s year of death to his date of death). (We note that either John’s children could pay the tax on the RRIF, or the funds in the AET could be used to pay this tax. In either case, the tax rules relating to graduated rate estates will need to be considered carefully in order to ensure that this payment does not create a tax problem.)

Let’s compare this result with the outcome if John did not have an AET. Upon his death, John’s RRIF and the taxable capital gain from his investment portfolio are included in John’s terminal return. John’s RRIF is large enough to soak up all of John’s marginal rates of tax (we reach the highest marginal tax rate in Ontario at an income level of $220,000). Therefore. a sizeable chunk of his RRIF, and the taxable capital gain from the investment portfolio, are subject to tax at the highest marginal rate. This is the same result as with the AET, so the income tax effects of having an AET are neutral for John. This is not always the case, however, and the income tax implications should be carefully considered by anyone who is looking at AET planning.

John has decided that the AET works for him. He has considered the cost of having his estates lawyer draft the deed creating AET and other documents (e.g., trust resolutions), and the cost of having a real estate lawyer transfer title of his home to the AET. John’s investment counsel has assured him that there is no cost to transfer his investment portfolio to the AET. John understands that he will be required to file annual tax returns for the AET, and has an idea from his accountant as to the annual fee for this service. (AET tax returns are due by March 31 – March 30 in a leap year – so earlier than John’s personal tax returns.) John is comforted by the fact that he is a trustee of the AET and has been given complete control of the AET while he is mentally capacitated to manage his financial affairs. He has concluded (somewhat pessimistically) that his life expectancy is such that while he will incur costs to set up and administer the AET, these costs are substantially outweighed by the probate tax savings provided by the AET.

If John has a spouse or common law partner, as defined under the ITA, he could create a similar trust, being the JPT. If both John and his spouse (Joanne) are 65 years of age or older, they can both transfer assets to the JPT without triggering capital gains tax. (If Joanne is younger than 65, she will have to wait until she turns 65 to transfer assets to the JPT on a rollover, or tax-free, basis.) All income generated by the JPT will need to be allocated to either John or Joanne (care must be taken here to ensure that the attribution rules under the ITA are considered – no shifting of income from one spouse to another is allowed). The JPT continues until both John and Joanne are deceased, at which time the tax results are as detailed above.

If you think that AET or JPT planning may be helpful, be sure to reach out to your advisors for their views on your particular situation. AETs and JPTs are far from simple planning - professional advice is an absolute necessity.


Katy Basi is a barrister and solicitor with her own practice, focusing on wills, trusts and estates. Katy practised income tax law for many years with a large Toronto law firm, and therefore considers the income tax and probate tax implications of her clients' decisions. Please feel free to contact her directly at (905) 237-9299, or by email at katy@basilaw.com. More articles by Katy can be found at her website, basilaw.com.


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 and for their specific province.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Monday, April 20, 2020

Six Financial Lessons of COVID-19

The last couple months have been very distressing from a medical and self-isolation perspective. They have also been difficult from a financial and business perspective. I was recently thinking about whether we could learn any financial and business lessons from this time. I came up with six lessons, which The Globe and Mail published on Thursday. I would like to thank Roma Luciw of the Globe for her editing skills.

The article can be found here. If the article does not open, it can be accessed at no charge by signing up with The Globe.

Government program update


I also want to mention some important recent changes to government programs:

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Monday, April 6, 2020

COVID-19 Government Program Updates – Plus: Why Emotions are a Poor Guide to Investing

It is extremely challenging to write financial posts on COVID-19 as the situation is fluid. Whatever the challenge in writing, it is far more difficult for Canadians and small businesses who are adapting to changes on the fly.

The programs Canadians intend to rely upon are upgraded and changed daily by governments, who themselves need to adapt to constantly changing economic conditions. This has caused significant confusion among Canadians about the qualifying conditions and application process for these programs.

For small businesses who are facing gut-wrenching decisions on staffing, the lack of clarity has been a significant issue, as they are not sure whether to lay off staff or to hold on and hope for financial assistance.

Government Program Updates


As I write this post, the original Emergency Care Benefit (ECB) and Emergency Support Benefit (ESB) programs have been replaced by a single more generous program known as the Canada Emergency Response Benefit (CERB).

On wage subsidies, the original 10% Employer Wage Subsidy Program (EWSP) has been maintained, but a sister program called the Canada Emergency Wage Subsidy (CEWS) was announced that introduces a 75% wage subsidy. These two programs will co-exist. It is hoped the CEWS has been upgraded to a level that will allow small businesses to keep their employees on payroll, rather than laying them off, and be incentive enough to rehire employees previously let go. See this detailed article to understand the CEWS and how it works with the EWSP.

Here is an update as of April 8th for the changes to the CEWS.

There have been multiple filing and payment extensions for tax returns, from personal tax, to corporate tax to HST returns. This document is an excellent summary of all the new deadlines and extensions.

If I had to suggest one thing you should do, it would be to watch this webcast by BDO - Part 2: Cash Flow Strategies and Government Incentives in the time of COVID-19. It is an oral breakdown of all these programs with questions. Register then watch here.

There are two other important programs, the Canada Emergency Response Benefit I noted earlier (This program will provide $2,000 a month for up to four months for workers who lose their income as a result of the COVID-19 pandemic) and the Canada Emergency Business Account (loans of up to $40,000). Please check back during the week as I hope to have links or further details added in the next few days.

The pace of change is so quick that some parts of this post may be overtaken by current events by the time you read it. To stay updated, I recommend this hub of COVID-19 coverage created and updated regularly by BDO.

Why emotions are a poor guide to investing


The roller coaster ride the stock market has taken us on has been far less exhilarating than the roller coaster at your favourite theme park. As of April 3rd, the Dow is down 26% for the year and the TSX is down almost 24%. However, on March 23rd, those numbers were down around 35% and 34% respectively. 

This ride really tests our risk tolerance - see the discussion in this blog post under equity exposure - and makes many of us emotional wrecks.

I have always been interested in the emotional side of investing and this topic came up during a conference call I was part of, put on by Tacita Capital, one of the investment managers on the BDO Wealth Advisory platform. The call’s main theme was COVID-19 and the state of the market, but one slide featuring a graphic by Russell Investments really caught my attention.

The graphic’s purpose was to point out how our emotions are a poor guide to investing, which I think most of us agree is a very true statement.

We start out with optimism, and the curve starts to move upwards as we get excited and moves higher as we are thrilled. We then hit a point of euphoria, which Tacita noted is the point of maximum risk. It is also the point where many people plow more money into the market assuming the good times will continue forever.

The curve then turns downward to anxiety, keeps moving downward to fear and from fear to panic, which I would suggest many of us reached on March 23 or earlier (based on what many friends, acquaintances and clients have told me). Unfortunately, the graphic reflects one more step on the downward slope, that being despondency.

The good news is despondency is also the point of maximum financial opportunity (assuming you have cash resources available). From there we thankfully start back up the curve, from hope to relief to optimism.

Every investor is sitting at their own individual stage. Whatever your investing mood and whatever your portfolio’s performance, I keep telling everyone - including myself - that the stage of hope will arrive. Here’s hoping that it arrives sooner rather than later for all of us.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Monday, March 23, 2020

COVID-19: Finances, Retirement, and the Impact on Small Business Owners

Not to assume I speak for all my readers, but my guess is that many of you are feeling like I do, knocked off kilter by limited social interaction, restricted working conditions and the disconcerting feeling of watching your retirement savings dwindle and finances sag.

I have not even mentioned the most serious issue: health. You or a family member may have contracted the new coronavirus. And if you have managed to avoid it, you may still be concerned for yourself and your loved ones, some of whom may be especially vulnerable.

Financial concerns


The financial concerns because of this virus are real. Whole industries such as travel, entertainment and oil have been hit extremely hard. Financial transactions have slowed or ground to a halt in certain industries. Many if not all businesses will be impacted by the economic consequences to fight this virus. Some will bounce back quickly, others more slowly.

We are impacted as employees, small business owners or retirees vis-a-vis the security of our jobs, the stability of our businesses and how we fund our retirement (with retirement funds down 10-30% depending upon your asset mix, in a matter of weeks). The anxiety we all feel is rooted in a reality that will not be fully measurable until the virus recedes and normal life resumes. But normal life will eventually resume, and we can take action now and in the future, to put us in the best position to rebound from the financial challenges of coronavirus.

I have received various questions from individuals and business owners. I will address those questions in this post.

Individuals


I have been asked two questions in particular by individuals:
  1. Should I reduce my equity exposure to limit my stock losses?
  2. I am near retirement - should I delay my plans?

Equity Exposure


In a perverse way, COVID-19 has forced many of us to learn about our risk tolerance and ability to handle the volatility of our current investment allocation; that volatility is often correlated to the level of equity we hold. If you cannot sleep at night with your current equity or investment allocation mix, then maybe you have too much investment risk and you need to speak with your investment advisor.

This discussion should revolve around whether your equity allocation truly suits your investment objectives and whether the potential volatility of your equity holdings is appropriate for your risk tolerance, now that you have been on the roller coaster ride and can quantify your risk aversion.

You will have noticed I have not directly answered the "should I reduce equity" question. That is because (1) as an accountant I cannot provide investment advice and (2) the answer is really based on your risk tolerance and other factors specific to your own situation. 

As a side commentary, while a requirement of the investment industry is to determine a client’s risk profile and create a portfolio that suits that profile, I would suggest this risk determination is often superficial. Most of us do not understand our true risk tolerance until a situation such as the markets’ rapid reaction to the virus knocks your portfolio down 25% in a matter of days.

The better investment managers I deal with, not only determine your risk tolerance through an interview process but also back-test your tolerance for that risk over the markets for the last 30 years or so. They do this before they invest your money. It would be interesting to see who has been more stressed recently, those with risk tolerances determined purely by questionnaire and discussion and those who also back-tested before they invested. I would guess the latter.

Retirement Plans


It may or may not be too early in this ordeal to alter your retirement plans. We have previously discussed how the sequence of returns can affect your retirement. While sequence of returns technically deals with your investment returns when you start retirement, the reality is that whether practically or psychologically, this significant drop in our retirement savings could impact when we start our retirement.

There is no one-size-fits-all answer to this issue as it will be very fact specific. If you have a pension from your job or some other anticipated flow of funds in retirement, a stock market decline may not be a large longer-term issue assuming the market bounces back at some point like it has done historically.

However, if you were going to draw on your retirement funds immediately upon retirement, the reduction in your nest egg in this bear market could severely impact your retirement plans.

My suggestion is that once things settle down, you review your plans (including the preparation of an actual financial plan or a review/update of an existing plan) with your financial planner, financial advisor or accountant. You will then have objective valuation of whether your retirement date may need to be pushed back a year or two.

Small Business Owners


Small business owners face a whole bunch of concerns sparked by COVID-19 that employees don’t need to manage. These fall into both short- and long-term buckets.


Short-term concerns


Short-term practical concerns include items like how you manage your cash flow, will insurance cover any of the lost profit or expenses and what are business owners’ employment responsibilities.

Many small business cash flow issues are addressed in this document.

I have been informed by colleagues at my firm who deal with preparing insurance claim reports and the related costs that there is no standard answer to whether a company’s insurance coverage will cover any of their losses due to COVID-19. Each claim will come down to the specific wording of the policy and how that policy deals with such terms as “pandemic,” “infectious disease” and “business interruption.” A legal interpretation may be required in many cases.

The employment law questions are complex and unique in this current situation, and unfortunately, I tell my clients they need to talk to their employment lawyer.

Clients are also asking if Ottawa or provincial governments will provide aid to help keep their businesses afloat. This is a fluid situation. The feds have announced a robust stimulus package, with many details still to follow. [ Note: after publishing this post, the Emergency Care Benefit and Emergency Support Benefit were subsequently rolled into the Canada Emergency Response Benefit (see details here)]. The provincial and territorial governments may also chip in to help their constituents.

Longer term concerns


As discussed earlier, certain industries and businesses have been hard hit by the economic slowdown caused by the virus, and almost all businesses will suffer to some degree – Netflix and Amazon are likely two of the high-profile exceptions. For a couple of the business owners I work with who have been considering selling their business, this sobering event has crystalized the risk of having their retirement concentrated on one major asset: their business. This is known as concentration risk.

They have now come to realize that almost any type of business could be severely impacted by a black swan event such as COVID-19. The risk to their retirement is significant if the concentrated business asset loses value due to an unanticipated event, especially close to their retirement date.

I think once the dust settles, some business owners may get very serious about the process of getting their business ready for a sale, whether in a year or over a couple years. As part of that process, they may undertake a value enhancement process to increase the sale price, by taking the necessary management, technological and other steps to become more attractive for a buyer (unashamed plug, BDO has specialists that assist you in achieving this value enhancement and others that can then take your business to market once the enhancement has been accomplished).

Tax considerations for difficult and uncertain times


Here is a link to a BDO publication released on March 16 about tax considerations for difficult and uncertain times. It is a good read.

A final note on the personal side of coronavirus


This was not a blog post I expected to write. Typically, at this time of the year, I write about how tax season is going. Coronavirus has disrupted our lives, sometimes in small areas that punch way above their weight.

Let me say upfront, I understand restricted social interaction including the cancellation of most sporting events is a minor inconvenience to help slow down the spread of the virus. In comparison to those who have fought wars or escaped warzones or been subject to other horrific issues, social distancing does not compare.

That being said, as most readers are likely aware, I am a big sports guy and I follow the Leafs, Raptors, Blue Jays, NFL football (sorry, CFL fans, I used to love the Argos, but that was many moons ago) and golf, among others. Like many of my friends, I have been shocked by the void of not having sports available to take our minds off the coronavirus as we have had during other economic downturns or communal crises, like SARS or even 9/11. The social distancing that is saving lives has also taken away a diversion that could help sustain everyone’s mental health.

I had never given it much thought, but when I went to my computer to surf and get my mind of the virus issues, I quickly realized the majority of my internet favourite list is made up of sports and investment sites. With no sports to write about and no desire to hear more bad investment news, my internet surfing has ground to a halt. Amazon is now the beneficiary of my increased Kindle book downloads. Probably a better thing intellectually, but I still have a sports void.

For those of you who expected this week to see Part 2 of the excellent series on Alter Ego and Joint Partner Trusts by Katy Basi, I hope to bring that to you in two weeks or when current events dictate. We are living in strange times, and I’ve always taken pride in The Blunt Bean Counter being a living blog, one that responds to events in the market and in our lives. It’s not business as usual for any us, but together we will get through this. I wish you and your families the best of health and a quick financial recovery.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Monday, March 9, 2020

Alter Ego Trusts and Joint Partner Trusts – A Primer

Readers have offered me several suggestions for topics over the last few months. The three most popular requests have been: (1) an update on Tax On Split Income (“TOSI”), which was covered off in late February; (2) a discussion on gifting and leaving money to grandchildren, which you can look forward to in the next month or two; and (3) a discussion on what exactly Alter Ego and Joint Partner Trusts are and the benefits of these trusts.

Your requests are my direction and today I present a primer on Alter Ego and Joint Partner Trusts, by Katy Basi. In two weeks, I will post another blog by Katy, which uses a sample situation to reflect when these types of trusts may be helpful. It will also discuss some of the income taxes associated with these trusts.

If you are a reader of this blog, Katy needs no introduction. If you are a new reader of the Blunt Bean Counter, check out Katy’s past guest posts, including Power of Attorney for Personal Care – Mental Capacity and Medical Assistance When Dying, Estate planning for Extended Families, New Will Provisions for the 21st Century - Your Digital Life, and Cottage Trusts.

I thank Katy for her assistance with this blog post.
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By Katy Basi

Alter Ego Trusts (“AETs”) and Joint Partner Trusts (“JPTs”) are relative newcomers to the estate planning scene, having been introduced into the Income Tax Act (Canada) (the “ITA”) effective January 1, 2000. As the popularity of AETs and JPTs has increased over the last few years, we thought it would be helpful to provide a simplified description of these trusts and some of the circumstances in which they can be useful.

An AET is generally set up for the benefit of one person: a JPT, for the benefit of spouses or common law partners. (In this post when we refer to “spouse” we mean “spouse or common law partner.”) These are inter vivos trusts, meaning that they are set up during a person’s lifetime, unlike testamentary trusts, which are created as a result of the death of a person, generally by being incorporated into the person’s will. (For more on trusts in general, see this great explainer piece.)

The conditions


AETs and JPTs allow a transfer of capital assets to the trust on a tax-deferred basis. In order to obtain this deferral, the ITA sets out a number of conditions.

Some of the key conditions are:
  1. The settlor, meaning the person who transfers assets to the trust, must be at least 65 years of age at the time the trust is created. A JPT sometimes has two settlors being the two spouses.
  2. For an AET the settlor must be entitled to receive all of the trust’s income before death.
  3. For a JPT, the settlor and/or their spouse must be entitled to receive all the trust’s income prior to the surviving spouse’s death.
  4. No one apart from the settlor or, for a JPT, the settlor and their spouse, is entitled to receive any assets from the trust prior the settlor’s death (or the death of surviving spouse in the case of a JPT).
  5. The settlor(s) must be Canadian.
  6. A majority of the trustees must be Canadian, as the trust must be a Canadian resident trust.

Why use an AET or JPT?


AETs and JPTs are not income splitting vehicles and are subject to income attribution. Hence when spouses both contribute assets to a single JPT, it is important to track the income derived from each spouse’s contribution, in order to ensure that the tax reporting is accurate. (In the case of contributed investments, often a JPT would have separate investment accounts for the purpose of tracking the income attributable to the assets originally belonging to each spouse.)

However, AETs and JPTs offer some other important benefits, including the following:
  1. Probate is not required for assets held by AETs and JPTs. For several provinces — notably Ontario, British Columbia, and Nova Scotia — this can save an estate thousands of dollars in probate fees or taxes. Other provinces, such as Quebec and Alberta, have minimal to no probate fees or taxes, and thus AETs or JPTs would not generally be used to avoid these fees.
  2. Wills that are probated are documents available in the public domain; however, an AET or JPT is not submitted for probate and remains private (provided that no litigation ensues requiring production of the AET or JPT deed in court).
  3. These trusts can save substantial professional costs that can be associated with probating and administering an estate, such as legal fees and executor compensation.
  4. As probate is not required for assets owned by an AET or JPT, upon the settlor’s death these assets are available to the trustees on a fairly quick timeline (it is critical to ensure that the settlor is not the only trustee named in the trust deed).
  5. The settlor is often one of the trustees of an AET or JPT. If the settlor becomes incapacitated, the trust deed is usually drafted to permit the other trustees to manage the trust assets. These trusts can therefore be viewed as an alternative to a financial power of attorney.

The downside of AETs and JPTs


You should watch out for several challenges when using an AET or a JPT:
  1. There are upfront legal setup costs and ongoing accounting and tax administration expenses.
  2. There are issues where U.S. persons or U.S. assets are involved or there are potential U.S. estate tax concerns.
  3. AETs and JPTs can restrict the tax benefits of charitable giving, both during a settlor’s lifetime and upon their death.
  4. Losses realized by a settlor personally may not be able to be utilized against gains realized by an AET or JPT, and vice versa.
  5. Capital gains exemptions may be left unclaimed as capital gains realized on assets in the trust will not qualify for the exemption.
If this blog has piqued your interest, check out our next AET/JPT blog in a couple of weeks, which will set out a sample fact situation where an AET or JPT could be a helpful planning tool.

Katy Basi is a barrister and solicitor with her own practice, focusing on wills, trusts and estates. Katy practised income tax law for many years with a large Toronto law firm, and therefore considers the income tax and probate tax implications of her clients' decisions. Please feel free to contact her directly at (905) 237-9299, or by email at katy@basilaw.com. More articles by Katy can be found at her website, basilaw.com.


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 and for their specific province.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Monday, February 24, 2020

Update on TOSI – Questions Answered and Remaining Ambiguities

My last blog post regarding Tax on Split Income (“TOSI”) was posted back in December of 2018. Since then, some tax practitioners have done their fair share of hair-pulling and sobbing over the TOSI rules now in effect. Some saw these rules get passed into law and decided it was a good time to retire. I refuse to retire before the Maple Leafs win that Stanley Cup, so I’m sticking around and digging into the TOSI rules (although based on the Leafs recent play, I may have to select other retirement criteria).

The main complaint from my tax colleagues and our corporate clients is not the new legislation’s complexity but its perceived vagueness. In an attempt to cover all the bases, the Department of Finance created a piece of legislation that is sometimes unclear – which makes advising clients a bit like throwing darts at a moving target.

(So much so that the upcoming new edition of the Canadian Tax Foundation’s book on the taxation of private corporations includes key TOSI info for the tax community. Shameless plug: BDO is co-writing this much-anticipated publication. The book will be out later this year and we will provide an update when it is available).

To get you updated on TOSI, I invited Robert Wyka to discuss and break down the recent developments. Rob is a senior tax accountant in BDO’s Markham office.
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By Robert Wyka

Over the past year, the CRA has provided some clarifying commentary on issues raised by the tax community. Below we discuss some of the items that the CRA has clarified along with remaining uncertainties. Much of the commentary comes from recent technical interpretations and CRA comments at various tax conferences where the CRA was asked how TOSI applies in a variety of circumstances.

Excluded business – The 20-hour test 


The TOSI excluded business exception can be met if a family member who is 18 or older works in the business on a “regular, continuous and substantial basis” in the current year or any five previous years. The legislation provides a “bright-line” test of 20 hours a week. This means that if your spouse or adult child regularly works at least 20 hours per week the exclusion is met and dividends paid to them would not be considered split income (assuming they are shareholders in the corporation).

On the surface, this appeared to be a straightforward test to meet. However, as people are starting to apply these rules to their own situations, some interesting questions arise:
  1. What if my business is seasonal and only operates for part of the year?
  2. What if the nature of the business does not require that many hours? For example, if the husband and wife are the only employees and can run the business with 30 hours of work a week total.
  3. What if I worked for more than 20 hours a week consistently but took a period of time off for maternity leave?
  4. Do the previous five years have to be consecutive?
  5. I married an ex-employee who worked for me several years ago - would they meet this exclusion?
It is important to remember that the 20-hour test is not in-and-of-itself the rule, but rather a tool to assist in determining whether you meet the excluded business criteria – if you work 20 hours a week, you will automatically qualify for this exclusion. The CRA has also confirmed that the requirement to be involved in the business on a “regular, continuous and substantial basis” can be met despite working fewer than 20 hours per week or taking a period of time off. The CRA warns, however, that this depends on the facts of your particular case and highlights the importance of proper recordkeeping. Finally, the 20-hour requirement applies to the portion of the year in which the business operates. If a business is seasonal, one can still meet the exception if at least 20 hours are worked per week when the business is operational.

The CRA has also confirmed that years for the “previous 5 years test” do not have to be consecutive.

Finally, if you marry an ex-employee who subsequently acquires shares of your corporation, those years they worked when not married to you still count for this test. HR types typically advise people not to date co-workers and subordinates, but it appears that, from a tax planning perspective, it just may pay dividends. 

Dividends


It is interesting to note that despite there being strict “reasonability” rules regarding paying related individuals’ salaries, the same may not be true for dividends. At the 2019 STEP conference, CRA was asked to comment on the “excluded business” test using the following fact pattern:
  • Individual X owns and operates a professional corporation, Xco.
  • Spouse Y owns shares of Xco and works as a receptionist for 20 hours a week, thus meeting the bright-line test.
  • Typically, a part-time receptionist working these hours would earn $18,000 per annum. However, because Y is a shareholder, Y receives a dividend of $150,000 each year.
The CRA confirmed that the $150,000 dividend would not be subject to TOSI, as the excluded business exception applies. This may be useful to keep in mind when contemplating remuneration strategies.

If you want to rely on this exclusion, thorough payroll records to support hours worked in the business will need to be available. 

TOSI after death


The death of a taxpayer triggers several serious tax consequences. Some of the most impactful tax planning we do as tax practitioners involves structuring people’s affairs in a way to minimize tax consequences as a result of death.

TOSI is no exception. Thankfully, there is relief for taxpayers who receive shares from spouses upon death. These “piggy-back” tax rules require you to look at how the income would have been treated in the original spouse’s hands. If the income would have been excluded from TOSI if earned by the deceased spouse, the same treatment will apply to the surviving spouse. However, what happens when both spouses die and shares are passed down to surviving children?

The CRA was asked to contemplate the following scenario:
  • Mr. and Mrs. A own all the shares of Opco, which operates a services business.
  • Mrs. A has been actively engaged in the business for at least five years, whereas Mr. A has not been actively engaged in the business.
  • Mrs. A passes away and all her shares are gifted through her will to Mr. A.
  • Subsequent distributions from Opco to Mr. A would not be split income as Opco would be deemed to be an excluded business in respect of Mr. A.
  • How will the deeming rules apply if Mr. A subsequently dies and those shares are gifted to the children as a consequence of his death?
The CRA’s response confirmed that in this situation the attributes of the original deceased parent – Mrs. A – would be transferred down to the next generation when Mr. A ultimately dies and his surviving children inherit the shares of Opco. Thus, Mrs. A’s “good attributes” could ultimately extend to the surviving children after Mr. A passes away, and thus TOSI would not apply to any dividends paid on such inherited shares. 

Multiple businesses


As if the TOSI legislation weren’t complicated enough, the CRA has made it clear that in situations where a corporation operates multiple “businesses,” certain amounts may have to be separately tracked on a business-by-business basis.

Let me illustrate this with an example:
  • Mr. A owns and operates a business through a corporation, BuildCo. His business specializes in two areas: construction, and property management.
  • Mrs. A works 40 hours a week handling the property management side of the business.
At first glance, it appears that Mrs. A meets the “excluded business” exception as she works, on average, over 20 hours per week. Unfortunately, it is the CRA’s position that the construction and property management endeavors represent two separate businesses. Each business is to be evaluated separately for the purposes of TOSI.

In the above scenario, Mrs. A would meet the excluded business criteria only for income derived from the property management business and NOT the construction business. This of course requires businesses to separately track the income and subsequent distributions for each business. 

Corporations that provide services


Typically, if the corporation is not a professional corporation, earns income from unrelated sources, and the specified individual owns directly 10% or more of the votes and value of the corporation, income distributions will not be subject to TOSI. However, an issue arises if the corporation provides “services.” As a condition for the excluded shares exception, the corporation must have less than 90% of its business income from the provision of services; otherwise, TOSI applies (unless another exclusion can be met).

There was some confusion regarding what “business income” meant for purposes of TOSI, as it is undefined. The CRA has clarified that they interpret it to mean gross business income, not net income. Some ambiguity remains for those business owners whose corporation earns service and non-service revenue. In certain circumstances, it may be difficult to determine what is and is not a service, or if the services provided are incidental to the activities generating the non-service revenue.

Consider, for example, a business that sells, installs, and repairs washing and drying machines in condominiums. The sale of the machines is not a service. What about the installation and repair? One can argue that the installation is merely incidental to the non-service item – the sale of the machine. Repair is more ambiguous. Are you repairing machines you previously sold, or are these machines purchased somewhere else but just need repair?

Depending on the facts of your situation, it may not be clear what is, and is not, a service. If you feel that your company may be approaching that 90% threshold, it would be prudent to do a more detailed analysis. The CRA has provided additional guidance and examples here.

Just as with the excluded business exception, the CRA recognizes and expects that taxpayers will have a greater compliance burden as they will now have to track specific revenue streams to ensure they are on side. If your corporation has multiple businesses or a mix of service and non-service revenue sources, speak with your accountant. Your bookkeeping may have to be modified in order to appropriately track these items. 

TOSI in retirement


A common retirement strategy for successful business owners is to sell their business and use the proceeds to purchase an investment portfolio to fund their retirement. This can take either of these forms:
  1. The corporation sells all of its assets and closes down the business. The resulting proceeds are used to purchase an investment portfolio. The corporation now no longer operates the original business but is simply used as a vehicle to hold the investment portfolio.
  2. A holding company is incorporated, which in turn sells the shares of the operating company. The holding company then uses the sale proceeds to purchase investments.
Let us consider scenario #1 for a moment using the following facts. Assume that when WidgetCo was operational, it was an excluded business for Mr. A. Dividends could be paid to Mr. A without triggering TOSI, because he was actively engaged in the business. Fast-forward to today, when there is no Widget business, just the investment portfolio. Can Mr. A still rely on the excluded business exception when receiving dividends from accumulated earnings (i.e., a dividend paid out of historical earnings, not from income derived from the investment portfolio) once that excluded business no longer exists? Based on an August 2019 Technical Interpretation, the answer would be no.

The dividend income will not be subject to the TOSI rules when it is received by “an individual who has attained the age of 17 before a particular taxation year, [and] if it is derived directly or indirectly from an excluded business of the individual for the year." 

The CRA’s position is that although the dividend income in scenario #1 is derived directly or indirectly from an excluded business, it would not be considered derived from an excluded business of Mr. A “for the year." Because WidgetCo’s business was no longer operating in the year the dividend was received, the income cannot be considered to be derived from that business for the year.

Scenario #2 has an analogous analysis and conclusion. 

What about the excluded share exception?


In a June 2019 Technical Interpretation, the CRA was asked to analyze a situation that resembles scenario #2 outlined previously. In this case, the CRA was asked if a taxpayer could rely on the excluded share exemption.

One of the requirements to meet the definition of “excluded shares” is that “all or substantially all of the income of the corporation for the [previous] taxation year … is income that is not derived, directly or indirectly, from one or more related businesses … other than a business of the corporation.”

This criterion creates an issue in Holdco-Opco structures. If Holdco’s only income is from Opco (a related business), being dividends or a capital gain on the sale of Opco, then shares of Holdco are not “excluded shares.” If the proceeds of Opco’s sale are reinvested by purchasing publicly traded securities, at what point does the CRA consider the funds held in Holdco not to be “derived directly or indirectly from a related business” (Opco)?

The CRA explained its position as follows:
  • Year of sale – Holdco shares would not be eligible for excluded share treatment. Holdco’s income from the prior year (or current year if this is the first year of Holdco’s incorporation) was derived from a related business (dividends from Opco and/or the capital gain on sale).
  • One year after sale – Holdco shares would not be eligible for excluded share treatment. Holdco’s income from the prior year is derived from the capital gain on sale of Opco, and any dividends paid prior to the sale.
  • Two or more years after sale – Holdco shares would be eligible for the excluded share exception (assuming all other conditions are met). None of its income from the prior year was derived directly, or indirectly, from Opco.
The different treatment of excluded business and excluded shares is important to consider when planning for retirement or a corporate reorganization. Whether or not a TOSI exclusion applies may change after a restructuring or business sale. 

What is a business?


For adults, TOSI only applies to amounts received from a “related business.” However, when considering the aforementioned retirement scenarios, is sitting on a beach drinking mojitos and collecting dividends really a “business”? After all, how is this any different from holding the investment portfolio in an RRSP or a TFSA? One would think that if no business is present, TOSI should not apply.

The CRA has illustrated a few examples that seem similar to the retirement scenarios I outlined above and did not analyze whether a business even exists. When pressed for more information, the CRA responded that for the purposes of those illustrations, they assumed there was a sufficient level of activity to consider the income derived from a business. It remains unclear how these passive investment corporations will be treated, but it appears the threshold level for considering them to be a business is quite low.

Reading this may frustrate those readers who have incorporated and own rental properties. Rental income is generally taxed as investment income as opposed to income from an active business because of its passive nature (unless you have five or more employees). This results in these corporations not being able to use the more favourable small business tax rates. It seems contradictory that the CRA in one circumstance sees your rental business as passive and thus not privy to lower corporate tax rates but, for purposes of TOSI, sees it as a business from which certain income may be subject to the TOSI rules. 

Reasonable return


If you are not able to fall into the more clearly defined exclusions, one last hope is the “reasonable return” exclusion for individuals 25 years of age or older (there is a more restrictive reasonable return test for individuals aged 18 to 24). However, this exclusion has probably the vaguest criteria to satisfy.

The legislation stipulates that you meet this exclusion if the income received is “reasonable” when regarding factors such as:
  1. Work performed
  2. Property contributed
  3. Risks assumed
  4. Total amounts paid/payable
  5. Other relevant factors
What is reasonable is incredibly subjective. The CRA has provided some basic guidance on their website. The guidance provided is useful in determining whether or not the individual should be receiving income at all. However, as soon as you answer in the affirmative, the question of “how much?” remains unanswered. How much work or risk is required per dollar of remuneration? If you are planning remuneration in advance, how confident can you be that the income you want to pay would meet this exception? Is $100,000 too high, or could you have paid more?

It is very difficult based on a vague set of factors to quantify what level of income is acceptable. It would be wise to try to meet one of the other exclusions and not rely on this one. 

TOSI story – Chapters remain to be written


If you have managed to read this far, you likely have realized TOSI is still very complex - even with the various clarifying statements and Rob's explanations. In all honesty, I had to ask Rob to clarify for me certain parts of his discussion.

TOSI's application is also very case-specific, and it requires a thorough understanding of your business and the role certain individuals play within it. It has become more important than ever to speak with your tax advisor. With proper planning, a good tax practitioner will ensure that your corporate structure and remuneration planning is done properly to reduce any potential TOSI impact.

I anticipate that we will write another TOSI update article in the future to discuss how the CRA is enforcing these rules. This will start to become clear once the CRA begins to issue reassessments, and taxpayers go to court to challenge those reassessments.

Due to the complexity of the TOSI rules, we won’t address any specific questions on this blog post in the comments section. You need to speak with your accountant who is aware of your specific fact situation. In the meantime, make sure you are keeping proper records.

BDO Canada LLP senior tax accountant Robert Wyka is based in Markham and can be reached at rwyka@bdo.ca.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.