2013 Federal Budget

The Federal Minister of Finance, Jim Flaherty, today presented the 2013 Federal Budget. While there are no changes to corporate income tax rates, there is an increase to the personal income tax rate on non-eligible dividends paid by most private corporations out of active business income. There is no change to the taxation of eligible dividends paid by most public corporations.

Small corporate business owners planning to sell their business got a pleasant surprise in the budget when Mr. Flaherty increased the capital gains exemption for qualified share sales to $800,000 from $750,000 effective for 2014.

The Finance Minister seemed somewhat preoccupied with closing tax loopholes and stopping international tax evasion and ensuring compliance with the filing of the Foreign Verification Form T1135. To that end, the CRA will launch the Stop International Tax Evasion Program, or the more appropriately named “International Snitch Program”. Under this program, the CRA will pay rewards to individuals with knowledge of major international tax non-compliance when they provide information to the CRA that leads to the collection of outstanding taxes due. The CRA will require the outstanding tax liability to be in excess of $100,000 before entering into such a contract. The reward will provide for payment of up to 15% of the federal tax collected.

Therefore, please be advised, I will not be writing my blog anymore as I will be compiling my snitch list and retiring to Barbados on my 15% reward earnings (Just joking CRA, I have never met or heard of an international tax evader).

I provide a link to my firm, Cunningham LLP's budget summary (which I helped write) for those who want details of the budget.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Cohesive Professional Advice

I have written a couple times about how important it is to ensure a client’s investment advisor, lawyer, insurance agent, banker, business consultant and accountant integrate their advice into one efficient coordinated plan. A plan that takes into account the client’s investment, retirement, income tax and successions needs. 

I have noted that when advisors operate in silos, only the client suffers. Even worse are situations where advisors operate at cross purposes, often trying to protect their own fiefdom and fees.

Thus, when Adrian Spitters, a senior Financial Planner with Assante and the blogger behind The Retiring Boomer blog, offered to write a guest blog on the importance of cohesive advice amongst professionals, I jumped at his offer.

In his blog below, Adrian discusses several situations in which the joint efforts of his clients team of professionals, prevented some potentially disastrous legal results and produced some significant income tax savings. Without further ado, on to Adrian’s blog.

Cohesive Advice

by Adrian Spitters

"Most Canadians find that they lack the financial knowledge, or the time required, to  research all the options available to them and to make the important financial decisions they need to make at critical points in their lifetimes." Individuals, who decide to forgo advice and think they can do it on their own, may find themselves ill-prepared for some of the most important financial and life changing decisions they will encounter in their lifetimes; especially since many of these significant decisions are complex and require cohesive planning from several professionals.

There are a lot of good financial, legal, accounting and insurance advisors to choose from. However, some are lone cowboys that focus on what they do best and give good advice, but rarely consult with their clients other advisors to understand how their recommendations affect their client’s overall financial well-being. This can lead to problems down the road.

For example, I had a client who resisted undertaking a detailed financial plan and financial check-up. Unfortunately, only when he took ill, did he relent and provide me all his financial documents (personal and business).

With his permission, I had a tax lawyer that I work with review his legal documents, as I had some concerns. The lawyer noted there was a $500,000 cash gift clause in his will that was potentially at cross purposes with an Alter Ego Trust that had been set-up previously. He asked my client if his intention was to give his wife $500,000 through his estate and an additional $500,000 from his Alter Ego Trust. My client replied that he only intended to give his wife $500,000 in total.

It turns out that years ago when my client remarried, he had a new will drafted that gave his new spouse a life interest in the home and $500,000 cash from his investment portfolio. As the years passed, it became apparent his only son and new wife did not see eye to eye. To deal with this situation, my client’s accountant recommended he settle an Alter Ego Trust.

My client then met with a new lawyer to create the Alter Ego Trust. He instructed the lawyer that it was his intention to give $500,000 of his estate to his spouse and the rest of his estate to his son. The lawyer, unaware that a $500,000 provision for his wife already existed in his original will, wrote this provision into the Alter Ego Trust. This resulted in a potential $1,000,000 obligation to his spouse, while potentially leaving his son out in the cold, which was not his intention. The new lawyer then redrafted the will to reflect the actual wishes of my client.

Another example of the benefit of cohesive advice is a client couple who wanted to retire and sell their respective 25% interests in a company that they owned with another couple. I had some concerns about certain assets reflected on the company's balance sheet, so I recommended to my clients that they have the financials reviewed by a lawyer and an accountant that I work with to determine if my concerns were well-founded and whether they had any recommendations. My client's agreed to the review. When the tax lawyer and accountant reviewed the company financials, they discovered that the company owned a condominium and also had a corporate insurance policy with significant cash value. As a result, the company did not meet the requirements of a qualified small business corporation (QSBC) and neither shareholder was entitled to their $750,000 lifetime capital gains exemption as the company was currently constituted.

Since the value of the company was approximately $1,200,000 and the shares had no adjusted cost base, the additional income tax owing would have been in the neighbourhood of $250,000 if the company could not be restructured to qualify for the capital gains exemption. However, we were able to work with their accountant and lawyer to restructure and purify their company by selling the condominium. I also arranged to have their insurance agent transfer the insurance policies form the company into their personal names. This process took two years and once the offending assets were removed they found a buyer to purchase their company shares. While there were some costs and taxes involved in selling the condominium and transferring the insurance policies out of the company into their personal names, these costs were minimal compared to the approximately $250,000 in combined tax savings to the shareholders.

In the process of working with this client, the accountant that I worked with discovered that their partners owned a holding company. He noted that the company had two $450,000 insurance policies on each of the partners. He had the insurance agent we work with review the policies. The agent found that the policies were owned by the company, the insurance payments were made by the company and the beneficiaries were the insured couple. This posed a significant tax liability should either of the insured die. When a company makes payments on an insurance policy on behalf of the insured and the insured’s estate receives the proceeds; the proceeds are taxable to the estate (Bloggers note: if the shareholders reported a personal taxable benefit for the insurance paid by their corporation on their behalf, the CRA typically does not deem the insurance proceeds taxable, although some professionals think the proceeds are taxable even if a benefit was reported).

To correct this, our insurance agent arranged to have my client’s insurance agent change the beneficiary of the policies form the insured’s estate to the company. This way the insurance proceeds will be received by the company tax free, and can then be paid as a dividend to the surviving shareholder tax free through the corporation’s capital dividend account. Soon after the changes were made the husband passed away and the spouse received the full $450,000 insurance proceeds tax free, saving her almost $220,000 in taxes.

These real life examples help illustrate the importance of seeking advice from a cohesive team of professionals, who work together to understand your complete financial picture. Otherwise you may find yourself inadvertently, negatively impacting your financial well-being.

Adrian Spitters, FSCI, CFP, FMA, is a Senior Financial Planner with Assante Capital Management Ltd in Abbotsford, BC. Adrian has extensive business experience that includes over two decades of helping individuals, business owners, professionals, and high-net worth families. For further information please visit http://www.assante.com/advisors/aspitters/ or contact Adrian at aspitters@assante.com

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Business and Income Tax Issues in Selling a Corporation

The sale of your business/corporation is typically a once in a lifetime event. Thus, in most cases, you will never have experienced the anxiety, manic ups and downs, legal and income tax issues, negotiating stances, walk-away threats and all the other fun that comes with the experience.

In order to navigate the sale minefield and to come up with a fair negotiated deal, you will require a team that includes a strong lawyer(s), accountant and maybe even a mergers and acquisitions consultant. 

With all that to look forward to, I figured I would provide some of the meat and potato issues you will also have to solve and negotiate.

Assets vs. Shares

In general, the sale of shares will yield a better return for the seller than the sale of assets, especially if the vendor(s) have their $750,000 Qualifying Small Business Corporation (“QSBC”) capital gains exemptions available. However, the purchaser in most cases will prefer to purchase the assets and goodwill of a business for the following two reasons: (1) The purchaser can depreciate assets and amortize goodwill for income tax purposes, whereas the cost of a share purchase is allocated to the cost base of the shares (2) the purchaser does not assume any legal liability of the vendor when they purchase assets and goodwill; whereas under a share purchase agreement, the purchaser becomes liable for any past sins of the acquired corporation (of course, the purchaser’s lawyer will covenant away most of these issues as best they can).

Consequently, the purchaser typically wishes to buy assets whereas the seller wishes to sell shares and thus, the first negotiation point. Whichever way it goes, the buyer knows why you want to sell shares and will typically discount the offer when buying shares instead of assets.

Working Capital (“WC”)

WC is the difference between current assets and current liabilities and measures the liquidity of a company. In simple terms, working capital is cash plus accounts receivable and inventory less accounts payable. WC can be a huge bone of contention in any sale, but especially in an asset sale. The purchaser in most cases blissfully assumes they will keep all the WC and also get a multiple of the corporation's earnings as the sale price. The purchaser typically wants enough WC left in the business such that they will not need to finance the business once they have made the initial purchase and contributed whatever cash or line of credit they feel is required upon the initial purchase.

The WC is a very esoteric concept at best and very hard for most sellers to grasp. Thus, it is vital to deal with this issue upfront and not leave it to the end where it can derail a deal, something I have experienced first-hand.

Valuation

Most sellers have valuation multiples dancing around in their heads like little sugar plum fairies. However, most industries have standard valuation multiples. For most small businesses the multiple is somewhere between 2 and 4 times earnings, with a higher multiple for strategic acquisitions, especially where the purchaser is a public company, since they themselves may have a 15 to 20 multiple.

For many acquisitions, especially by public and larger corporations, the multiple is based on Earnings before Interest, Taxes and Amortization (“EBITA”). However, in addition to EBITA, there will be adjustments to the upside for management salaries in excess of the salary that would be required to replace the current owner (typically you are adding back bonuses paid to the seller in excess of their monthly wages and any other family wages). Occasionally the adjustment could be to the downside, but that is typically only in situations where the business is a technology company or similar that is just starting to make money or finalize a desired product, and the owners wages have not yet caught up to market value. Finally, there will be other additions to EBITA for things like car expenses, advertising and promotion, etc. that a new owner would not necessarily need to incur upon the sale.

Where a purchase is made by a private company, instead of EBITA, the price may be based on a capitalization of normalized after-tax earnings or discretionary cash flows.

Retention

In most cases, the purchaser will require the seller to stay on for a year or two to ensure a smooth transition. The owner will thus be entitled to a salary for that period in addition to the sales proceeds. The retention period can go several ways, some blow up quickly, some end after the year or two, but often the former owner stays on as the business is now growing due to additional funds or more sophisticated management and they enjoy remaining with their baby without the stress of ownership.

Continued Ownership

It is not uncommon for a purchaser to require that the seller maintain some ownership in their company so that they still have some “skin” in the game, especially when they will be staying on with the business. This is also the case where the purchaser is consolidating several similar businesses with the intent of going public. In these cases, we counsel our clients to assume the worst (i.e. that the new owner will make a mess of the business) and to ensure they receive proceeds equal to or only slightly less than they initially desired. We have seen several disasters in consolidation purchases where the seller ends up with minimal proceeds after keeping significant share positions with the lure of the consolidated entity going public and the consolidated company just does not have the expected synergies.

Tax Reorganizations

Where the deal is a share purchase, often the current corporate structure is not conducive to utilizing the QSBC capital gains exemption, especially where a holding company is in place or the company being sold has a large cash position. It is thus vital to ensure at least some initial income tax planning is done so that if the deal moves forward, proper consideration has been given to the income tax planning and the planning is not a wild last minute scramble.

I have only touched on a few of the multitude of issues you encounter upon the sale of your business. As noted initially, it is vital to understand the process and how stressful it may be from the start, and to assemble the proper team to help you navigate through the sale process.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.