The Best of The Blunt Bean Counter - Legacy Stocks - To Sell or Not Sell? That is the Question?

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting a March, 2017 blog on whether to sell Legacy stock positions. People are often frozen into "in-action" because of the tax consequences of selling a legacy position, especially where you have a large unrealized capital gain.

Legacy Stocks - To Sell or Not Sell? That is the Question?

Some people, typically seniors/baby boomers have owned stocks for decades, either through direct purchase or an inheritance of some kind (stocks transferred from a deceased spouse pursuant to their will generally have an adjusted cost base equal to what the deceased spouse originally paid for the shares; shares inherited from a parent or grandparent will generally have a cost base equal to the fair market value on the day of inheritance). These stocks are commonly known as Legacy Stocks; more often than not, they will include shares of Bell Canada, the Canadian bank(s) and/or insurance companies.

In early 2017,  Rob Carrick, The Globe and Mail’s excellent personal finance columnist  mentioned to me that several of his readers had asked him about selling their legacy stocks (or as more typically is the case, not selling their legacy stocks). I told him I thought the issue would make a good blog topic and asked him if he was okay with me using his idea to write a post. He gave me his blessing, so today I am writing about the issues and considerations for those of you holding legacy stocks and similar type securities.

The Common Quandary

The issue with selling legacy stocks is that they:

1. Typically have huge unrealized capital gains and thus the sale of these stocks creates a large tax bill

2. The realization of the capital gain can result in a clawback of Old Age Security ("OAS"), which seniors are loathe to ever repay

I know some readers, especially my millennial readers are thinking to themselves “Is Mark really going to write about minimizing the large capital gains of baby boomers that have already benefited from the huge increases in real estate? Cry me a river that they owe some tax.” The answer is yes, since a tax issue is a tax issue and this blog, although meant for everyone, is targeted to high-net-worth individuals and owners of private corporations.

There Is No One Size Fits All Answer

If you have a legacy stock(s) you are considering selling, there is not a standard “one size fits all” answer. There are various investment and income tax considerations. I discuss these issues and considerations below.

Capital Gains Rates

The marginal tax rate for capital gains in Ontario for income in the $45-$75k range is approximately 12-15%. This rate jumps to 19-22% or so between $90-$140k in taxable income and hits 26.8% once your taxable income exceeds $220,000.

Capital gains rates are the lowest tax rates you get in Canada. So from my perspective, the taxes you would pay from the sale of a legacy stock should not be the determinant in deciding to sell. The key factor (subject to the discussion below) should always be what the best investment decision is. Watching a stock drop 15%, to save 20% in capital gains tax, makes absolutely no sense, when viewed in isolation.

There has been concern the last few years that the Federal government may change the taxable inclusion amount of a capital gain from 1/2 to 2/3 or even 3/4. However, as this is only conjecture, if you were to sell for this reason only, you would be accelerating your tax payable.

Old Age Security Clawback

As noted above, the capital gains tax tail should not wag the tax dog. However, there is one issue that complicates the matter for seniors and that is the Old Age Security Clawback.

As evidenced by many accountants’ scars and wounds, never cause even the sweetest senior to have an OAS claw back, because all hell breaks loose :). I am only half-joking; seniors really resent having their OAS clawed back. I assume it is because they feel they have an entitlement to this money and the government does not have the right to claim all or some portion back (even though, they did not directly fund this program).

Seniors must pay back all or a portion of their OAS as well as any net federal supplements if their annual income exceeds a certain amount. For 2017, if your net income before adjustments is greater than $74,789 ($73,756 for 2016) then you will have to repay 15% of the excess over this amount, to a maximum of the total amount of OAS received. The maximum repayment is hit around $119,000.

So if you have a capital gain on a legacy stock of $90,000 ($45k taxable) and you are right at the $74,789 OAS limit before the capital gain, the tax cost of the capital gain would be around $15,000 or 17% of the $90,000 gain. However, when you add the OAS clawback that would be applicable, the combined tax and OAS clawback could approach $22,000 or 25% or so. That is why you cannot look at the gain in isolation.

If you do not have an investment reason to sell your stock, you may want to consider selling the stock over a few years to minimize the tax and OAS clawback, assuming you wish to keep the stock each year.

Holding Company

A “sexier” alternative, especially for seniors is to transfer your stocks to a holding company. You should be able to do this on a tax-free basis under Section 85 of the Income Tax Act. The benefit to doing this is any dividends earned and the eventual capital gain are taxed in the holding company and thus, do not affect your OAS clawback. In addition, if you have any potential U.S. estate tax exposure (see this prior blog post on estate tax), the U.S. stocks in your holding company will not be subject to U.S. estate tax if there is estate tax in place at the time of your passing (estate tax is a U.S. political issue that keeps changing depending upon the party in charge). So while you do not save any actual income tax, you can save your OAS from being clawed back and possibly gain some U.S. estate protection.

The downside to this strategy is the cost to transfer the stocks (legal and accounting) and ongoing accounting costs, which can be high for a holding company and thus, potentially a significant part of the OAS clawback savings is now paid to your accountant instead of the government, so you have to weigh the savings versus the costs.

Capital Losses

If you plan on triggering capital gains on legacy stocks, you should review if you have any capital losses you can apply against these gains. The CRA notes your capital loss carryforward balance on your notice of assessment and if you have a My CRA account, you can get this information online. It should be noted, the application of the losses only reduce the capital gains tax, not the OAS clawback.

Charitable Donation

Where you donate public securities to a registered charity, the capital gains inclusion rate is set to zero. Thus, there would be no capital gain to report on the donation of a legacy stock (have your accountant run the numbers, but this should minimize or eliminate the clawback) and you receive a donation credit. This is reported on Form T1170 . This strategy is effective if you make large donations every year or were planning to make a substantial donation and helps the charity since you have more funds to donate than with an after-tax donation.

The decision to sell a legacy stock is not a simple one. The overriding decision should still be an investment decision; however, where you are indifferent to selling, you need to consider the various issues and options I have noted above. Before undertaking any legacy stock selling, you should consult your investment advisor and possibly your accountant.

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. Please note the blog post is time sensitive and subject to changes in legislation or law.

The Best of The Blunt Bean Counter - Capital Dividends - A Tax-Free Withdrawal from your Company

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game (which is not going well by the way, as my handicap has gone up 3 strokes since the beginning of the year). Notwithstanding my handicap increase, I just came back from an awesome trip to Cabot Links. The picture below of the 16th hole at Cabot Cliffs is a bit deceiving since the tee is actually to the left and further up, but it is a blind shot to a two tier green so no day in the park. Plus, when the wind blows it is crazy. The first day with no wind I actually hit to within 15 feet of the pin, the next day with huge winds I aimed ten yards out to the ocean and the ball still blew left of the green, pretty crazy.

Anyways, back to the topic at hand. Next week I start a three-part series on cottages, but today, I am re-posting a March 2015 post that discussed how small corporate business owners can take advantage of the Capital Dividend Account ("CDA"). Given I had over 80 comments, it was of definite interest.

As per my post last week, Tax Planning Using Private Corporations - The New Liberal Proposals there may be future tax changes that impact the CDA. However, at this time, I cannot state with any certainty how those changes may impact the CDA account. 

Capital Dividends - A Tax-Free Withdrawal from your Company

If you are a private corporate business owner, you may be sitting on a treasure trove of tax-free money. Yes, I said tax-free money. The source of these “free” funds is the CDA, which I discuss in greater detail below. Although a CDA account is most often found in holding/investment companies, the largest accounts are often generated in active companies who have sold all or part of their business.

Private business owners often discuss with their professional advisors whether they should take salary and/or dividends, which are both taxable to the owner when paid. However, surprisingly, the possibility of paying a tax-free dividend is often overlooked, which is possible if the dividend is paid from the Capital Dividend Account (“CDA”) of a private corporation to a Canadian resident individual.

The Capital Dividend Account

The CDA tracks certain amounts that are not taxable to the Company and may be distributed to shareholders with no personal tax. For example:

(i) if the company earns a capital gain which is 50% taxable, the half that is not taxable is added to the CDA.

(ii) if the company was paid a capital dividend from another company it invested in, that amount is not taxable and is added to the CDA.

(iii) if the company sells a particular eligible capital property (“ECP”) in the year, the portion of the gain that is not taxable is added to the CDA. Please note that the addition to the CDA occurs at the end of the year in which the sale of the ECP took place. As a result, the CDA cannot be paid out tax-free until the first moment of the following taxation year (there have been significant changes to the ECP rules since I wrote this post, please speak to your accountant. For reference, I wrote this blog post on the changes).

(iv) if the company receives proceeds from a life insurance policy which are considered to be non-taxable, this is added to the CDA.

(v) if the company incurs a capital loss, 50% of such amount that will not be deductible in the current or future years against capital gains and will reduce the CDA.

Filing and Declaring a Capital Dividend

The following are the filing procedures and considerations as to the timing of declaring a capital dividend:

i) For the dividend to be tax-free, the company needs to make an election on Form T2054 - Election for a Capital Dividend Under Subsection 83(2), which is due to be filed with the Canada Revenue Agency on or before the earlier of the day that the dividend is paid or becomes payable.

A certified copy of the Director(s) resolution authorizing the capital dividend and a detailed calculation of the CDA at the earlier of the date the capital dividend is paid or becomes payable must accompany the Form T2054.

If the Form T2054 and attachments are filed late, a penalty will arise.

ii) If the Canada Revenue Agency reviews the election and determines that the capital dividend paid (or declared) was too high, then a penalty, equal to 3/5 of the excess of dividend over the CDA balance available, will arise.

It is possible to avoid such penalty if an election is made to treat the excess portion as a taxable dividend at the time it is paid, and such election is filed within 90 days after the date of the notice of assessment in respect of the tax on the excess, noted above.

To avoid these negative consequences, it is important to properly calculate the CDA.

iii) The CDA is a cumulative account from the date of incorporation (assuming it has always been a private corporation). If the company has not previously filed a Form T2054, it will be necessary to review the historical capital gains and losses and corporate activities from the date of incorporation to the date of the dividend in order to determine the correct CDA balance.

iiii) The CDA is paid at a moment in time. If you have a CDA balance but incur a loss the next day, your CDA balance is reduced. Thus, in general, it is prudent to pay a CDA dividend when the account reaches a material amount (this amount is different to each person) so that you do not take the risk of a capital loss reducing the balance in the account. If you pay a capital dividend and then incur a capital loss, the account can go negative.

Further analysis may be required for any non-resident shareholders, since a payment from the CDA to a non-resident of Canada is subject to non-resident withholding tax and the dividend may be taxable in their country of residence.

Journal Entries

Some companies reflect capital dividends by adjusting journal entry (“AJE”), rather than paying the actual dividend. Where the dividend is paid by AJE, the shareholder loan is credited. This creates a tax-free loan owing from the company to the shareholder. The CRA has stated that an AJE on its own does not constitute payment of the funds and that a demand promissory note accepted by the recipient as absolute payment together with an indication of such an intention in the resolutions is at a minimum required to have the dividend considered paid and received.

Balance Determination

Where a company has had more than one accountant and/or has amalgamated with other corporations in the past, the determination of the CDA can be problematic. The CRA now allows you to file Schedule 89 to help your verify the account. Note, they may only verify part of the years, so for older companies, this may still be problematic.

Speak with your accountant to see if your private company has a CDA balance. If so, paying out a capital dividend should be considered as part of your Company’s overall remuneration strategy.

 

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. Please note the blog post is time sensitive and subject to changes in legislation or law.

Legacy Stocks - To Sell or Not Sell? That is the Question?

Many people, typically seniors/baby boomers have owned stocks for decades, either through direct purchase or an inheritance of some kind (stocks transferred from a deceased spouse pursuant to their will generally have an adjusted cost base equal to what the deceased spouse originally paid for the shares; shares inherited from a parent or grandparent will generally have a cost base equal to the fair market value on the day of inheritance). These stocks are commonly known as Legacy Stocks; more often than not, they will include shares of Bell Canada, the Canadian bank(s) and/or insurance

companies.

Several weeks ago, Rob Carrick, The Globe and Mail’s excellent personal finance columnist  mentioned to me that several of his readers had asked him about selling their legacy stocks (or as more typically is the case, not selling their legacy stocks). I told him I thought the issue would make a good blog topic and asked him if he was okay with me using his idea to write a post. He gave me his blessing, so today I am writing about the issues and considerations for those of you holding legacy stocks and similar type securities.

The Common Quandary

The issue with selling legacy stocks is that they:

1. Typically have huge unrealized capital gains and thus the sale of these stocks creates a large tax bill

2. The realization of the capital gain can result in a clawback of Old Age Security ("OAS"), which seniors are loathe to ever repay

I know some readers, especially my millennial readers are thinking to themselves “Is Mark really going to write about minimizing the large capital gains of baby boomers that have already benefited from the huge increases in real estate? Cry me a river that they owe some tax.” The answer is yes, since a tax issue is a tax issue and this blog, although meant for everyone, is targeted to high-net-worth individuals and owners of private corporations.

There Is No One Size Fits All Answer

If you have a legacy stock(s) you are considering selling, there is not a standard “one size fits all” answer. There are however, various investment and income tax considerations. I discuss these issues and considerations below.

Capital Gains Rates

The marginal tax rate for capital gains in Ontario for income in the $45-$75k range is approximately 15%. This rate jumps to 22% or so between $90-$140k in taxable income and hits 26.8% once your taxable income exceeds $220,000.

These capital gains rates are the lowest tax rates you get in Canada. So from my perspective, the taxes you would pay from the sale of a legacy stock should not be the determinant in deciding to sell. The key factor (subject to the discussion below) should always be what the best investment decision is. Watching a stock drop 15%, to save 20% in capital gains tax, makes absolutely no sense, when viewed in isolation.

Some tax pundits think the upcoming (no date yet announced) Federal budget may change the taxable inclusion amount of a capital gain from 1/2 to 2/3 or even 3/4. If you are one of those people, now may be a time that the capital gains rate becomes a more significant factor in making your decision to sell a legacy stock (some people are selling and buying back). However, this is only a rumour and if there is no change in legislation, you would accelerate your tax payable.

Old Age Security Clawback

As noted above, the capital gains tax tail should not wag the tax dog. However, there is one issue that complicates the matter for seniors and that is the Old Age Security Clawback.

As evidenced by many accountants’ scars and wounds, never cause even the sweetest senior to have an OAS claw back, because all hell breaks loose :). I am only half-joking; seniors really resent having their OAS clawed back. I assume it is because they feel they have an entitlement to this money and the government does not have the right to claim all or some portion back (even though, they did not directly fund this program).

Seniors must pay back all or a portion of their OAS as well as any net federal supplements if their annual income exceeds a certain amount. For 2017, if your net income before adjustments is greater than $74,789 ($73,756 for 2016) then you will have to repay 15% of the excess over this amount, to a maximum of the total amount of OAS received. The maximum repayment is hit around $119,000.

So if you have a capital gain on a legacy stock of $90,000 ($45k taxable) and you are right at the $74,789 OAS limit before the capital gain, the tax cost of the capital gain would be around $15,000 or 17% of the $90,000 gain. However, when you add the OAS clawback that would be applicable, the combined tax and OAS clawback could approach $22,000 or 25% or so. That is why you cannot look at the gain in isolation.

If you do not have an investment reason to sell your stock, you may want to consider selling the stock over a few years to minimize the tax and OAS clawback, assuming you wish to keep the stock each year.

Holding Company

A “sexier” alternative, especially for seniors is to transfer your stocks to a holding company. You should be able to do this on a tax-free basis under Section 85 of the Income Tax Act. The benefit to doing this is any dividends earned and the eventual capital gain are taxed in the holding company and thus, do not affect your OAS clawback. In addition, if you have any potential U.S. estate tax exposure (see this prior blog post on estate tax), the U.S. stocks in your holding company will not be subject to U.S. estate tax (if there is U.S. estate tax -President Trump intends to eliminate the tax). So while you do not save any actual income tax, you can save your OAS from being clawed back and possibly gain some U.S. estate protection.

The downside to this strategy is the cost to transfer the stocks (legal and accounting) and ongoing accounting costs, which can be high for a holding company and thus, potentially a significant part of the OAS clawback savings is now paid to your accountant instead of the government, so you have to weigh the savings versus the costs.

Capital Losses

If you plan on triggering capital gains on legacy stocks, you should review if you have any capital losses you can apply against these gains. The CRA notes your capital loss carryforward balance on your notice of assessment and if you have a My CRA account, you can get this information online. It should be noted, the application of the losses only reduce the capital gains tax, not the OAS clawback.

Charitable Donation

Where you donate public securities to a registered charity, the capital gains inclusion rate is set to zero. Thus, there would be no capital gain to report on the donation of a legacy stock (have your accountant run the numbers, but this should minimize or eliminate the clawback) and you receive a donation credit. This is reported on Form T1170 . This strategy is effective if you make large donations every year or were planning to make a substantial donation and helps the charity since you have more funds to donate than with an after-tax donation.

The decision to sell a legacy stock is not a simple one. The overriding decision should still be an investment decision; however, where you are indifferent to selling, you need to consider the various issues and options I have noted above. Before undertaking any legacy stock selling, you should consult your accountant and investment advisor to account for all your personal circumstances.

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.

The Best of The Blunt Bean Counter- Should Your Corporation’s Shareholder be a Family Trust instead of a Holding Company?

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting a June, 2012 post on whether your corporation's shareholder should be a family trust or holding company.

This determination is a very complex and requires analysis by a tax expert. If you are considering a family trust, you must obtain professional advice to ensure you do not trip over any tax "land mines".

Should Your Corporation’s Shareholder be a Family Trust instead of a Holding Company?

I am often asked by clients incorporating a new company, whether they should hold the shares of the new corporation directly or whether they should utilize a holding company or a family trust.

The exact same question often arises a second time, years later, when a business has been successful and the shares of the corporation have been held by the client and/or their spouse directly and the client is now contemplating whether it makes sense to introduce a holding company or family trust into their corporate ownership structure, for creditor proofing and/or estate planning purposes.

I have discussed utilizing a holding company and introducing a family trust as a shareholder of a private corporation in prior blogs. Today I will discuss these alternative structures in context of a newly incorporated business and a mature business.

When a person decides to start a new business and incorporates (see my blog on whether to start a business as a proprietorship or corporation) there is often a level of uncertainty as to whether the new venture will be successful and cost control is often paramount. Thus, most people opt to keep their corporate structure simple (which really means, they do not want to spend money on lawyers and accountants to set-up holding companies and trusts) which is very understandable.

However, if you have the resources upon incorporation, you may wish to consider having a family trust own the shares of the private corporation rather than directly owning the shares or using a holding company from the outset. The two reasons you may wish to consider this corporate structure are as follows: (1) you can have a holding company as a beneficiary of a family trust which can provide all the benefits of a direct holding company; and (2) a family trust provides the ultimate in tax planning flexibility.

There are several benefits to having a family trust as a shareholder of your private company (I am assuming your corporation is an active company, not an investment company, for which the above is problematic). If the company is eventually sold, a family trust potentially provides for the multiplication of the $750,000 lifetime capital gains exemption on a sale of qualifying small business corporation shares (as of July, 2016, the exemption has risen to $824,177). That is, it may be possible to allocate the capital gain upon the sale to yourself, your spouse, your children or any other beneficiaries of the trust, resulting in the multiplication of the exemption and creating substantial income tax savings. For example: where there are four individual beneficiaries of a family trust, the family unit may be able to save as much as $700,000 (closer to $880,000 as of July, 2016) in income tax if a corporation  is sold for $3,000,000 ($3,300,00 as of July, 2016) or more . In addition, where your children are 18 years of age or over, the family trust can receive dividends from the family business and allocate some or all of the dividends to the children. The dividends must be reported in the tax return of the child, but in many cases, the dividends are subject to little or no tax (if a child has no other income, you can allocate almost $40,000 in dividends income tax-free).

Finally, where you have surplus earnings in a corporation and you wish to creditor proof those earnings, but do not want to allocate those funds to your spouse or your children, you may be able to allocate those funds tax-free to the holding company if it is a beneficiary of the trust. This provides for an income tax deferral of the personal taxes until the holding company pays a dividend to its shareholders.

So you may be asking “Mark, why would I ever not choose a family trust? Some of the reasons are as follows:

1. The initial accounting and legal costs may be as high as $8,000 - $12,000.

2. You may not have children or, if you do have children, they are young and you cannot allocate them dividends without the dividends being subject to the “Kiddie Tax” (a punitive income tax applied when minors receive dividends of private companies directly or through a trust).

3. You are not comfortable with allocating to your children any capital gains from a sale of the business and/or any dividends since legally that money would belong to them.
4. If the business fails, it may be problematic to claim an Allowable Business Investment Loss (a loss that can be deducted against any source of income) that would otherwise be available if the shares of the company were held directly by an individual.
5. There are some income tax traps beyond the scope of this blog post when a holding company is a beneficiary.

As discussed in the opening paragraph, once a business is established and has become successful, clients often again raise the issue of whether they should introduce a holding company or a family trust into the corporate ownership structure. At this stage, a holding company can easily be introduced as a shareholder. The mechanics are beyond the scope of this blog but the transaction can take place on a tax-free basis. However, the holding company essentially only serves one purpose, that being creditor proofing. A holding company is also often problematic, as the level of cash the holding company holds can put it offside of the rules for claiming the lifetime capital gains exemption if the business is sold in the future. Thus, you may wish to consider utilizing a family trust, unless you do not have children or do not anticipate being able to sell the corporation.

If one waits until the business is successful to introduce a family trust, as opposed to introducing one as an original shareholder when the business is first incorporated, the value of the business as at the date of the reorganization must first be attributed to the original owner(s) utilizing special shares (typically referred to as an estate freeze). This means the beneficiaries of the trust only benefit from the future growth of the corporation (i.e.: if the corporation is worth $2,000,000, the parent(s) are issued shares worth $2,000,000 and the children will only benefit on any increase in value beyond the $2,000,000). The costs of introducing a family trust with a holding company beneficiary as part of an estate freeze could be as high as $15,000 -$20,000 as a business valuation is often required.

The above discussion is very complex. The key takeaway should be that having a holding company as a direct shareholder of an operating company, may not always be the most tax efficient decision. A family trust with a holding company beneficiary may be the more appropriate choice depending upon the circumstances.

In any event, believe it or not, the above discussion has been simplified and you should not even consider undertaking such planning without consulting a professional advisor to understand the issues related to your specific fact situation to ensure the planning makes sense and that you are not breaching any of the hidden income tax traps.

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. Please note the blog post is time sensitive and subject to changes in legislation or law.

What Small Business Owners Need to Know - Intercorporate Dividends are not Necessarily Tax-Free Anymore

For many years, it has been standard tax planning to pay any excess cash from your operating company (“Opco”) as a dividend to your holding company (“Holdco”) for asset protection, retirement planning or other investment or business reasons. Where your Holdco is connected to your Opco (in general terms, Holdco is connected where it owns more than 10% of the votes and value of Opco), those dividends will flow tax-free to your Holdco. Where Opco has refundable dividend tax on hand, a dividend paid to Holdco can trigger Part IV tax; so speak to your accountant first.

[Note: As discussed in my blog post the Capital Gains Exemption is Not a Gimme, you may not always want your Opco to be owned directly by your Holdco].

The government became concerned taxpayers were utilizing the tax-free nature of intercorporate dividends to defer or reduce capital gains tax, especially prior to the sale of a business. Thus, the 2015 Federal budget introduced anti-avoidance rules (draft legislation was released in July, 2015 with request for comments) effective for dividends received by a corporation on or after April 21, 2015. These anti-avoidance rules have caused uncertainty in respect to the payment of what were prior to the budget, tax-free intercorporate dividends.

Currently there are “capital gains stripping " anti-avoidance rules contained in Section 55 of the Income Tax Act. These rules have been in place for years and generally are only problematic where there is a contemplated or actual sale to an arm’s length person and the payment of a dividend and an ownership change are part of the same series of transactions. These rules are very complex, but in basic terms, dividends can be paid tax-free to the extent the corporation has what is known as “safe income”, which in simplistic terms is essentially income earned by the corporation after tax. To the extent the corporation does not have safe income, the dividend in whole or part will be converted to a capital gain.

The new rules are broad and now not only catch the arm’s length sales noted in the prior paragraph, but will now capture dividends for which the purpose of the dividend “is to significantly reduce the value of the share”. This is why the new rules are troublesome. When is the standard dividend planning noted in the first paragraph, a dividend to reduce the value of a corporation’s shares?

The rules leave taxpayers and their advisors in the positions of needing to prove that the significant reduction of value that obviously occurs when the operating company pays excess cash to its Holdco is not the intended purpose of the dividend. The issue is more vexing when you consider that often the reduction of the value of Opco was intended, but was not done for tax purposes, but for business or investing purposes.

We are left with uncertainty where large dividends are paid to a holding company, including where the dividend was paid for asset protection purposes and then loaned back to the Opco. The CRA has stated that “lumpy dividends” (large one-time payments) may be considered to have been paid to reduce the value of a share, which is disconcerting.

There are other concerns including stock dividends, but they are beyond the scope of this blog post.

You should discuss with your accountant whether intercorporate dividends should be deferred until there is further clarity in respect of the legislation or whether it is prudent to undertake a calculation of safe income (which are expensive and time consuming) prior to paying a dividend, even if not in contemplation of a sale.

To reflect how much uncertainty and confusion there is with these rules; I am going to have a double disclaimer today. In addition to my usual disclaimer at the bottom of my post, I will again inform you; do not act on any of the general information in this blog post without discussing the issue with your accountant.

I will also not address or answer any of the comments and questions on this post, because of the uncertainty of the rules.

Small Business Owners - Get on my Mailing List

If you are an owner-manager and/or a shareholder in a corporation and would like to be on 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.

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. Please note the blog post is time sensitive and subject to changes in legislation or law.

Holding Companies – Issues to Consider

I have written several blog posts dealing with utilizing a holding company (“Holdco”) either directly as a parent company to your operating company (“Opco”) or indirectly as a beneficiary of a trust. These posts include:

Creditor Proofing Corporate Funds - This post discusses how a Holdco can protect surplus corporate funds and how for income tax purposes, the transfer of funds via a dividend from your Opco to the Holdco is in many cases tax-free (connected corporations).

Should Your Corporation’s Shareholder be a Family Trust instead of a Holding Company? - This blog examines some “fancier” tax planning to not only creditor proof funds, but allow for possible income splitting and multiplication of the capital gains exemption.

Corporate Small Business Owners: Beware; the Capital Gains Exemption is not a Gimme - This post explores the potential issues you may have in accessing the Capital Gains Exemption (“CGE”) including where your Holdco over time has accumulated too much cash and investment assets.

Because the concepts discussed in the blogs above are very complex (even for accountants), these posts have led to numerous questions by readers. In reading these questions, people are typically confused by the interaction of creditor proofing, income splitting and accessing the CGE, especially where they already have a Holdco in place with significant excess cash and/or investment assets. Thus, I thought today I would try and provide a bit of a road map for using a Holdco.

Working Backwards

Creditor Protection

The main reason small businesses owners typically consider using a Holdco in the first place is to creditor protect excess funds earned in their operating company. Most people find the concept of creditor protection (transferring cash and other assets from your Opco to remove the risk of someone suing Opco and making a claim on those assets) simple to grasp and in almost all cases; it makes business and income tax sense. Thus, I am assuming creditor protection is a given when considering using a Holdco.

Capital Gains Exemption

Where you do not think you can sell your business (the value of your business is just personal goodwill such as in a consulting business) a standard holding company often makes sense.

Where Holdco planning gets more complicated is when you want to ensure you have access to your CGE (while alive or when you pass away) and/or want to multiply the exemption and/or want to use your Holdco for income splitting purposes. The key concept to understand here is that; to access your CGE you or a family member must personally sell the shares of your Holdco (since you own the shares of your Holdco which in turn owns your Opco) and Holdco must meet various criteria to qualify for the CGE. If you have your Holdco sell the shares of your OPCO, there is no CGE, since it is a corporation selling, not an individual.

Situations Where you do not Currently have a Holdco in Place

If you currently own 100% of your Opco or own your Opco together with your spouse, you have a couple decisions to make before incorporating a Holdco.

Again, assuming creditor protection is a given, you need to determine if you think you will be able to access the CGE in the future. If the answer is no, you will probably be fine with a garden variety Holdco (Holdco owns 100% of Opco) especially if you already own Opco with your spouse.

Where you own Opco 100% personally and do not think you can access the CGE, you may want to give consideration to freezing (value of Opco is “frozen” at the current fair market value and you get special shares worth the frozen value) Opco and bringing your spouse in as a shareholder in Holdco. Again, in this situation, you would probably just use the typical Holdco/Opco structure with Holdco owning Opco 100%; however, you would have to concern yourself with ensuring you are not subject to punitive income tax rules, for which you would need income tax advice.

No Holdco in Place, but You may be able to Sell your Company in the Future to Access the CGE

Where you think your corporation is saleable to an arm’s length person in the future, the standard Holdco/Opco structure may not be appropriate, as damming cash in your Holdco may put your ability to claim the CGE in jeopardy.

In these cases, subject to your specific circumstances and only after consulting with your tax advisor, you may use either taxable dividends, stock dividends, an estate freeze or some kind of butterfly (a reorganization in which non-qualifying assets are transferred on a tax-free basis to a newly formed corporation, provided that no sale to an arm's length party of the shares of the small business corporation is contemplated at the time of the reorganization) to provide a structure that will allow Opco/Holdco to either constantly remain onside the criteria for the CGE or at least provide a mechanism to stay onside. Based on the recent Federal budget, your advisor may have to concern themselves with your company's safe income, in addition to the punitive rules I noted above.

As discussed in the “Should Your Corporation’s Shareholder be a Family Trust instead of a Holding Company?”, where you have children (especially teenage children or older), it will often make sense to “freeze” the current value of your operating company to you and/or your spouse (if they have original ownership in the Opco) and have a family trust (with a holding company as a beneficiary of the family trust) as the parent of Opco.

Excluding the cost of undertaking this transaction, this structure can provide for multiplication of the capital gains exemption, income splitting (many parents use this structure to tax effectively pay for University) and creditor protection. The nuance here is that the Holdco is not the parent of Opco, but a beneficiary of the trust and therefore is not an impediment to accessing the CGE in the future. Once again, there are punitive tax rules to be wary of and tax advice is essential.

What if I Have a Holdco already in Place?

In situations where you already have a Holdco in place with significant assets, your planning is very complicated and fact specific and beyond the scope of this post. However, typically, subject to your specific fact situation, your advisor will likely suggest either a butterfly, freeze transaction, payment of a taxable dividend or use of a stock dividend that will allow for potential access to the CGE in the future. In cases of a freeze, this may mean you will be required hold the shares at least two years to qualify for the CGE.

I have attempted in this post to provide a bit of a road map for using a Holdco or a variation of a Holdco. However, this topic is extremely complex and fact specific and as such, I have not even got into the various punitive income tax provisions such as the corporate attribution rules amongst the various other punitive rules.

Thus, I cannot stress enough, that this entire blog is simplified and that you should not even consider undertaking any kind of Holdco planning without receiving tax advice from your accountant or tax lawyer.

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. Please note the blog post is time sensitive and subject to changes in legislation or law.

Capital Dividends - A Tax-Free Withdrawal from your Company

If you are a private corporate business owner, you may be sitting on a treasure trove of tax-free money. Yes, I said tax-free money. The source of these “free” funds is the Capital Dividend Account (“CDA”), which I discuss in greater detail below. Although a CDA account is most often found in holding/investment companies, the largest accounts are often generated in active companies who have sold all or part of their business.

Private business owners often discuss with their professional advisors whether they should take salary and/or dividends, which are both taxable to the owner when paid. However, surprisingly, the possibility of paying a tax-free dividend is often overlooked, which is possible if the dividend is paid from the Capital Dividend Account (“CDA”) of a private corporation to a Canadian resident individual.

The Capital Dividend Account

The CDA tracks certain amounts that are not taxable to the Company and may be distributed to shareholders with no personal tax. For example:

(i) if the company earns a capital gain which is 50% taxable, the half that is not taxable is added to the CDA.

(ii) if the company was paid a capital dividend from another company it invested in, that amount is not taxable and is added to the CDA.

(iii) if the company sells a particular eligible capital property (“ECP”) in the year, the portion of the gain that is not taxable is added to the CDA. Please note that the addition to the CDA occurs at the end of the year in which the sale of the ECP took place. As a result, the CDA cannot be paid out tax-free until the first moment of the following taxation year.

(iv) if the company receives proceeds from a life insurance policy which are considered to be non-taxable, this is added to the CDA.

(v) if the company incurs a capital loss, 50% of such amount that will not be deductible in the current or future years against capital gains and will reduce the CDA.

Filing and Declaring a Capital Dividend

The following are the filing procedures and considerations as to the timing of declaring a capital dividend:

i) For the dividend to be tax-free, the company needs to make an election on Form T2054 - Election for a Capital Dividend Under Subsection 83(2), which is due to be filed with the Canada Revenue Agency on or before the earlier of the day that the dividend is paid or becomes payable.

A certified copy of the Director(s) resolution authorizing the capital dividend and a detailed calculation of the CDA at the earlier of the date the capital dividend is paid or becomes payable must accompany the Form T2054.

If the Form T2054 and attachments are filed late, a penalty will arise.

ii) If the Canada Revenue Agency reviews the election and determines that the capital dividend paid (or declared) was too high, then a penalty, equal to 3/5 of the excess of dividend over the CDA balance available, will arise.

It is possible to avoid such penalty if an election is made to treat the excess portion as a taxable dividend at the time it is paid, and such election is filed within 90 days after the date of the notice of assessment in respect of the tax on the excess, noted above.

To avoid these negative consequences, it is important to properly calculate the CDA.

iii) The CDA is a cumulative account from the date of incorporation (assuming it has always been a private corporation). If the company has not previously filed a Form T2054, it will be necessary to review the historical capital gains and losses and corporate activities from the date of incorporation to the date of the dividend in order to determine the correct CDA balance.

iiii) The CDA is paid at a moment in time. If you have a CDA balance but incur a loss the next day, your CDA balance is reduced. Thus, in general, it is prudent to pay a CDA dividend when the account reaches a material amount (this amount is different to each person) so that you do not take the risk of a capital loss reducing the balance in the account. If you pay a capital dividend and then incur a capital loss, the account can go negative.

Further analysis may be required for any non-resident shareholders, since a payment from the CDA to a non-resident of Canada is subject to non-resident withholding tax and the dividend may be taxable in their country of residence.

Journal Entries

Some companies reflect capital dividends by adjusting journal entry (“AJE”), rather than paying the actual dividend. Where the dividend is paid by AJE, the shareholder loan is credited. This creates a tax-free loan owing from the company to the shareholder. The CRA has stated that an AJE on its own does not constitute payment of the funds and that a demand promissory note accepted by the recipient as absolute payment together with an indication of such an intention in the resolutions is at a minimum required to have the dividend considered paid and received.

Balance Determination

Where a company has had more than one accountant and/or has amalgamated with other corporations in the past, the determination of the CDA can be problematic. The CRA recently announced that as of April, 2015, a CDA balance request form will be available to hopefully alleviate this tracking issue.

Speak with your accountant to see if your private company has a CDA balance. If so, paying out a capital dividend should be considered as part of your Company’s overall remuneration strategy.

 

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. Please note the blog post is time sensitive and subject to changes in legislation or law.Please note the material is time sensitive and subject to changes in legislation or law.

Tax Planning Strategies to Minimize the Old Age Security Clawback

Question: How does an accountant enrage a sweet, mild mannered genteel grandmother?

Answer: Tell her some or all of her Old Age Security (“OAS”) payments were clawed-back on her tax return.

One lesson I have learned over the years is that whether a senior is a multi-millionaire or just well to do, they consider their OAS payment as sacred and any tax planning that causes even one dollar to be clawed-back may result in a tirade against their shell-shocked accountant.

I can only surmise that people feel they are entitled to so little in retirement related payments that they feel it is very unfair to have any of it taken away. I also think some people mistakenly think they have paid taxes to fund the Old Age Security program; however, that is a common misconception. The plan is funded out of the general revenues of the Government of Canada, which means that you do not directly pay into the OAS plan.

In any event, it is prudent for you and/or your accountant to plan to minimize any OAS clawback and that is my topic for today.

Old Age Security

The OAS is a monthly payment available to most Canadians 65 years of age (will gradually increase from 65 to 67 over six years, starting in April 2023). The eligibility requirements are here:

The maximum monthly OAS payment is currently $563.74 (October to December).

For 2014, you must reimburse all or part of your OAS pension if your net individual income exceeds $71,592 (including the OAS pension). The total amount of this reimbursement is equal to 15% of your net income (including the OAS pension) that exceeds $71,592. The full amount of OAS will be repaid when net income exceeds approximately $117,700.

Avoiding the Clawback

Split Income Election

For most people, the best income splitting technique available, and the most effective way to reduce your income, and thus reduce your OAS clawback, is to elect to split pension income (pension income includes most types of pension income, excluding OAS, CPP/QPP). The election is made by filing Form T1032, “Joint Election to Split Pension Income” with you and your spouse’s annual tax returns. CPP can be split also, but a request must be made to Service Canada (Pension sharing form ISP-1002A)

Income Sources

Not all income is treated equally. Only ½ of your capital gains are taxed, while interest income is fully taxable. Dividends are a strange animal as they are subject to a dividend gross-up (38% for public co. dividends) which causes your income to be increased. Thus, dividends can be detrimental for OAS planning purposes; however, the dividend tax credit tail should not solely wag the investment decision.

Holding Company

If you transfer your non-registered investments into a Holding Company (a rollover tax election form needs to be filed), you will no longer earn this income personally and you may reduce or eliminate your holdback. This sounds like a sexy solution, however it often comes with complications. First of all, you will most likely have to pay an accountant to prepare financial statements and tax returns, which will eat up around half your OAS savings. In addition, upon your death, or upon the death of your spouse if you leave your assets to them, you will have a deemed disposition of your Holding Company shares. That means your estate must pay tax on the value of your holding company at death. This may cause a double tax on death that can often only be alleviated by undertaking some complicated tax planning.

However, you may be able to plan around the double tax issue as discussed by Tim Cestnick in this article: 

To quickly paraphrase Tim’s plan; you transfer your investments into a Holdco and take back an interest free loan. Each year the Holdco declares a dividend to you equal to the full amount of the after-tax earnings of the company. It is important to note the dividend is payable, not actually paid. To cover your yearly cash requirements, you repay your interest free loan as required. Depending upon your financial situation and longevity, at some point the loan is paid off and the company then begins to actually pay the declared dividends, but this could be 15-20 years from now.

When you pass away, your heirs become the owners of the Holdco. The investments can then be distributed from the company in the form of the declared and unpaid dividends and may allow for some income tax savings. More importantly, the value of the company’s shares at the time of your death may have minimal value because the dividend liability owing by the company may be around the same value as the investment assets. This significantly reduces the double tax issue.

This planning is complicated and before you undertake Tim’s plan, you should consult your accountant to ensure the plan makes sense based on your personal circumstances.

A Holdco also is very effective if you have significant US assets, as the Holdco assets are not subject to US estate tax.

Finally, if you have a separate will for your Holdco (at least in Ontario) you can minimize your probate fees.

TFSA

If you have not maximized your TFSA, you should transfer non-registered money that is generating taxable income into your TFSA, to the extent of your unused contribution limit.

Alter Ego Trust

Alter Ego Trusts are special trusts that can only be created by individuals 65 or over. During the individuals lifetime they must be the only person entitled to receive the income of the trust and the individual creating the trust must be the only person entitled to receive the assets of the trust prior to the death of the individual. There is also a similar concept known as a “joint partner trust” with pretty much the same rules, for married or common law partners.

Where you have non-registered assets throwing off significant interest and dividend income that is causing an OAS clawback, it may make sense to transfer these assets to an Alter Ego Trust to reduce your clawback. Generally the transfer of these assets to the trust is tax-free.

However, since the income earned on these assets will be taxed at the highest marginal rate in the Alter Ego Trust, you have to consider whether the OAS clawback savings and other advantages (probate protection), outweigh any extra income tax costs (i.e.: is the extra tax payment a result of having all this income tax at the highest rate, less than the OAS you get to now keep by moving those assets into the trust).

I have outlined various strategies above that may be used to reduce your OAS clawback. However, I caution you; the complications and extra costs of some of these strategies need to be compared to the actual OAS savings they produce, as I have found that many clients over 65 want fewer complications in their life, not more. Consequently, you may face a tug of war between complicating your financial life or just accepting an OAS clawback.

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.

Using a Corporation to Hold Your Investments

In December 2011, I wrote a post titled “Should your Investment Income be Earned in a Corporation”. Notwithstanding this post, I continue to receive questions and emails on two related topics:

1. Readers who are earning substantial personal investment income ask; should they transfer their investments into a corporation?

2. Small business owners with excess investable assets inquire if they should incorporate a holding company to hold the shares of their existing active corporation’s? An active corporation is a corporation that carries on a real business (manufacturing, providing services, etc.) that does not earn rental income (see exception below), royalties, interest, dividends or capital gains.

Based on these questions and the fact that my clients who have corporations that earn investment income, either ask me to “explain this again” each year or just roll their eyes, when I discuss the taxation of investment income, I figured I would give this topic one more try.

Please note that all tax rates noted below ignore (figuratively and literally) the May 1st Ontario Budget.

Reasons to Incorporate Investment Income

For income tax purposes (as I detail below), there are essentially no reasons to incorporate investment income. However, there are several non-income tax related reasons for which it may make sense to incorporate your investment income.

1. Creditor Proofing - If you have an active corporation (“Opco”), you can protect your cash and retained earnings from creditors (assuming this is not a fraudulent conveyance) by paying any excess cash or retained earnings as a dividend to a newly formed Investment Holding Company (“Holdco”). As long as the Holdco is connected to the Opco for income tax purposes (simplistically, owns greater than 10% of Opco), any dividends can be paid tax-free to Holdco.

This allows you to use tax-deferred funds to invest (i.e.: in Ontario, the small business rate is only 15.5%, so potentially you may defer and have 31% more funds to invest [46.46% high non-super tax rate if you earn income personally-15.5% corporate rate]). Once the excess funds have been transferred and your Holdco earns investment income on these funds, the tax is essentially the exact same amount you would have paid if you earned the income personally. Thus you have no significant tax savings by using a Holdco to earn investment income, the main benefit is creditor proofing. [Note: For fancier planning, you may be able to use a family trust to own Opco and have a holding company as a beneficiary of the family trust].

2. U.S. Estate Tax - if you own U.S. securities, you can avoid U.S. estate tax by moving these securities into a Holdco. However, again there are no actual Canadian income tax savings.

3. Rental Properties- Many people incorporate their rental properties. However, unless you are a large rental operation with more than five employees, the only reason to do this is for creditor proofing in case a tenant or visitor to the building sues you.

There may be a couple other reasons, but these are the three main reasons people use a Holdco for their investment income.

Double Taxation

The utilization of a Holdco is potentially problematic when you pass away. The reason for this is that upon death, you are deemed to dispose of your Holdco shares on your final terminal tax return for their fair market value (unless they are left to your spouse). So you pay tax upon your death on the value of these shares. However, when your estate starts selling the individual securities in Holdco, the Holdco has to pay tax on the same securities you paid tax upon on your final return, a double tax. In order to avoid this result, fancy tax planning is typically undertaken, which can be costly and cumbersome.

Why There are no Tax savings

If you read my December, 2011 post, you will realize that the reason there is no benefit to incorporating your investment income, is because of the extra layer of tax imposed by a refundable tax known as RDTOH (“Refundable Dividend Tax on Hand”).

As I mentioned above, I have been unsuccessful in trying to explain this RDTOH mechanism to my clients, and have now taken a new simpler approach which I will use below.

My examples will use a high-rate Ontario taxpayer (not super-rate) who pays tax at the rate of 46.41% on any interest income earned, 29.54% on eligible dividends and 23.2% on capital gains.

Interest

If you use a Holdco and earn $1,000 in interest income, you would pay the following corporate income tax:

Non-refundable corporate tax $195

Refundable tax $267

Total Tax $462 (46.2%)

As I note above, a high-rate Ontario taxpayer would pay 46.41% on interest income. Thus, for all intents and purposes, there is no benefit to incorporating investment income to earn interest income as the corporate tax rate is almost exactly the same as the personal rate. Further the administrative costs (especially the costs paid to your accountant) of maintaining a corporation would also impact negatively on the use of  a corporation.

Eligible Dividends

If you use a Holdco and earn $1,000 in public company dividends, you would pay corporate tax as follows:

Non-refundable corporate tax $0

Refundable tax $333

Total Tax $333 (33.3%)

As I note above, a high-rate Ontario taxpayer would pay 29.54% tax on an eligible dividend. Thus, the corporation pays more tax initially and there is no benefit to incorporating eligible dividend income (or non-eligible dividend income). However, when a dividend is paid by Holdco, the refundable tax is refunded by the CRA and the taxpayer ends up with an actual tax cost of 29.54%, so there is not an extra tax cost, just an initial disincentive to incorporate dividend income.

Capital Gains

If you use a Holdco and earn $1,000 in capital gains, you would pay corporate tax as follows:

Non-refundable corporate tax $98

Refundable tax $133

Total Tax $231 (23.1%)

As I note above, a high-rate Ontario taxpayer would pay 23.21% on a capital gain. Thus, again, for all intents and purposes there is no benefit to incorporating capital gain income, as the corporate tax rate is almost exactly the same as the personal rate.

I hope I have done a better job simplifying this complicated issue so I don’t have to revisit this issue again in the future; if not, I cry uncle anyways.

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.

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.