Further to my last entries, below is an excellent article written by Bessner Gallay Kreisman, Chartered Accountants :
Tax planning is most effectively carried out throughout the year, and the latter part of the year is an appropriate time to review various income tax and financial planning techniques that are available to individual and corporate taxpayers. Most tax planning transactions require analysis before being implemented so that they can be applied properly and in the right circumstances. For this reason, and since certain matters affected by the federal and various provincial budget proposals could differ from the actual law when enacted, all taxpayers should consult with their financial and tax advisors before initiating any of the strategies outlined in this issue.
PLANNING FOR OWNER-MANAGERS
Freeze or refreeze?
An estate freeze is used to ensure that future growth in the value of a company accumulates in the hands of a shareholder's heirs; it "freezes" the current fair market value of the company in preferred shares. In today's difficult economic environment, when the value of a business decreases substantially, the benefits of freezing are not fully realized, because new shareholders see the value of their shares fall. At such a time, it might be prudent to "unfreeze" the company and refreeze it. Refreezing enables taxpayers to exchange their old preferred shares, obtained at the time of the initial freeze, for new shares with a lower redemption price. Any future gains in value will then be passed on to the holders of common shares. This type of planning helps reduce tax on the death of taxpayers by lowering the redemption price of their preferred shares and transferring more value to their heirs.
The operations of unfreezing and refreezing are accepted by tax authorities and are not considered to be tax avoidance activities, provided that the redemption price of new shares issued at the time of refreezing is equal to their fair market value at that time and the lower value of the company is not the result of a dividend stripping operation.
Salary/Dividend planning
Many factors must be considered in determining the most beneficial combination of remunerating the owner/manager of a closely-held corporation. As with other planning, each case must be examined separately and no one "rule of thumb" can apply to all situations. Here are a few factors to be taken into consideration:
The tax rate of the corporation; the small business deduction (SBD) rate was increased to
$500,000 from $400,000 for active business income effective January 1, 2009
The tax rate of the individual
Exposure to Alternative Minimum Tax
The need for salary income by the individual to qualify for RRSP and CPP/QPP contributions or
to benefit from child care expenses
Wage levies applicable to salaries, such as the Ontario Employer Health Tax and Quebec's Health Services Fund and 1% Training Tax (if the payroll exceeds $1,000,000)
Quebec restrictions on the deductibility of investment expenses by individuals
Whether eligible dividends can be paid to shareholders
Full or partial loss of the dividend credit if taxable income is not high enough
Higher net income with a dividend than with a salary, dividend income is grossed up by 45% or 25% (depending on whether the dividend is eligible or not) which can have an impact on certain credits and benefits
Some planning techniques include: Remuneration that is accrued and expensed by a corporation must be paid to the employee within 179 days of the corporation's year-end. Where that year-end falls in the latter half of the calendar year (actually, after July 5), the corporation can cause the owner/manager's remuneration to fall into either the current or subsequent calendar year. The payment of dividends can be used to reduce or eliminate the owner/manager's CNIL, thus maximizing the amount of capital gains exemption that may be available to the taxpayer. To the extent that private corporations did not benefit from the small business deduction, the dividends paid from their active business income are eligible dividends that benefit from a lower tax rate. Since only Canadian residents may benefit from this type of dividend, it might be worthwhile to issue a separate category of shares for non-resident shareholders.
Income splitting
Investment income earned by an individual who invested money borrowed at low or no interest from a related person will be attributed back to the lender. Subject to a purpose test, this rule does not apply where the loan is to a related person other than a spouse or minor child. Nor will it apply where the loan is to a spouse or minor child if interest is charged at the prescribed rate in effect at the time the loan is made (the prescribed rate for the fourth quarter of 2009 is 1%). When utilizing this exception, interest must be paid no later than 30 days after the end of the year to avoid attribution of income. For instance, the high-income spouse could lend investment funds to the low-income spouse at the current 1% rate and receive (and pay tax on) the interest income each year, for as long as the loan remains outstanding. The low-income spouse would pay tax on the income generated by the funds and deduct the interest paid to the high-income spouse. Since the attribution rules are complex, caution is advised when contemplating a transfer of property or a loan to a spouse or a child (including transfers indirectly through a corporation or a trust). Some other basic planning ideas would include:
Gifting growth assets to a minor child, as the resulting capital gain is not attributed to the donor;
Gifting property to a child who is not a minor;
Segregating and re-investing "attributed" income of a spouse or minor child;
Deposit Canada Child Tax Benefit (CCTB), Universal Child Care Benefit (UCCB) and Quebec
Child assistance payments (CAP) directly into accounts opened in the children's names;
Use the income of the spouse with the higher income to pay all the family's expenses so that the
spouse with the lower income has more capital available for investment;
Using a trust for the benefit of family members to hold shares of a closely-held corporation.
However, there are restrictions in regard to income-splitting with minor children.
Spouses can choose to share their QPP and CPP retirement pensions. Income splitting may be achieved by having your spouse be your business partner or by having a business owner pay reasonable salaries to his or her spouse or children.
Shareholder loans
Any loan granted by a corporation to an individual who is a shareholder or to a person with whom the shareholder does not deal at arm's length will be taxable in the year in which the loan is advanced, unless one of the following exceptions applies:
The loan is repaid no later than 12 months following the corporation's fiscal year in which the loan was granted. It must be ensured that a new loan is not granted immediately to the shareholder to replace the old one, because the original loan will be taxed as if it had not been repaid
If the shareholder received the loan in his or her capacity as an employee for the purpose of purchasing a home, a car or newly issued shares of the corporation. However, this type of loan must be available to all employees and bona fide arrangements for repayment must be made at the time the loan is made
The loan is made in the normal course of the company's business activities
If the loan meets one of these exceptions, the shareholder will be required to pay to the corporation interest at a rate at least equal to the prescribed rate no later than January 30 each year. If a shareholder loan exists at any time during the year, a taxable benefit must be calculated based on the prescribed interest rate, less the interest actually paid. When a loan is repaid, the shareholder may claim a deduction up to the amount that had been included in income. It might be worthwhile for a corporation to make a loan to an adult child of the shareholder at a time when the child does not have much income. The loan may be repaid in a subsequent year, when the child's marginal tax rate is higher. Since shareholder loans are not deductible from a corporation's income, it is recommended that shareholders verify whether it would be more advantageous to be paid a salary or a dividend. It is very important that any loan contract between a corporation and one of its shareholders be adequately documented.
Capital gains exemption
A capital gains exemption is available for individuals to use in relation to gains realized on qualified small business corporation shares and some other properties. The maximum lifetime capital gain exemption is $750,000. Notwithstanding the income attribution rules, it may be advantageous to transfer a certain portion of qualifying growth assets to children to enable future capital gains to be exempt from taxation by utilizing the child's capital gain exemption. Consideration should be given to crystallizing a gain that qualifies for the exemption. Because of Alternative Minimum Tax (AMT), however, a crystallization may be more beneficial if spread over more than one year. Be aware of the possible disadvantage of selling investments eligible for the $750,000 capital gains exemption and investments with losses in the same year. Capital losses realized in the year must be offset against capital gains of that year including "exempt" gains, thus leaving a smaller amount available to claim the exemption against. Investments with losses should therefore be kept until the next year.
Capital gains rollovers for small business investors
To improve access to capital for small businesses with high growth potential, there exists a tax measure that, subject to certain conditions, permits individuals to defer capital gains on eligible small business investments to the extent that the proceeds are reinvested in another eligible small business. The reinvestment in an eligible small business must be made at any time in the year of disposition or within the first 120 days of the following year.
Acquisition of assets
Accelerate the acquisition of depreciable property used in carrying on a business otherwise planned for the beginning of the next year. This will allow additional depreciation to be available to be claimed in the current year. The "available-for-use rules" should be considered (generally requiring the depreciable property to be used in operations for the depreciation deduction to be allowed). Eligible computers and software acquired after January 27, 2009 and before February 2011 are entitled to a capital cost allowance of 100% the first year in which the assets are available for use. Conversely, consider delaying until the subsequent year the acquisition of depreciable property in a class that would otherwise have a terminal loss in the current year.
Corporation tax on capital
In Ontario, the capital tax rate, which will be eliminated effective July 1, 2010, will drop from 0.225% of paid-up capital in 2009 to 0.15% for the first 6 months of 2010. Taxpayers affected are granted a $15 million deduction from paid-up capital. In Quebec the capital tax will be eliminated effective January 1, 2011. At the same time, the rate will fall from 0.24% in 2009 to 0.12% in 2010. A $1 million deduction applies to the paid-up capital of a group of associated corporations. A corporation with liquid assets at its disposal may reduce its capital tax if, before its fiscal year-end, it uses them for the repayment of certain liabilities such as shareholder loans or to purchase eligible investments. However, the corporation must have held certain of these investments for a continuous period of at least 120 days, including the date of its fiscal year-end.
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