Business owners: 5 resolutions for the New Year!

You are a successful business owner...but are you satisfied with your results?

I didn’t think so. Let me help you make your business even more successful in 2011. Here is how I can help:

1. Setting up a proper share structure

Save on taxes! I’ll say it again, save taxes! Having the right structure allows flexibility in terms of tax planning. While you are only required, in law, to have one class of shares (common), it is always best to provide additional classes of shares so that you will have the needed flexibility. You might want an opportunity to income split between family members and save substantial taxes; to attract new investors and possibly to make use of a family trust. The right share structure will help you save on your tax bill in 2011.

2. Enter a shareholders’ agreement

Because happy endings only happen in Hollywood! Every entrepreneur should understand the importance of a written contract to resolve conflicts. A shareholders’ agreement defines the way in which the company should be governed and managed so as to avoid messy and expensive disputes in the future.

3. Set up a holding company

To protect the assets you need to operate your business. You need operating cash flow, a place of business and equipment to make a profit right? So why would you subject them to attacks from creditors? The best way to protect the assets of an incorporated business is through the use of a holding company (Holdco). And you can also save on taxes because when the operating company has excess cash in the operating company each year, it can pay the excess capital to the Holdco as a tax-free dividend.

4. Use discretionary family trusts to maximize income-splitting

Save taxes (again) thanks to your spouse and children. If you have children and/or are married, you should consider owning their shares through a discretionary Family trust because you can further reduce your income tax bill. The benefits of a family trust include: (a) Income splitting: A well-structured family trust allows for the splitting of income earned by the trust among the various beneficiaries (b) Funding of children’s education at a potential and very low tax rate of 16% instead (c) Multiply the allowable tax free gains (capital gains exemption) should you sell your company: Hence, the $750,000 capital gains exemption may be multiplied by the number of family members who are beneficiaries of the trust, without direct share ownership.

5. Prepare primary and secondary wills

Did you know that you’ll be taxed even when you pass on? Yes, thanks to probate fees! You can save significant probate fees if you have a secondary will? Probate fees are the fees charged by provincial governments to probate your Will when settling your estate. As a result, Ontario’s probate fees for a modest estate of $500,000 now amount to $7,000. In order to avoid probate fees on their corporate holdings (i.e. shares in private companies) and by using the “double will” technique, every shareholder should have a primary and secondary will drafted and executed.

2010 Year End Tax Planning for Business Owners

As we all know, Dec. 31st is coming real fast and I advise all my clients to ensure that they doing some year end tax planning. Below is a great summary prepared by the accounting firm, Bessner Gallay Kreisman LLP. As usual, please do not hesitate to contact me directly should you have any questions.

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2010 YEAR END TAX PLANNING

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 that should be taken into consideration:

• The tax rate of the corporation
• The marginal tax rate of the individual
• Exposure to Alternative Minimum Tax
• The ability to benefit from child care expenses, paternity/maternity benefits and to make RRSP and CPP/QPP contributions is based on salary and not dividend income
• 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 where expenses exceed investment income
• 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, as dividend income is grossed up by 44% 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:
• If the corporation has Refundable Dividend Tax on Hand (RDTOH), the payment of a dividend will result in a refund of 33 1/3% of the dividend payment up to a maximum of the RDTOH balance
• Remuneration that is accrued and expensed by a corporation must be paid to the employee within 179 days of the corporation's year-end. When a year-end falls after July 5, the corporation can cause the owner/manager's remuneration to fall into either the current or subsequent calendar year

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. This is accomplished by "freezing" the current fair market value of the company in the form of preferred shares. If the value of a business subsequently decreases, the benefits of freezing may not be fully realized and it may be advantageous to consider "unfreezing" and "refreezing" a company.

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.

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 2010 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
• Have your spouse as your business partner or pay reasonable salaries to your 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 a particular exception applies.

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 and do not generate refunds of RDTOH 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. 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. Consider selling investments with losses the following year. Subject to certain conditions an individual may defer capital gains on eligible small business investments to the extent that the proceeds are reinvested in another eligible small business. The reinvestment 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 (CCA) 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).

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.

Eligible new computers and software acquired before February 2011 are entitled to a capital cost allowance of 100% the first year in which the assets are available for use. Computers purchased after January 2011 will revert to a CCA rate of 55% and be subject to the half-year rule.

Death Benefit

A corporation can make a onetime tax free payment of up to $10,000 to the spouse or heirs of a deceased employee. This payment will not be taxable to the recipient and will be fully deductible by the corporation.

Doctors: What are the Tax Advantages of a Physician Professional Corporation?

Why Have a Professional Corporation (“PC”)

Physicians who carry on their medical practice in Ontario personally pay income tax at a rate in excess of 46%. Such physicians are not permitted to split income with family members, except to pay “reasonable salaries” to family members who provide actual services to the practice. Such salaries are frequently attacked by Canada Revenue Agency (“CRA”). By incorporating a PC to carry on the medical practice, a physician can achieve significant tax advantages by way of paying tax at a much lower corporate tax rate (18.6% rather than 46.4%) and income splitting with family members by paying dividends (which themselves are taxed at a lower rate).

What are the Legal Requirements for a PC?

A PC is incorporated under the Ontario Business Corporation Act (the “OBCA”) as a regular corporation. However, a PC is subject to a number of special rules and restrictions pursuant to the OBCA and the Regulated Health Professions Act. Some of the key restrictions and requirements are as follows:

A physician must be the sole director, officer and own all of the shares with general voting rights;

The name of the corporation must include the physician’s surname plus “Medicine Professional Corporation”; Other family members (spouse, children, parents and trust for minor children) can own non-voting shares(recent change to legislation);

A Certificate of Authorization for the PC from the College of Physicians and Surgeons of Ontario is required;

The physician remains personally liable for all professional matters relating to the practice; and

The activities of the PC must be limited to carrying on a professional medical practice (and related matters and investments).

Are There Any Non-Tax Advantages

The main advantages and reasons for establishing a PC are income tax related. However, although the physician remains personally liable for professional matters, the PC does offer some advantages of limited liability for non-professional matters, such as if the PC borrows money and enters into agreements, such as an office lease and equipment leases.

How does the Lower Corporate Tax Rate Result in Tax Savings

A corporation (including a PC) can earn up to $500,000 per year of active business income at the 17.6% tax rate. This provides a tax savings of approximately 28.8%, compared to the personal tax rate in Ontario that applies if the physician earns the practice income personally (46.4%). This lower tax rate applies only to income left behind in the PC.

What Can You do with Money Left over in a PC

There are a number of efficient uses for the extra after-tax dollars left in the PC. If, for example, a physician is able to leave $50,000 of profit per year in the PC, there will be significant tax savings. The after-tax amount left to invest inside the PC would be approximately $40,700, rather than $26,800, if the $50,000 was earned personally by the physician. This represents a tax savings of $13,900 per year. This after-tax amount can be invested in the PC the same way it would be invested personally by the physician and provides an excellent, tax-efficient method to build up investments more quickly and save for retirement.

Also, the additional after-tax income left in the PC allows the PC to pay off debts more quickly than if the income was earned personally by the physician and provides a tax-efficient method to pay certain non-deductible expenses (life insurance premiums and some entertainment expenses).

How Can You Income Split with a PC

Physicians are allowed to split income with other family members, such as a spouse, parents, children and trusts for minor children. The income splitting is achieved by having the family members own non-voting shares of the PC that can receive dividends as determined by the physician. Dividends are taxed more favourably than other types of income. An individual with no other income can receive up to approximately $32,000 of dividends tax-free. Dividends can be paid most tax-efficiently to family members who do not have significant other income.

What Factors do you need to Consider when setting up the Share Structure:

It is extremely important that the share structure of the PC be set up with advance planning at the outset, in consideration of the following:

Flexibility for changing circumstances of family members;

Flexibility to pay dividends to whatever family members are selected each year by the physician;

Ensuring that the physician retains complete control of the PC;

Allowing the physician to cancel the shares of family members if the circumstances warrant (i.e. marital problems);

Establishment at the time of incorporation of multiple classes of shares, so there is a separate class for each family member (allowing complete flexibility as to dividends payable to each family member); and

Establishing special classes of shares to be issued to the physician on the transfer of goodwill and other assets relating to the practice, such as equipment.

Are There Any Other Tax Advantages

The most significant tax advantages available to a PC are generally the corporate tax rate advantage and the income splitting advantage. However, there are additional possible tax advantages, such as creating an individual pension plan, tax deferral (to next year) by bonus accruals, use of non-calendar year end, no GST payable on dividends and no requirement for dividend recipients to perform reasonable (i.e. any) services.

How Can You Transfer Assets and Agreements to the PC

Since the medical practice will be carried on by the PC, it is necessary to consider what assets and agreements need to be transferred from the physician to the PC. In order to avoid possible tax problems, it is necessary that goodwill relating to the medical practice be transferred from the physician to the PC. Also, it is necessary to consider if there are other assets, such as equipment to be transferred to the PC. Finally, one must consider what agreements there are relating to the practice, such as office lease and equipment leases, which should be transferred to the PC.
Summary

A PC can offer significant income tax savings to a physician. However, it is important that there be proper tax planning in advance by the physician, accountant and lawyer. On the legal front, the lawyer must implement the corporate share structure properly, in order to achieve the maximum tax savings, provide the most flexibility for changing circumstances and to avoid the various tax traps that can apply.

If you would like to consider the suitability of a PC for your situation, please contact me.

Taxman cracks down on IT consultants

Today I would like to share an interesting article written by Peter Kovessy from the Ottawa Business Journal. If you are in this situtation, I encourage you to contact me to review your situation before you get audited by CRA. Its important to have the proper agreement in place, the right set of facts, etc.

Government ignoring committee’s call to recognize realities of ‘modern labour market’
Thousands of local IT consultants are facing hefty tax reassessments as the Canada Revenue Agency reexamines their relationship with staffing agencies that help connect them to the federal government, experts say.

In recent months, the CRA has started “aggressively” auditing these incorporated businesses and ruling their role is more like an employee of a staffing firm than an independent contractor.

The financial stakes for these consultants are said to be high, with some facing reassessed tax bills of up to $50,000, say those involved in the fight with CRA.

If these businesses are deemed to be what the tax agency terms “personal services businesses,” they can no longer claim business expenses – such as office space, supplies and training – as deductions on their taxes. It also means they’re no longer eligible for the favourable small-business tax rate, adding a further financial strain.

“It can have such a significant impact in this town,” says Doug McLarty, managing director of accounting and financial services firm McLarty & Co.

While the frustrations of IT consultants may currently be directed at the CRA, a 1960s-era CFL coach may actually be at the root of the problem.

Ralph Sazio, who led the Hamilton Tiger-Cats to three Grey Cup championships, felt he would be better off tax-wise if he incorporated himself and contracted his services to the football club, says Gowlings partner and tax lawyer Mark Siegel, who represents a “fair number” of IT consultants fighting their reassessments.

He says the tax agency took the case to court and lost, prompting new rules that prevented individuals who incorporate themselves – but perform the functions of an employee – from realizing the tax benefits of a small business.

Government downsizing in the 1990s resulted in many federal bureaucrats becoming consultants to their former employer, especially in the IT sector. Rather than dealing with thousands of individual contracts, the government moved to a relatively small number of standing offers with staffing firms, which in turn subcontracted the consultants.

But Mr. Siegel says the CRA decided in the early 2000s that the consultants were more like employees than independent contractors of the staffing firms, which were then on the hook to make CPP and EI contributions.

To avoid these costs, many staffing firms then required consultants to be incorporated companies if they wanted work, according to Mr. Siegel.

But in 2009, the CRA started taking a different view of many of these independent corporations, observers say.

“They are reassessing these (individuals) – mainly IT consultants – who have created corporations (and) are providing their services, generally, through a staffing agency to federal government departments,” says Mr. Siegel.

“They’re between a rock and a hard place. If the assessment were to come along, a normal person would say, ‘I won’t be incorporated anymore.’ But then the staffing agencies won’t hire them.”

Jennifer Smith, an executive director in the Ottawa tax practice with Ernst & Young LLP, says incorporated individuals deemed to be personal services businesses face a double financial hit.

First, they can no longer deduct normal business expenses incurred while earning revenues.

They’re also ineligible for the favourable 15.5-per-cent tax rate on the first $500,000 of active business income, which is substantially lower than what an individual is taxed.

The CRA weighs several factors in determining whether an incorporated individual is an employee or an independent contractor, such as the degree of financial risk taken, level of control, and the opportunity for profit.

Mr. McLarty adds contractors who do the bulk of their work at a single department are at a higher risk than those with multiple clients.

Federal politicians are aware of the problems caused by the CRA’s new interpretation.

In June, the House of Commons finance committee released a report calling on the government to change the Income Tax Act to reflect “the realities of the modern labour market, particularly in terms of small information technology companies, in order to ensure tax fairness for those small business owners who are deemed to be ‘incorporated employees.’” The recommendation has so far been ignored.

Those representing the affected IT firms say they’re simply seeking clarity for their clients.

“These people are are facing tax bills they can’t pay ... (the CRA is) destroying entrepreneurship in the IT sector,” says Serge Buy, a lobbyist for CABiNET, which represents IT professional service providers in the National Capital Region.

“There should be clear rules that allow you to establish your business practices in a stable way.”

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Common-law tests of whether an individual is an employee or an independent contractor:



-The level of control the employer or hirer has over the worker's activities;

-Whether the worker provides his or her own equipment;

-Whether the worker hires his or her own helpers;

-The degree of financial risk taken by the worker;

-The degree of responsibility for investment and management undertaken by the worker;

-The worker's opportunity for profit (or risk of loss) in the performance of his or her tasks; and

-The intention of the parties, as expressed in the relevant documentation and by their actions.

Source: Ernst & Young

Business Owners: Income Splitting 101 & How can you reduce your tax burden with some Income Splitting" strategies?

if you follow my blog, you know that I enjoy reading Tim Cesnick's article published in the Globe & Mail. Once again, Tim's article is a MUST read for all of you. As usual, please do not hesitate to contact me should you wish to discuss some personal tax strategies.

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The Concept

Income splitting is one of the pillars of tax planning. It involves moving income from the hands of one family member who will pay tax at a higher rate to the hands of someone else in the family who will pay tax at a lower rate. By taking advantage of the lower tax brackets of family members, the overall tax burden for the family can be reduced.

How much tax can be saved? It varies by province, but the average across Canada is $17,000 in potential tax savings annually per family member. Your actual savings will depend on your level of income, your family member’s level of income, and your province of residence. The provinces where the greatest annual tax savings are possible are Nova Scotia ($21,000), Ontario ($19,565) and B.C. ($18,908). Alberta offers the smallest opportunity for annual savings at $13,196.

The Challenge

Here’s the problem: The attribution rules in our tax law are designed to prevent you from simply moving income to someone else’s hands. If you’re caught under these rules, the income earned by your family member will be attributed back to you to be taxed in your hands. The most common situations where these nasty rules will apply are where you give or lend money (at no or low interest) to your spouse or minor children.

The good news? There are quite a few strategies that can be implemented to split income that will sidestep the attribution rules.

The Strategies

Set yourself up for tax savings next year with one of these ideas:

1. Lend money to your spouse or child. You can simply lend money to your spouse or a child for them to invest. In the case of your spouse, all income and capital gains will be attributed back to you, and in the case of minor children, all income (but not capital gains) will face tax in your hands. But second generation income (that is, income on the income) will not be attributed back to you. It makes sense to move the income annually into a separate account so that its growth can be tracked separately from the original loan amount.

2. Lend money to family at interest. This idea is much the same as the one above, except that you can charge interest on the loan to avoid the attribution rules. By charging the prescribed rate of interest (currently just 1 per cent) your family member, not you, will face tax on any income earned. Your family member will have to pay you the interest every year by Jan. 30 for the prior year’s interest charge (if this is overlooked even once, the attribution rules will apply every year going forward). And get this: The current prescribed rate can be locked in indefinitely. So, if you set this loan up before Dec. 31 of this year, the 1-per-cent rate can apply forever. To the extent your family member earns more than 1 per cent on the funds, you’ll effectively split income.

3. Lend or give money to acquire a principal residence. If you help a family member to purchase a home, this will free up the income of that family member for other purposes – such as investing – effectively moving investable assets from your hands to theirs. In addition, if the property appreciates in value, the capital gain could be sheltered using the principal residence exemption of your family member if they are older than 18 or married.

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Example of how you can save $26,000 or more in taxes if you use a Family Trust

Example of the Operation of A Family Trust

Scenario 1: Income Splitting

Mr. X establishes a trust for the benefit of himself, his spouse, Mrs. X, and their three children, A, B and C. A and B are over 18 years of age and attending university. C is a minor living at home.

The participating shares of Opco, Mr. X’s active business corporation, are owned 100% by the trust.

After salaries are paid to Mr. X, Opco is earning $100,000 before tax and $82,000 after tax.

Based on current tax rates, if Mr. X wishes to pay out the net after corporate tax income of $82,000 to himself to enable him to use it personally, he would pay additional taxes of over $26,000 if he were the sole shareholder of the company.

Using the family trust arrangement and paying the income earned by the trust equally to the adult beneficiaries (except Mr. X.), the trust’s dividend could be split evenly between Mrs. X, A, and B. The tax liability on the dividend would thus be taxed as follows:

Mr. X = O in dividend (he is paid via salary)

Mrs. X, A and B all take a Dividend of $27,334 each for a total of $82,000. Hence, if Mrs. X, A, and B have no other sources of income, they would pay no taxes at all on this amount.

Note, that dividends allocated to the minor child would be subject to tax at top marginal rates with no personal tax credits applicable, pursuant to the “Kiddie Tax” provisions.

By using a family trust arrangement, Mr. X has just saved the family unit about $26,000 in tax.

Scenario 2: Capital Gains Splitting

Mr. X has received an offer to sell the shares of Opco (which are "qualified small business corporation shares") for $2,000,000. The shares were acquired for a nominal amount ($100). If Mr. X were to receive the sale proceeds as sole shareholder of the business, his tax liability might be computed as follows:

Proceeds $ 2,000,000
Cost (100)
Capital Gain 1,999,900
Capital Gains Exemption (750,000)
Capital Gains Subject to Tax $ 1,240,900
Taxable Capital Gain $ 620,450
Tax $ 310,225

Under the family trust arrangement, the trust would receive the total $2,000,000 proceeds. The trust's capital gain could be paid out to trust's beneficiaries (if desired by the trustee) and the beneficiaries could shelter the gain with their own $750,000 capital gains exemptions. In this case up to the entire $310,225 in tax calculated above could potentially be saved (subject to alternative minimum tax
considerations).

Note that this benefit can be achieved even if the beneficiary is a minor child, since the "Kiddie Tax" does not apply to capital gains.

Any trust income not actually paid or payable to a specific beneficiary in a given year would be taxable in the trust at the highest marginal tax bracket (thus eliminating the benefits of using the trust).

Amounts will be paid or payable to a beneficiary in the year under the following scenarios:

1. An expense report detailing the year’s expenses incurred by the parent on behalf of a beneficiary is submitted by the parent to the trustee. The trustee initials the report to evidence the exercise of his discretion pursuant to the terms of the trust agreement, and a trust cheque is issued to the parent before the end of the year.

2. The parent requests the trustee in writing to make certain payments to a third party for the benefit of the beneficiary. The trustee initials the written request to evidence the exercise of his discretion and makes the payments to the third party before the end of the year.

3. The trustee declares an income distribution using a trustee’s minute and either issues a trust cheque payable to the beneficiary before the end of the year, or issues a demand promissory note to the beneficiary as evidence of payment before the end of the year.

4. Where the amount of trust income earned is not known in the year (e.g., where a trust owns units in a mutual fund trust) the trustee resolves to make an income distribution to a beneficiary equal to a certain percentage of the undistributed income earned by the trust in the year using a trustee’s minute, and issues a demand promissory note to the beneficiary as evidence of payment before the end of the year.
Under the most recent guidelines released by Canada Revenue Agency, the trust can pay for, or reimburse a wide variety of expenses for a child as long as the payment of the expense clearly benefits the child. Such expenses may include (but are not necessarily limited to):

• Education and tuition expenses
• Recreation expenses and equipment
• The child’s share of restaurant meals and family grocery bills
• Clothing
• Medical and dental expenses
• Spending allowances
• Toys
• Car expenses, including per kilometre reimbursements for driving to and from the child’s activities
• A proportionate share of vacation costs

Asset purchases (e.g., cars, boats, vacation properties) and mortgage payments which cannot or will not be legally registered in a child’s name are problematic and we generally suggest that they not be reimbursed by the trust.

In all cases, receipts should be retained that document the fact that trust funds were spent on the beneficiary’s behalf.

Business owners: What is a business lawyer ?

What is a business lawyer?

A "business lawyer" or a "corporate lawyer" generally refers to a lawyer who primarily works for corporations and represents business entities of all types. These include sole proprietorships, corporations, associations, joint venture and partnerships. Typically business lawyers also represent individuals who act in a business capacity (owners-managers, entrepreneurs, directors, officers, controlling shareholders, etc.). Further, business lawyers also represent other individuals in their dealings with business entities (e.g. contractors, subcontractors, consultants, minority shareholders, employees). Generally, when I use the term "business lawyer" I think of all three of the above.

What types of clients do I represent?

On a daily basis, I represent start ups, family businesses, owners/managers and mid size companies at the regional, provincial, national and international level in a wide range of industries and I advise clients on their legal issue and their day-to-day business issues, including but not limited to: contracts, corporate structure, mergers & acquisitions, corporate reorganizations (family trust, holding company etc.), estate planning and any other corporate matters. Further, my primay focus is on the creation of various tax-effective structures for the preservation, accumulation and transfer of wealth for entrepreneurs.

Do I need a business lawyer?

If you are a business owner and you are concerned with the legal protection of your business and your personal assets, the answer is YES.

A business lawyer can advise you of the applicable laws and help you comply with them.
A business lawyer can help steer you away from future disputes and lawsuits.
A business lawyer can help protect your tangible and intangible assets.
A business lawyer can help you negotiate more favourable business transactions.

Having a business lawyer can also project positively on your business. Further, an established relationship with a business lawyer can be invaluable when you need to turn to someone who knows your business for quick legal guidance.

Over the years, I have realized that many small businesses have genuine concerns about lawyers running up large tabs for unwanted, unnecessary or questionable work. Hence, I am extremely sensitive to that concern and actively work with you to control legal costs. I believe it is in both our interests to discuss the scope of work and the costs involved before I provide any legal services.

You should seek a business lawyer if you or your company are . . .

- Starting a new business; (partnership, sole proprietorship or corporation)
- Issuing shares, stocks, options, warrants or convertible notes;
- Hiring your first employees (i.e. employment agreement);
- Negotiating a new lease;
- Acquiring another business;
- Reorganizing your affairs to save taxes (i.e. family trust, holding company, etc.)
- Transferring your business to you children and/or employee (Section 86 – Estate Freeze)
- Selling your company;
- Succession planning; (estate planning, estate freeze, primary and secondary will, etc.)
- Planning to create and develop new ideas, products and services;
- Seeking to resolve internal disputes. (i.e. shareholders agreement);
- Any other business/legal issues

For any questions on the above, please do not hesitate to send me an email at hugues.boisvert@andrewsrobichaud.com or at +1.613.237.1512 x 255

Business owners: What are the benefits of an Estate Freeze?

As you may know, I practice corporate & tax law with a focus on the creation of various tax-effective structures for the preservation, accumulation and transfer of wealth for entrepreneurs. One technique that I like to use is called Estate Freeze. Hence, Today, I would like to share an article written by Bessner Gallay Kreisman, Chartered Accountants.

What are the benefits of an Estate Freeze?

For an owner-managed business, tax minimization is central to the overall financial plan. One popular tool is an estate freeze. An estate freeze is a corporate re-organization that allows business owners to freeze the value of the company at today's value. As a result, future increases in the value of the company can be transferred to the benefit of children, key employees or a trust. Such a freeze allows business owners to minimize capital gains tax due to deemed disposition rules at death and provides a deferral of tax.

A freeze in combination with the creation of a discretionary trust can provide a flexible framework that can lead to further tax minimization. The use of a trust facilitates income-splitting strategies between family members, and if properly planned, can also result in each beneficiary being able to utilize their $750,000 capital gain deduction concurrently. In a company that is expected to experience continued growth, the ability to benefit from multiple capital gain deductions can result in substantial tax savings.

For many companies that have already undertaken such a freeze, the current economic climate has unfortunately eroded valuations. However, from an estate planning perspective the decrease in values may have created a unique opportunity to re-freeze shares. Re-freezing at a lower value can help further reduce the tax liability upon death and defer the same to the next generation.

An important factor to consider with any estate freeze is the valuation of the shares being frozen. Given the nature of a freeze, and the potential benefits to non-arms length parties, the need to ensure a fair and impartial valuation is critical. While many may believe an ad-hoc valuation is sufficient, determining the value that may be attained in an open and unrestricted market, between informed and prudent parties, is a complex process that poses several challenges. A formal report ensures that adequate research is conducted and the valuation can be defended in the event the transaction comes under review by the taxation authorities.

Given the unique characteristics of each situation, effectively implementing such a strategy requires careful consideration of both technical and non-technical components. An estate freeze is only one component that can be utilized as part of a global tax and estate plan.

A New Chapter in Taxation of Trusts: The Residency of a Trust

Below is an excellent article published by Collins Barrow, Chartered Accountants.

A New Chapter in Taxation of Trusts

The recent decision of the Tax Court of Canada in Garron Family Trust v. R (2009 DTC 1568) has cast doubt on some common international and inter-provincial tax planning structures that involve the use of trusts. Generally, these trust structures reallocated income to jurisdictions that had either lower tax or no tax at all on certain types of income. This was accomplished by implementing a tax strategy that involved a trust and relying on the residency of that trust to determine the jurisdiction in which the trust's income would be taxed.

For over thirty years, tax professionals have relied on the principles set out in the well-known Thibodeau Family Trust case (78 DTC 6376) to determine the residency of a trust. Now, as a result of the decision in the Garron Family Trust case, we appear to have a new set of rules for determining the residency of a trust. These new rules can have a serious impact on any trust tax planning strategy that relies on the old residency rules of the trust to minimize or eliminate taxation.

Pursuant to the Thibodeau case, the residency of a trust was based on the residency of the managing trustees. The Thibodeau trust had three trustees, one resident in Canada and two in Bermuda. The trust was administered in Bermuda and the books and records of the trust were in Bermuda. The Court concluded that the trust resided in Bermuda because the trust document required that a majority of trustees agree on all matters of trustee discretion, and the majority of trustees resided in Bermuda. The Court rejected the notion that the residence of a trust should be similar to that of a corporation, and therefore disregarded the "management and control" test used for corporations. The Court then concluded that the residence of a trust should be determined based on residency of the trustees.

Just over thirty years later, we now have a different opinion from the Tax Court regarding this issue. With the Garron Family Trust decision, the Court has now embraced the notion that the residence of a trust should be similar to that of a corporation. The Court will look to the management and control of the trust to determine residency of the trust. The Court concluded that adopting a similar test of residence for trusts and corporations promotes the important principles of consistency, predictability and fairness in the application of tax law.

With an update in the jurisprudence related to the residency of trusts, the Canada Revenue Agency (CRA) is now aggressively reviewing tax planning structures involving trusts to reduce tax avoidance through international and inter-provincial tax planning.

The CRA recently hired additional auditors to review the residency of Alberta trusts. During the past several years, it has been attractive and popular for individuals located in provinces other than Alberta to set up an Alberta resident trust to access Alberta's low provincial tax rates. With this review of Alberta Trusts, the CRA is seeking to determine the "management and control" over the trust assets. As a result, it has distributed questionnaires to Alberta trustees, requesting the following information:

•a list of the duties and responsibilities as the trustee;
•the signing and/or contracting authority of the trustees; and
•the responsibility of the trustees for the management of any business or property owned by the trust, the banking and financing arrangements for the trust, and the preparation of the trust's accounts and reporting to the beneficiaries.
If the CRA determines that the management and control over the trust assets rests with any person(s) other than the Alberta trustees, it may determine the residence of the trust to be other than Alberta and reassess the provincial taxes accordingly.

Based on the 2010 Federal Budget, and the Department of Finance's desire to close various loopholes in the Income Tax Act, and to try to find ways to generate revenue to assist in reducing the deficit, we can anticipate the CRA will also apply the same aggressive nature toward international tax planning strategies involving trusts.

This may be a new chapter in the taxation of trusts, but the story is not over yet. The Garron Family Trust has requested leave to appeal to the Federal Court of Appeal. We will have to wait for the outcome of that appeal to see whether a new chapter is written once again, or if the book is closed for the foreseeable future.

Business owners: Should you take a Salary or a Dividend??

Today I would like to share an excellent article written by Tim Cesnick published in The Globe and Mail.

Business owners: Should you take a Salary or a Dividend??

Business owners face all types of challenges. Human resources issues may be the greatest – but tax issues are also near the top of the list. How should you compensate yourself? Should you pay yourself more salary? How about dividends? Are there other alternatives? Let’s talk about your compensation.

The Theory

If you own an incorporated business, there are two primary ways to pay yourself: salary, and/or dividends. If you pay yourself salary, the amount is a deductible expense to your company and is taxable in your hands. Another alternative is to have the income taxed in your corporation and then pay the after-tax earnings to yourself as dividends. Your company doesn’t claim a deduction for dividends paid. You’ll face tax on the dividends paid to you, but at a lower tax rate than salary. Why? Because the corporation has already paid tax on the income. When you receive dividends, the amount is “grossed up” (to approximate the pretax income of the company) and then you’re entitled to a dividend tax credit (to provide a tax credit for the approximate tax that was paid by the company).

Our tax system is based on the theory of integration. The theory is that there should be no difference between earning income personally, or earning it in a corporation and then paying that income out to yourself as dividends. If integration is perfect, the amount of income in your hands would be exactly the same, either way.

In the past, integration only worked, albeit not perfectly, in the case of small, Canadian-controlled private corporations (CCPCs) that have been eligible for a lower rate of tax (on the first $500,000 of taxable income today; this results from the “small business deduction” available only to CCPCs). The government changed this in 2006 when it introduced “eligible dividends.” To make a long story short, eligible dividends are those paid after 2005 out of business income that was taxed at a higher rate – rates applicable, for example, to income earned by publicly traded companies or smaller-company income that is not sheltered by the small business deduction. Eligible dividends have been subject to a different gross-up and tax credit rate. This effectively reduced the level of personal tax paid on those dividends, to make integration work better where the company has paid higher rates of tax.

Today, you’ll face a different tax rate on eligible dividends (paid out of corporate income taxed at higher rates) and ineligible dividends (paid out of corporate income subject to lower rates, thanks to the small business deduction).

The Reality

The fact is, integration doesn’t work perfectly. And so there may be advantages to paying dividends over salary, or vice versa. To complicate things, general corporate tax rates are falling over the next couple of years, which may shift your approach. You see, as corporate tax rates fall, the level of tax you’ll pay personally on eligible dividends is due to increase. Why? To keep integration as close to perfect as possible.

The general federal corporate tax rate is currently 18 per cent in 2010, will be 16.5 per cent in 2011, and 15 per cent in 2012. The top federal marginal tax rate on eligible dividends is 15.88 per cent in 2010, will be 17.72 per cent in 2011, and 19.29 per cent in 2012. Regardless of your province of residence, it’s still true that the tax rate on eligible dividends is going up.

So, what does all this mean for you? First, if you do plan to pay yourself eligible dividends, your best bet may be to accelerate those dividends to pay them out in an earlier year rather than later, to take advantage of the current lower tax rates. There was some confusion from my article last week where I had mentioned that it could be beneficial to wait until 2011 to pay out eligible dividends. That read incorrectly. I had intended to suggest that paying dividends sooner, say in 2010, would be better.

Business owners: Unconventional ways of saving for your child's education

Below is a great article written by Tim Cesnick and published in The Globe and Mail.

Family trusts and life insurance options are often overlooked when thinking of how to pay for a post-secondary education

Now that my kids have decided they want to be brain surgeons, I’ve been thinking about how to pay for their post-secondary education. Two methods of saving for a child’s education are often overlooked. The first is a family trust, and the second is life insurance.

FAMILY TRUST

A trust is simply a legal relationship between three parties: The settlor (the person creating the trust), the trustee (the person who holds and controls the property of trust) and the beneficiary (the person for whom the property of the trust is being held). The nice thing about a trust is that it’s possible to have the income of the trust taxed in the hands of the beneficiaries, who may pay little or no tax if they are minors and have little or no other income.

Setting up a trust does come with a cost, so it’s not generally going to make sense unless you’re willing and able to commit a sustantial sum to the trust over a short period of time. You can make this a loan to the trust if you want, so that you can take back your capital again later, as a repayment of the loan.

Once the money is in the trust, any interest and dividend income earned in the trust will be attributed back to you to be taxed in your hands while the beneficiaries of the trust are minors (unless you charge the taxman’s prescribed rate of interest on a loan to the trust), but capital gains can be taxed in the hands of the beneficiaries. Also, any second generation income (that is, income on the income, even if it’s interest or dividends) can be taxed in the hands of your children.

You can pay for all or part of your child’s education costs out of the income or capital of the trust. The taxman will consider payments to third parties, including reimbursements to you, as being paid to the beneficiary as long as those payments were clearly for the benefit of your child. To the extent that little or no tax has been paid on the income of the trust over the years (by having income taxed in your child’s hands), you’ll effectively be using pre-tax dollars to pay for the child’s education.

The benefits of the trust include: protection of the assets of the trust from creditors, splitting income with your children, maintaining control over the assets, and flexibility to use the trust funds for things other than education. There’s a lot to consider when setting up a trust. Visit a tax pro for help.

LIFE INSURANCE

Life insurance is an interesting tool because you can accumulate investments inside a policy on a tax-sheltered basis. Further, if it is the life of your child that is insured, you’re able to transfer ownership of the policy, including the accumulated investments inside the policy, to your child free of tax once he or she reaches age 18. Your child can then make withdrawals of those investments from the policy to pay for education. While those withdrawals are generally going to be taxable to your child, he’ll likely pay little or no tax if he has little or no other income.

One of the benefits of choosing a whole life insurance policy is that the returns have been incredibly stable over the years, even throughout 2008. The reason for this is that the insurance companies are allowed to smooth, or average, the returns you receive over a period of years.

Consider some numbers. If you pay $2,750 annually into a whole life policy each year until your child is 18, there could be $70,000 to $75,000 in the accumulating fund to be accessed (varies by insurance company), assuming a 5 per cent annual return inside the policy. If you set aside the same $2,750 in a tax-free savings account (TFSA) you could end up with approximately $84,000 earning that same 5 per cent, but this would assume a portfolio that is largely in equities that is subject to the volatility of the markets. If you earned, say, 6 per cent in the TFSA, you’d have close to $92,000 in this case, with the volatility.

Life insurance also offers asset protection, flexibility to use the assets for any purpose, and a death benefit ($265,000 in my example) over and above the investment component of the policy if your child passes away prematurely. Insurance is just another tool to consider.

As usual, please do not hesitate to contact me should you have any questions. hugues.boisvert@andrewsrobichaud.com or +1.613.237.1512 x 255

Family Trust Audits Highlight Need for Proper Trust Records

Today, I would like to share an excellent article written by BDO Canada - As usual, please let me know if you have any questions.

Family Trust Audits Highlight Need for Proper Trust Records

A family trust can provide significant benefits as the
legalities and benefits of ownership can be separated. A
discretionary trust allows the benefits of ownership to flow
to beneficiaries while the trustee maintains control and ownership
of trust property and can ultimately decide on who will receive the
property at a later date. Due to this, family trusts are a powerful tool
in terms of income splitting and capital gains splitting, including
multiplying access to the capital gains exemption.

As is often the case, beneficial tax planning vehicles often carry a
greater recordkeeping and compliance burden, and family trusts are
no different. In particular, one of the key benefits of a discretionary
family trust is the ability to allocate income in different shares to
different beneficiaries, or to retain the income in the trust. For a
discretionary family trust, it is important to note that the default
position is that all of the income belongs to the trust and will be
taxed there if no further action is taken. If it is beneficial to have
income taxed in the hands of a beneficiary, that income can be
allocated in one of two ways:

• It can be paid to them during the year, or the trustee(s) can
declare that the income is payable to the beneficiary at the end
of the year. In other words, the income belongs to the beneficiary.

• It can be allocated by way of a special tax rule called the
preferred beneficiary election (under this election, it is possible to
allocate income to a beneficiary of the trust that is mentally or
physically infirm or disabled without giving them a right to that
income).

Most likely due to the popularity of family trusts and the tax
benefits they provide, the Canada Revenue Agency (CRA)
implemented an audit project on these trusts. The CRA’s audit work
on trusts is focused on the following:

• Has the trust been properly formed? If your trust was set up in writing by a lawyer, this should not be a significant issue.

• Where trust income has been allocated, was the income actually
paid or is there a bona fide obligation to pay that income to a
particular beneficiary? The CRA will be looking for documentation
such as trustee resolutions that allocate the trust’s income, proof
of payment for income paid during the year and promissory notes
or other proof that the trust has made the income payable to the
individual beneficiaries.

• Where the trustees make payments to third parties, was the
payment made for the benefit of the beneficiary? It is also
possible to “pay income” to a beneficiary by making payments
to third parties for the benefit of that beneficiary. In this case,
the trustee will need to document the payments made and
also provide evidence that the payment benefited a particular
beneficiary. For example, if a parent is reimbursed for expenses
incurred on behalf of a child who is a beneficiary, receipts for the
expenses should be retained to prove the child benefited from the
payment and not the parent.

In addition to these particular issues that arise for family trusts, the
CRA will also be reviewing the records of the trust in the same way
it does for other taxable entities to determine whether income has
been calculated and reported properly. So, you should ensure that
bank and investment accounts are set up as needed and proper
records are maintained. Also, your trust agreement and the property
used to settle the trust should be kept in a safe place.

Business owners: why you MUST use separate corporations.

USE OF SEPARATE CORPORATIONS

The use of separate corporations to carry on different businesses is a basic creditor proofing technique that should always be considered when starting a new business. Separate corporations generally have limited liability, which will help insulate the assets associated with one business from any risks associated with another business. The use of separate corporations is also recommended where a business has used accumulated earnings to acquire significant liquid and/or investment assets or perhaps real estate. For example, it is desirable for real estate and/or equipment which is used in the business to be owned by a separate company(Holding Company), rather than be owned by the operating company. In this manner, the real estate can be protected from direct creditors of the operating business.

If the operating company already owns real estate, it may be possible to separate the real estate by means of a tax deferred corporate reorganization. Where the real estate is owned separate from the operating company, the company owning the real estate would generally charge the operating company a fair market value
rent.

This type of arrangement may also provide ancillary tax benefits with regard to the potential for a more rapid deduction of the leasehold improvements incurred by the operating company.

In addition to real estate assets, other liquid assets(such as cash) accumulating in an operating company should be separated from the company to the extent there are accumulated earnings. For example, term deposits owned by an operating company could be separated and transferred to a holding company by having the operating company pay a tax-deferred dividend to the holding company. In the future, if the
operating company requires the funds, the holding company could then loan the funds back by way of a registered debenture, so that, in the event of a business failure, the holding company’s right to realize on the loan would precede the rights of any general unsecured creditors of the operating company.

If a holding company does not currently exist, a relatively simple re-organization6 could take place to establish a holding company and protect the investment assets of the operating company.

As usual, you should seek professional advice before implementing your new structure - call me or email me if you have any questions.

Business owners: 5 myths that you MUST know about Family Trusts...

Over the past 2 years, I've been blogging extensively about the various advantages of using a Family Trust for business owners and owners/managers - On a daily basis, I spent a considerable amount of time educating people on the benefits of using such structure. Today, I would like to share an excellent article written by Chaya Cooperberg published in the Globe & Mail.

The Truth about Family Trusts.

The perception of family trusts as vehicles for only the extremely wealthy is one of the misperceptions about trusts that Ms. Blades wants to put to rest. Here are her top five myths and realities about the structure.

Myth #1: They are inflexible.

Reality: Trusts can be quite versatile and are often the best option to provide for disabled beneficiaries or for children of blended marriages. The terms of the trust can vary. There can be a fixed-interest trust, where an amount is invested and the beneficiary gets the money. Or a trustee can be appointed to pay it out. You can also stagger the payments so that funds are paid out when the beneficiary reaches certain age milestones.

Myth #2: They are mainly used to avoid estate taxes and probate costs.

Reality: Trusts can offer significant tax benefits and avoid probate costs, but they also have other benefits like asset protection, investment management, and protection for disabled family members or the client if they become incapacitated.

“It’s always a cost benefit analysis with a trust,” says Ms. Blades. “You would never just look at the financial benefits such as how much tax is saved; you would also look at the beneficiary benefits. You need to do the analysis to see when and where it is worthwhile.”

Myth #3: They are only for the very wealthy.

Reality: Trusts can be set up for anyone with specific needs and are useful vehicles for passing funds to children or grandchildren. There are multimillion-dollar trusts and there are much smaller trusts.

Myth #4: You lose control.

Reality: Trusts are customized vehicles designed in line with your wishes and ensure that cash is ultimately transferred to beneficiaries as desired. While you no longer own the money, you can say when and how you want it used. Your control comes in under the terms and conditions you’re drafting.

Myth #5: Trusts are complicated and onerous to manage.

Reality: The provisions of a trust can be as simple or as complex as you want or need. To set up a trust, you would first need to meet with a will and estate planner or a lawyer to draft the agreement. It is also important to get separate tax advice from an accountant to ensure the trust is a worthwhile vehicle for you. If you make the trust a part of a will – this type of trust is called a testamentary trust – the cost will be built into the cost of the will. If you create a trust that takes effect while you are alive – known as a living trust or inter vivos trust – it will cost at least $1,000 to set up and establish. For a large trust, you will need to appoint a trustee to oversee it and manage investments held within the trust. This comes with a typical annual fee of 1 per cent.

Family Trust: Discretionary vs. Non-Discretionary

A family trust can be either discretionary or non-discretionary. A discretionary trust gives the trustee full discretion to allocate income and capital among beneficiaries.

In a non-discretionary trust, the trust deed sets out the parameters within which income and capital are allocated. For example, if a trust has three beneficiaries, each beneficiary could be entitled to one-third of the income on an annual basis, and
one-third of the trust capital when capital allocations are made.

Most trusts are irrevocable, as the tax rules deem any income or capital gains earned by a revocable trust to be those of the contributor and taxed in his or her hands, and not income or capital gains of the trust.

As previouly explained, Trusts can be an effective part of your tax and estate planning. This posting is a brief summary of some features of trusts and is not a thorough examination. Always contact your lawyer and/or accountant for more information.

Shifting taxable income to someone else? You still might foot the bill

Today I would share an excellent article written by Tim cesnick published in the Globe and Mail.

Shifting taxable income to someone else? You still might foot the bill.

Some things just seem a little backward. Take my cousin Julia’s situation for example. Julia is an environmentalist – a self-proclaimed “tree-hugger,” to use her words. Her husband is a competitive swimmer. She doesn’t shave her legs, but he shaves his. It just seems backward to me.

The folks at the Canada Revenue Agency (CRA) often take offence to things when they’re backward. No, I’m not talking about personal grooming habits – CRA doesn’t care much about whether or not you shave your legs. But CRA does care when someone else pays a tax bill and it should be you paying the tax instead.

The rules

Let me tell you about subsection 56(2) of our tax law, which can cause real problems in certain situations. Specifically, this subsection will cause certain amounts to be taxed in your hands even when the amounts were received by someone else. Subsection 56(2) applies when the following conditions are met:

1. There is a payment or a transfer of property to a person other than you.

2. This payment is made at your direction, or with your concurrence.

3. There is a benefit to you, or a benefit you wish to confer on the other person.

4. You would have been taxable on the amount had you received the payment or transfer of property.

In situations where these conditions are met, subsection 56(2) will cause the amount to be taxed in your hands rather than the hands of the other person who received the amount. If subsection 56(2) applies, the amount in question will need to be added to your income; CRA will however reduce the income of the person who initially received the amount, in order to prevent double taxation.

The examples

Clear as mud so far? Let me share a few examples where 56(2) might apply.

* Sale of an asset. If you sell an asset but direct the sale proceeds to be paid to your spouse or a family member with the hope that they’ll pay the tax instead, 56(2) could apply to cause you to pay the tax anyway.

* Business income. Perhaps you own a business, provide goods and/or services to a customer, and then direct the customer to make payment to your spouse or family member and not you. Beware of 56(2).

* Rental income. If you own a rental property, or part thereof, and you instruct a tenant to make payment to your spouse, child, a charity, or some other party, subsection 56(2) could apply.

* Employment income. As an employee you could be subject to 56(2) if your employer makes a payment to one of your family members for services provided by you.

* Gifts by a corporation. Perhaps you’re a shareholder and the corporation makes a gift of cash or property to one of your family members. Subsection 56(2) could apply to tax you on the value of the gift because the gift would likely have been taxable to you as a shareholder benefit had it been made to you.

* Property sold to family. If you’re a shareholder and your corporation sells an asset to a family member at an amount below fair market value subsection, 56(2) could apply.

* Dividends paid to shareholders. Consider a situation where dividends are paid to a shareholder who is not entitled to receive dividends and/or you had a pre-existing right to dividends. Or where you might waive your dividend entitlement for the purpose of transferring income to other shareholders. Subsection 56(2) could apply to tax you on those amounts.

Now you get the drift. Subsection 56(2) is not to be confused with the other attribution rules in our tax law that can cause investment income to be taxed in your hands when you give or lend investment assets to a family member. This provision is broader. It can even apply to tax you on payments made to unrelated third parties.

The solutions

You should note that there’s often a way to accomplish the same tax savings without triggering 56(2).

This might mean receiving a payment yourself and then paying a deductible amount to a family member, properly transferring an asset to your spouse or child to allow them to pay tax on a sale later, restructuring your employment contract to allow payments to an assistant who might be a family member, or revising the terms of your company’s share classes to allow a more flexible sprinkling of dividends, among other ideas.

It’s also worth noting that there’s an exception for the splitting of CPP benefits, which is specifically allowed under our tax law.

Business Owners: Did you ever use some income splitting techniques?

below is a great article written by BDO Canada, Chartered Accountants.

Family income splitting

The following opportunities exist to split income with other members of your family:

Make an interest-free loan to your spouse or children for investment purposes.

Under the attribution rules, income earned by your spouse or child on the funds will be taxed in your hands, just as it would have been had you not made the loan. However, that income becomes their property and can be reinvested without further attribution. Over time, family members can build up a large pool of funds which earn income taxed in their hands. Be sure to deposit the income in a separate bank account so that it can be properly tracked and separated from the funds advanced as a loan. Also, you may want to consider setting up a trust to manage the funds if minor children are involved.

The attribution rules do not apply to loans that bear interest at the prescribed rate—an interest rate set quarterly by the Canada Revenue Agency (CRA) that approximates short-term Treasury Bill rates. If you loan funds to your spouse or child and the funds are invested so that the rate of return is higher than the prescribed rate, the excess income will be taxed in their hands. Note that interest on the loan must be paid no later than 30 days after the end of the year. Where the interest is not paid on time once, the loan will be subject to the attribution rules until repaid. The interest rate on the loan does not have to be adjusted each time the prescribed rate changes.

Loan funds to family members other than your spouse to invest in assets that produce capital gains.

Consider loaning funds interest-free to low-income family members other than your spouse. They can use the funds to purchase investments with low returns, but with the potential to produce capital gains. Capital gains arising on these investments will not be subject to attribution.

Many mutual funds invest in growth stocks with low dividend rates. Such investments are well-suited for this plan, as any distribution from these funds are often a distribution of capital gains.

If a child’s in-trust account or a trust for the child has investments with accrued gains, consider triggering these gains each year to the extent the child’s personal exemptions are not otherwise utilized. This will help ensure that the child won’t have a large gain that will be taxed at some point in the future.

Make gifts to adult family members.

If you support adult family members, such as children at university or elderly parents, consider giving them assets which they can invest to earn their own income. The income will be taxed in their hands, not yours, and they’ll have more after-tax funds than if you had earned the income and paid their expenses.

This situation can arise where an adult child needs money for his or her education, or where your parents are dependent on you for support. Bear in mind that a gift means you give up control of the asset. If making gifts to low-income parents, you may want to ensure that the assets will be left to you in their wills. Also, if you give property other than cash to any relative, you’re deemed to dispose of it at fair market value, which could result in a taxable capital gain.

Ensure the high-income spouse pays all family expenses, while the low-income spouse saves.

Often, both spouses contribute equally to household expenses, where each have a source of income. This may seem fair and reasonable, but it’s poor tax planning. To the maximum extent possible, the low-income spouse’s salary and other earnings should be saved for investment purposes, while the higher income spouse pays for expenses such as food, clothing, mortgage payments etc. You can even pay your spouse’s taxes. This ensures that the family’s total investment income is taxed at the lowest possible rate.

Loan or give funds to family members to purchase a principal residence.

If you support a child in residence at university or pay rent for elderly parents, consider loaning or giving them funds to purchase a separate residence. This will reduce your investment income subject to tax and, since the funds aren’t earning income, there’s no attribution. Also, if the property increases in value, the family member may be able to use the principal residence exemption.

Invest the Child Tax Benefit and the Universal Child Care Benefit in the name of your children.

The Child Tax Benefit is based on family income. Consequently, higher income families do not qualify for the benefit. The Universal Child Care Benefit is available to all parents for children under the age of six and is paid in instalments of $100 per month per child. To the extent that you receive these benefits, you should invest the funds in a separate account in trust for your children. Investment income on these funds will not be attributed to you.

Invest inheritances for the benefit of your children.

If your child inherits money, make sure that you segregate these funds and invest them in the name of the child. If you or your spouse will inherit funds from a relative you can split income from that inheritance as well, if your relative names your child as a beneficiary. Keep in mind that if a child’s inheritance from a relative, that is not their parent, includes shares of a private company, the dividends will likely be subject to the kiddie tax (which we discuss later in the section entitled “Income splitting through corporations”).

Treat educational support to your spouse as a loan.

If you’re supporting your spouse while he or she is in attendance at a school, college or university and the spouse is expected to eventually be the high-income earner, treat the amounts spent on his or her education as a loan. Later, when the individual earns income, the amount can be repaid to you for investment purposes. You should document the amounts spent and have a written loan agreement.

Shift assets between spouses.

The attribution rules don’t apply if you transfer assets to your spouse in return for assets of equal value. If your spouse has non-income-producing property (i.e. such as a cottage), consider purchasing these assets for cash (or other income-producing assets) at their fair market value. You and your spouse can continue to enjoy the assets, as your spouse earns income from the funds.

Usually, assets can be exchanged between spouses with no tax consequences. However, to avoid attribution, you and your spouse must elect to have the sale occur at fair market value. If the assets transferred have accrued gains, a capital gain will result. If the election is made, any future income or capital gains on the income-producing property would not be attributed back to the transferring spouse.

Contribute to a Registered Education Savings Plan (RESP).

An RESP is a vehicle through which you can defer taxes, split income with your children and save towards their post-secondary education all at the same time. Unlike a Registered Retirement Savings Plan (RRSP), contributions to the plan are not deductible. However, income earned in the plan is not taxed until distributed as educational assistance payments to someone named by you as a beneficiary under the plan. At such time, the income is taxable in the hands of the recipient, presumably at a lower rate, and the original contributions are returned tax-free.

Before the 2007 Federal budget, you were allowed to contribute up to $4,000 annually to an RESP – with a cumulative lifetime contribution limit of $42,000. Changes announced in the 2007 Federal budget eliminated the $4,000 annual RESP contribution limit and the lifetime RESP contribution limit was increased to $50,000. What this means is that you can contribute $50,000 immediately to an RESP. Note that if more than one plan has been set up for a particular beneficiary, you and the other contributors must share the contribution limit. The plan itself must be wound up after 25 years.

There are two types of plans—individual plans and group plans. In addition, there are two kinds of individual plans – non-family plans and family plans. A non-family plan is a plan you set up for just one beneficiary, and there are no restrictions on who can be a beneficiary of such plan. A family plan can have more than one beneficiary; however, each beneficiary must be connected by blood or adoption to each living subscriber under the plan or have been connected to a deceased original subscriber.

A group plan (also referred to as a pooled plan or a scholarship plan), is a set of individual non-family plans that are administered based on a specific age group. Individual plans are more flexible, as they give the contributor more control over the investments made and the timing and amount of educational assistance payments made to beneficiaries. It is important to review all plans carefully to fully understand the provisions of the plan in the event that beneficiaries do not attend college or university within the required time period.

An added benefit of using an RESP is the Canada Education Savings Grant (CESG). The CESG is a federal grant that is added to your eligible contributions. Changes in the 2007 Federal budget increased the maximum annual RESP contribution qualifying for the 20% CESG to $2,500 from $2,000, which increases the maximum annual CESG per beneficiary for 2007 and subsequent years to $500 from $400. Similarly, the maximum CESG for a year has been increased to $1,000 from $800 if there is unused grant room because of contributions of less than the maximum amount in previous years. It is worth noting that the $7,200 lifetime CESG limit is unaffected by these changes.

Despite these beneficial changes, it may still make sense to use both an RESP and an “in-trust” account when saving for a child’s education. For more information, see Are You Getting a Passing Grade on Education Savings? in the 2008-01 issue of The Tax Factor.

Pay your spouse’s interest-bearing debts.

If your spouse has incurred interest-bearing debts such as a car loan, consider paying off these debts on behalf of your spouse. The reduction in interest expense is not subject to attribution. Your spouse will then have more funds to invest in the future.

Note that this plan does not work if the debts were incurred to acquire income-producing properties. If you pay off these debts, any income from the properties will attribute to you.

Provide for a testamentary trust in your will.

Rather than leaving your estate directly to your spouse, children or other dependants, consider leaving some funds in a testamentary trust for the benefit of these individuals. A testamentary trust pays tax as though it were an individual. Income from the funds will be taxed in the trust and will thereby benefit from an additional set of lower marginal tax rates. It is even possible to set up multiple testamentary trusts under your will, one for each beneficiary, which can multiply the availability of lower marginal tax rates on the income earned by the assets in your estate. The capital and after-tax income can be distributed over time to your beneficiaries free of tax. Your BDO advisor can help you select the method which best suits your needs and can assist you in other areas of estate planning.

Business income splitting

If you carry on a business, other income splitting opportunities are available to you:

Make your spouse a partner of your unincorporated business.

If you operate an unincorporated business in which your spouse is active, you may be able to establish that he or she is your partner, eligible to share in the profits or losses of the business. To be considered a bona fide partner, your spouse must either devote a significant amount of his or her time, specified skills, or training to the business or must have invested his or her own property in the business. You must ensure that your spouse’s share of income is reasonable compared with the amount of work or capital put into the business. A partnership agreement is recommended.

Pay your spouse and children a salary.

If your spouse or children work in your business, consider paying them a salary. The salary must be reasonable given the services performed. A good rule of thumb is to pay them what you would have paid a third party for the same services. A record should be kept of the time actually spent and the services actually performed.

When you pay salaries to your spouse or children, you usually must make withholdings for income tax, Canada/Quebec Pension Plan (for individuals over 18 years of age) and any applicable provincial payroll taxes. There will generally be no liability for employment insurance on remuneration paid to members of your family.

Pay your spouse a director’s fee.

If your spouse is a director of your corporation, consider paying your spouse a director’s fee for services performed. A director’s services usually include attending directors’ meetings, directing the management and affairs of the business, approving financial statements, declaring dividends, approving changes to share capital and electing officers of the company. Note that your spouse will also be jointly liable with the other directors for the fulfillment of certain regulatory requirements, such as salary withholdings and GST collections.

Pay a guarantee fee to your spouse.

If your spouse is required to pledge assets or to otherwise guarantee a business loan, he or she can be paid a fee by the business.

Again, the amount paid must be reasonable in the circumstances. In determining reasonableness, one would look at the amount of the loan, subsequent ability of the business to repay the loan and the amount that would have otherwise been paid to an arm’s-length party to guarantee the loan. The fee will also help in establishing deductibility of the loan for your spouse, should the debt become bad and the guarantee ever be called.

Loan funds to your spouse to start-up a business.

Only income from property is subject to attribution. Income from a business is not. If your spouse has a promising business venture, you can provide interest-free financing without any attribution. If the venture is risky, you should consider that an interest-free loan would not qualify for capital loss treatment should the venture fail. If this is the case, you might want to make a capital contribution to the business as a partner and share in the start-up loss. When the business becomes profitable, you can make interest-free loans to the business for further expansion. A gift could also be used to finance a new venture. Your spouse’s share of profits from the venture can be invested by your spouse and would not be subject to income attribution.

Income splitting through corporations

In the past, income splitting was possible with all members of your family through your corporation by issuing shares to your spouse and children, as long as you were careful to overcome certain obstacles. Dividends paid by the corporation to the shareholders would be taxed in their hands, provided you did not give or loan them the funds interest-free to acquire the shares. However, with the introduction of the kiddie tax, the government created yet another obstacle when it comes to income splitting with minor children. In order to implement a corporate income splitting plan that is successful, you must be aware of all of the obstacles that prevent income splitting.

The first obstacle is a set of rules commonly referred to as the corporate attribution rules. Without these rules, you could avoid attribution by simply making interest-free loans to a corporation where your spouse and children are shareholders, instead of directly to them. The corporate attribution rules provide that, if you make a low-interest or interest-free loan or transfer any property to a corporation with the main purpose of reducing your income and benefiting your spouse or minor children, you are deemed to receive interest on the loan or the value of the property transferred at the CRA’s prescribed rate. This income inclusion to you is reduced by any interest, by 5/4ths of any ineligible dividends and 145% of any eligible dividends you actually receive from the corporation. This deemed interest arises even if no income is earned by the corporation and no dividends are paid to your spouse or children. Consequently, it is a penalty provision that should be avoided.

The rules do not apply during any period that the corporation is a small business corporation (SBC). An SBC is a Canadian-controlled private corporation (CCPC) in which at least 90% of the assets (on a fair market value basis) are used in operating an active business in Canada. Therefore, as long as your corporation carries on business and does not accumulate significant investment assets, your spouse and children, particularly those 18 years of age and older, can be a shareholder and receive dividends.


The second obstacle is the kiddie tax, which prevents the transfer of income from high-income individuals to their children under the age of 18. Rather than redirecting income and taxing it in the hands of the high-income family member, the rules provide for a tax on minors who receive income under an income splitting arrangement.

Beginning in the year 2000, minor children are taxed at the top federal personal tax rate on dividends or business income received from a family business.

Specifically, this tax will apply on the following sources of income:

Taxable dividends received directly by a minor, or indirectly through a trust or partnership. Dividends from publicly traded corporations are excluded.
Income inclusions required under the Income Tax Act, in respect of the ownership by any person of shares of the capital stock of a corporation. Shares of a class listed on a prescribed stock exchange are excluded.
Business income from a partnership or trust, where the income is from property (prior to 2003, this reference was to goods) or services provided to, or in support of, a business carried on by:
a person related to the minor, including a relative who is a partner of the partnership earning business income, a corporation where a relative of the minor owns 10% or more of the corporation’s shares, or a professional corporation where a relative of the minor is a shareholder.

The reference to business income earned in support of another business carried on by a relative appears to be designed to prevent you from having your management company or partnership bill third parties directly, rather than your own business, for services rendered. Generally effective for 2003 and subsequent years, the government has proposed to extend the income splitting tax to catch rental or interest income earned by a trust or partnership from a family business and received by minor children.

Personal tax credits cannot be claimed to reduce this tax. However, the minor will be allowed to claim the dividend tax credits and foreign tax credits, where applicable, to reduce the tax.

Although limited, there are some exceptions to the kiddie tax:

the tax will not apply where both of the minor’s parents are non-residents of Canada, the tax will not apply on income from property inherited from a parent, and
if the child is going to college or university, or is disabled, income from property inherited from others won’t be subject to the tax. With the tax on minor children, it is difficult to achieve business income splitting through a corporation with minor children. However, income splitting with your spouse and children who are 18 years of age and older is alive and well. In a typical corporate income splitting arrangement, shares with nominal value are issued to the spouse and children. Dividends are later paid on these shares as income is earned by the corporation. The dividends paid often exceed the amount paid for the shares. Since different classes of shares are usually issued to different family members, it’s possible to determine the dividend amount to each person to minimize tax. (Note that the dividends paid to minor children will now be subject to the income splitting tax.)

This process, called “dividend sprinkling”, was the subject of a 1990 Supreme Court case (The Queen v. McClurg). The following guidelines were drawn from the outcome of that case:

1.If you’re setting up multiple classes of shares, you should ensure each class is different in some respect from the others—for example, one class of shares can be voting while the others are not, some shares can share in growth while other shares are redeemable at a set price. By varying the attributes of the shares, it is possible to have several unique classes of shares.
2.Fair market value consideration must be paid by your family members in exchange for the shares issued. This may be difficult if the shares have high value and the family members have no independent source of funds. Income splitting arrangements are often accompanied by a “freeze” in the value of the company. This is accomplished by having the owner-manager exchange their common shares for preferred shares having a redemption amount equal to the value of the company. Provided the preferred shares have attributes that support this fair market value, any new common shares issued should then have only a nominal value.
3.Each shareholder should pay for the shares using his or her own funds and not funds provided by the owner-manager.
If you have an existing income splitting plan that involves minor children, the kiddie tax will generally now make the payment of dividends to these children unattractive. The best way to optimize your current income splitting plan is to reinvest as much money as possible, that was accumulated in the past under your plan, for the benefit of your child. Your BDO advisor also has other more sophisticated income splitting strategies that might make sense for you.

Corporate income splitting is still very much an option with your spouse and children who are 18 years of age and older. Remember to consider the corporate attribution rules where a spouse will be a shareholder. Great care is required when developing a corporate income splitting plan and your BDO tax advisor should be consulted prior to undertaking any arrangement.

Holding companies have their benefits - Tax-free dividends, creditor protection among them

Today I would like to share an excellent article written by Tim Cesnick published in the Globe and Mail.

When you understand the rules of the game, you can make them work to your advantage.

I think of Roger Neilson, former National Hockey League coach, who also coached the Peterborough Petes when my brother-in-law played for the team years ago. Mr. Neilson knew the rules of the game better than anyone. On one occasion, when the opposition was awarded a penalty shot, he pulled his goalie and put a defenceman in net. When the opposing player picked up the puck at centre ice, the defenceman came rushing out of the net and hit the confused shooter. No goal. Hey, there was nothing in the rules to stop this type of tactic. Well, not at that time. The rulebook has since been changed. Mr. Neilson was probably responsible for more changes to the rulebook than any single coach.

Things are no different in tax planning. If you know the rules, you can use them to your advantage. For those who are business owners, taking advantage of tax law will mean setting up a holding company in most cases. Today, I want to talk about the benefits of a holding company.


The story

Gord is a business owner who established a holding company (Holdco) several years ago. Holdco, in turn, owns all the shares of Gord's operating company (Opco), which carries on an active business - he distributes light fixtures.

Gord pays part of the earnings of Opco to Holdco as a dividend each year. This is generally a tax-free, intercorporate dividend. Gord then uses that money to invest in other things, such as real estate, marketable securities, and other private businesses. If Opco needs more cash for any reason, Gord can arrange for Holdco to lend the money to Opco.

Gord also pays income out of Holdco to himself, and other family members, each year.

The benefits

Gord enjoys a number of benefits:

Tax-free dividends. Dividends paid by an operating subsidiary (Opco) to the parent holding company (Holdco) in Canada are generally tax-free dividends to Holdco. Tax free is always good.

Creditor protection. Because Gord has excess earnings in Opco each year, he pays the excess to Holdco as a tax-free dividend, which protects those earnings from creditors of Opco. If necessary, he can lend that money back to Opco on a secured basis to retain that protection from creditors.

Efficient reinvestment. Gord has been reinvesting some of Opco's excess earnings in other assets to diversify his holdings. He does this by paying tax-free dividends from Opco to Holdco and then having Holdco make those other investments. If he paid the excess earnings from Opco to himself, personally, to make those investments, he would pay tax first, leaving less to reinvest. As it stands, Holdco filters out that layer of tax, making reinvestment tax efficient.

Income splitting. Gord is able to pay income to his wife and children each year so that some of the earnings are taxed in their hands, not his. The income can be in the form of salary (if the relative is doing work of some kind), or dividends, among other things. Because Gord's children have very little other income, they'll pay no tax at all on the income he pays to them. You do have to be aware that dividends paid to minors (perhaps through a trust) will be taxed at the highest marginal tax rate. But once the kids reach age 18, they can receive up to about $40,000 (it varies by province) each year in Canadian dividends virtually tax free.

Timing income. Think of Holdco as a private pension in many ways. Gord can draw money out of Holdco when he wants it. He chooses to pay himself dividends every second year rather than every year, which allows him to avoid personal tax instalments each quarter, because it's possible to base instalments on either the previous year's tax owing, or the current year's expected liability. If Gord has little or no tax liability every second year, he can base his instalments annually on the year he expects to have little income.

Avoid U.S. estate tax. Canadian residents could be subject to U.S. estate tax if they own "U.S. situs property," which includes shares in U.S. corporations, among other things. If you're otherwise subject to U.S. estate tax on those securities, you can hold those investments in a Canadian holding company to avoid the estate tax.

The addition of a holding company required professional help; hence, contact me to talk about all the pros and cons.

Business owners: Documenting the use of a vehicle to comply with CRA's requirement

This posting explains the ways in which a person who uses a vehicle in a business can keep track of business travel.

When a vehicle is used partially for business purposes and partially for other purposes, the expenses relating to its use must be apportioned. Only those expenses relating to the business travel or commercial activity are considered eligible for a business deduction and for input tax credits on GST/HST. The proration in such cases is done based on the distances driven. To support a deduction or claim, the person must know and be able to demonstrate the distance travelled for business purposes and commercial activities.

The Income Tax Act and the Excise Tax Act do not set out specific documentary requirements for recording the usage of a vehicle. The general rule is that the person must retain records that would enable an objective determination of the person's tax payable.

Full logbook
The best evidence to support the use of a vehicle is an accurate logbook of business travel maintained for the entire year, showing for each business trip, the destination, the reason for the trip and the distance covered.

Alternative records
The fact that a viable business exists is usually a strong indicator that a person incurred vehicle expenses, because it is extremely difficult to carry on a business without doing at least some driving. Claims for a very low amount of business use do not require extensive records to demonstrate business travel. As the percentage of business use and the related expense claims increase, more documentation, as discussed below, is expected to be available.

For many persons, the books and records they already retain as part of their normal business operations may be indicative of the presence of and the extent of business driving. An appointment diary indicating what addresses were visited and why, or a log of service calls might be sufficient. Purchase or sales invoices may indicate that items were picked up or delivered by the taxpayer. Examples of other evidence that may be taken into consideration may include:

•whether the person has another vehicle for personal travel,
•the type of vehicle,
•the nature of the business and the business travel likely required,
•who else drives the vehicle (e.g., family),
•how the vehicle is insured, and
•indications of other personal travel.

CRA auditors will generally consider the usage of a vehicle in the context of the entire operation of that particular business. A proposal to disallow a portion of a claim for vehicle expenses would only occur where the claimed travel seems out of proportion in that overall context and is not supported by sufficient evidence as described here. However, it should be noted that individuals will be responsible for providing sufficient evidence to demonstrate the accuracy of their claims for business distances driven throughout the year.

Logbook for a sample period
The CRA would be prepared to afford considerable weight to a logbook maintained for a sample period as evidence of a full year's usage of a vehicle if it meets the following criteria.

•The taxpayer has previously filled out and retained a logbook covering a full 12-month period that was typical for the business (the “base year”). The 12-month period is not required to be a calendar year.
•A logbook for a sample period of at least one continuous three-month period in each subsequent year has been maintained (the “sample year period”).
•The distances travelled and the business use of the vehicle during the three-month sample period is within 10 percentage points of the corresponding figures for the same three-month period in the base year (the “base year period”).
•The calculated annual business use of the vehicle in a subsequent year does not go up or down by more than 10 percentage points in comparison to the base year.
The business use of the vehicle in the subsequent year will be calculated by multiplying the business use as determined in the base year by the ratio of the sample period and base year period. The formula for this calculation is as follows:

(Sample year period % ÷ Base year period %) × Base year annual % = Calculated annual business use

Where the calculated annual business use in a later year goes up or down by more than 10%, the base year is not an appropriate indicator of annual usage in that later year. In such a case, the sample period logbook would only be reliable for the three-month period it had been maintained. For the remainder of the year, the business use of the vehicle would need to be determined based on an actual record of travel or alternative records, as discussed above. In these circumstances, the taxpayer should consider establishing a new base year by maintaining a logbook for a new 12-month period.

Example:

An individual has completed a logbook for a full 12-month period, which showed a business use percentage in each quarter of 52/46/39/67 and an annual business use of the vehicle as 49%. In a subsequent year, a logbook was maintained for a three-month sample period during April, May and June, which showed the business use as 51%. In the base year, the percentage of business use of the vehicle for the months April, May and June was 46%. The business use of the vehicle would be calculated as follows:

(51% ÷ 46%) × 49% = 54%

In this case, the CRA would accept, in the absence of contradictory evidence, the calculated annual business use of the vehicle for the subsequent year as 54%. (I.e., the calculated annual business use is within 10% of the annual business use in the base year – it is not lower than 39% or higher than 59%.)

Even though records and supporting documents are only required to be kept for a period of six years from the end of the tax year to which they relate, the logbook for the full 12-month period must be kept for a period of six years from the end of the tax year for which it is last used to establish business use.