There are a number of advantages to incorporate a consulting business, rather than operating as a sole proprietor.
4 Benefits of Incorporating
1. Increased opportunities for income splitting with family members.
2. Opportunity to save and defer tax.
3. Opportunity to shelter capital gain on the sales of shares of the corporation.
4. Limited Liability.
On a weekly basis, I'm meeting with consultants looking at the advantages of beeing incorporated - I can tell you that a lot of them save substantial taxes by using a corporation - Please do not hesitate to contact me should you wish to discuss further.
Saturday, February 27, 2010
Owners/Managers: Take a Fresh Look at Your Remuneration Strategy *
If you are a small business owner, you have a fair amount of flexibility when it comes to setting your remuneration strategy and deciding how you get paid. The amount that you pay to yourself and how you pay yourself may have been set a number of years ago, and may no longer be optimal. This discussion will focus on remuneration strategies as they relate to business owners who carry on business through a corporation.
If you are a business owner, you may have a great deal of flexibility in setting a remuneration strategy. You do not have carte blanche. There can be some constraints that will limit how you can remunerate yourself:
If you are a business owner, you may have a great deal of flexibility in setting a remuneration strategy. You do not have carte blanche. There can be some constraints that will limit how you can remunerate yourself:
- the Income Tax Act will deny a deduction which is not considered reasonable in relation to the services being provided. If you take too much salary, all or a portion of the expense may be denied to the corporation. The salary will still be taxed in your hands, leading to a clear case of double taxation. Administratively, the CRA will not challenge the salary paid to an owner manager who is active in the business and to whom the success and profits of the company could be attributed. However, if part of the remuneration strategy involves paying salary to family members, such as your spouse or children who are involved in the business, you should be respectful of the reasonableness requirements;
- a Shareholders' Agreement may exist, and it is possible that the Agreement may put limitations on how much can be drawn from the company, or the form in which it can be drawn;
- there may be a restrictive covenant resulting from a bank loan or other lending arrangement which could put a limit on what could be taken out of the company by the owners, or which require the company to maintain certain working capital requirements. This may limit your remuneration options. Violation of the restrictive covenants in a lending arrangement can have very serious consequences.
- corporate law may also restrict your remuneration options. For example, if part of your remuneration plan involves the payment of dividends to you, corporate law will require all shareholders of the same class to receive their pro-rata share of dividends as well. This may not be something that you want to happen. Most jurisdictions also limit your ability to pay dividends if it will render the corporation incapable of satisfying its' creditors.
Although this may seem like a rather daunting list of constraints, in practice there are often few constraints that operate to limit how you remunerate yourself.
Setting the amount of your remuneration is a process which is usually based on your personal cash needs. The starting point should be to figure out how much after-tax cash you and your family need each month. From there, we reverse engineer this number to arrive at the gross compensation that you need to receive in order to reach your target after-tax cash. As a general rule, you will be better off leaving cash in the corporation if your personal cash needs are modest. For example, if you require $40,000 of after-tax cash each year to meet personal needs, you will most likely be incurring additional and unnecessary taxes if your remuneration provides you with $60,000 of after-tax cash. While that is really just a generalization, it usually holds true because of the fact that personal rates of tax in most provinces exceed the corporate rate of tax on active business income.
Once you've determined how much after-tax cash you'll need, the next big decision is to determine in what form that cash will be provided to you. The decision is whether or not to remunerate yourself by way of salary, dividends, or some combination of the two.
You will need to understand a little tax theory in order to understand what is best for you. If you take your compensation in the form of salary, the salary expense will be deductible to the corporation. While you will pay tax on the receiving end, the company will benefit and save tax because of the deduction that it receives. Salary is also considered to be earned income for the purposes of generating RRSP contribution room and for the purposes of determining whether you are eligible to deduct child care expenses. These are some of the benefits associated with drawing salary. On the downside, however, salary does attract payroll taxes such as CPP, EI, worker's compensation and Employer Health Tax (EHT) in Ontario. These payroll taxes are not inconsequential. In many instances, the owner-manager will be exempt from EI by virtue of his or her shareholdings, and may also be exempt from worker's compensation by virtue of their position as a director of the company. Still, it is quite possible that the salary will attract CPP and EHT, thus increasing the overall costs associated with a salary based remuneration plan.
Dividends will be subject to a lower rate of tax than salary. While that may seem attractive at first, it is important to bear in mind that dividends are not tax-deductible to the corporation which pays the dividend. The tax that you pay on the dividend that you receive should be combined with the tax that the corporation has already paid in order to arrive at the true tax cost of a dividend-only remuneration strategy.
To narrow the thought process, it is important to determine how important RRSP contribution room is to you, and to a lesser extent, how important it is to build up future CPP entitlements. If you do not believe that RRSP contributions are important, and you do not believe that CPP is a universal social program that will even exist when you're ready to retire, then you may be leaning towards a dividend only scenario. If RRSP room is important, then you may be leaning towards a remuneration strategy which is heavily weighted towards salary. Such a strategy would provide you with a salary sufficient to generate the maximum RRSP contribution room, with any excess cash being provided to you through dividends.
It is important to realize that there is no right or wrong answer when looking at a remuneration strategy. There are simply too many variables, including RRSP investment returns, to make a precise determination of how you should be remunerated. Your personal feelings regarding RRSP room will have a strong impact on the remuneration strategy.
To illustrate the differences between various remuneration strategies, consider the following hypothetical, but realistic, example. An Ontario resident individual is the sole shareholder of an Ontario resident corporation, which generates annual profits of about $200,000. The individual has very high cash needs, and needs approximately $100,000 of after tax cash each year to meet living expenses, which would include an RRSP contribution of $14,500. Let's assume that if we adopt an approach which does not generate any RRSP room, their cash needs will drop from $100,000 per year to $85,500 per year, since they will not be making the $14,500 RRSP contribution. The company has a number of employees, and all salary earned by the shareholder would be fully subject to Ontario EHT.
The calculations show the overall results of three possible remuneration strategies: salary sufficient to generate maximum RRSP room with dividends to supplement the salary, an entirely salary driven compensation plan, and an entirely dividend driven compensation plan. The calculations indicate that a dividend only scenario would provide the shareholder with the lowest overall tax cost. The salary + dividend approach would provide the shareholder with maximum RRSP room, but would be more expensive from a tax perspective. Is the RRSP room worth the extra $4,196 in tax cost? Maybe, but that depends on how the RRSP performs, and a host of other variables.
And just to make a complex decision even more complex, consider these additional points:
- You may be able to get a better result if your corporate structure allows you to stream dividends to select individuals. This would allow you to take salary personally to generate RRSP room, and put dividends into the hands of other family members who are in a lower marginal tax return. Unlike salary, dividends do not need to be reasonable in relation to the services being provided by the dividend recipient.
- You should carefully review your disability insurance plan to make sure that you are not causing problems for yourself in the event of disability. If your disability policy will provide you with benefits based on salary only, then a remuneration strategy which is heavily weighted towards dividends may result in a lower benefit in the event of disability. Many newer disability policies take into account all forms of remuneration when determining your benefits. You should, nonetheless, have your disability policy reviewed by someone who is qualified to determine the impact, if any, that your remuneration strategy will have on your disability payout.
Tax rates change over time. Your cash needs change over time. CPP rates are scheduled to increase substantially over the coming years. This means that today's remuneration strategy may not be the best one for you in a few years. Ideally, you should review your remuneration strategy every year.
As always, seek professional advice.
* written by J. Rolland Vaive, CA, TEP, CPA - Rollie can be contacted at rvaive@taxadvice.ca
New Tax Guide Issued for Post-Secondary Students
The Canada Revenue Agency has issued an updated version of its publication P105 — Students and Income Tax. The guide reviews the common deductions and credits that may be claimed by students enrolled in post-secondary education, as well as the tax treatment of the various types of income (employment income, scholarships, and bursaries) that are typically received by such students.
The updated guide is available here.
The updated guide is available here.
Wednesday, February 17, 2010
Business Owners: How can you protect your Assets?
The time to protect your assets and your investment in your business from creditors is before any financial problems arise. If you attempt to protect your business assets after you borrow money or after a financial or creditor issue arises, you may allow your business’ creditors a better chance of accessing your assets and challenging any planning you have done.
Liability
As a shareholder of the business, your exposure is generally limited to the amount of your investment, both by way of shareholdings and through shareholder loans to the corporation. However, various situations may arise to impose liability upon you. If you have given personal guarantees to guarantee the debts and obligations of the corporation, creditors may sue you and attach (by way of garnishment or seizure) your personal assets to the amount of the personal guarantee. As a director or officer of the corporation, you may also have additional personal liability for such things as:
• unpaid employee salaries
• uncollected or unremitted G.S.T.
• unremitted payroll deductions
• breach of contract
How to Protect Your Personal Assets
Prior to signing a personal guarantee, engaging in a new business opportunity or agreeing to be a
director or officer of a corporation, you may wish to consider the following:
• you may want to transfer your personal assets to your spouse or some other party (at fair
market value)
• you may want to consider investing your money in assets which are exempt from
creditors’ claims
• certain forms of RRSP investment may also be beyond the reach of creditors
• you may want to set up an Asset Protection Trust
Protecting the Company’s Profits
There are similar steps you can take to protect the profits of the business:
• Establish a holding company to hold the shares in the corporation. The business’ profits could
then be paid on a tax-free basis to the holding company through dividends on the shares. Those
profits could then be reinvested or loaned back to the corporation as a shareholder’s loan, which
would ensure that the business’ cash flow remains unaffected. The business can grant security
back to the holding company for repayment of the loan, making the holding company a secured
creditor. In addition, the holding company can purchase equipment or land otherwise needed by
the business and then lease it back to the business, at a profit. These assets could be out of reach
from business creditors.
• Establish a family trust. Any shares in the holding company could be transferred to the family
trust, and any funds paid by the holding company to the trust by way of a dividend would
belong to the trust for the benefit of the trust beneficiaries. These funds would not be available to creditors even if one or more of the beneficiaries signed personal guarantees, or have other
personal obligations.
All creditor proofing strategies require careful consideration of taxation issues so as to avoid income attribution problems or the unexpected triggering of capital or income gains. The above opportunities and strategies represent only a sample of what ought to be considered. Each circumstance will offer its own opportunities and restrictions on planning.
Liability
As a shareholder of the business, your exposure is generally limited to the amount of your investment, both by way of shareholdings and through shareholder loans to the corporation. However, various situations may arise to impose liability upon you. If you have given personal guarantees to guarantee the debts and obligations of the corporation, creditors may sue you and attach (by way of garnishment or seizure) your personal assets to the amount of the personal guarantee. As a director or officer of the corporation, you may also have additional personal liability for such things as:
• unpaid employee salaries
• uncollected or unremitted G.S.T.
• unremitted payroll deductions
• breach of contract
How to Protect Your Personal Assets
Prior to signing a personal guarantee, engaging in a new business opportunity or agreeing to be a
director or officer of a corporation, you may wish to consider the following:
• you may want to transfer your personal assets to your spouse or some other party (at fair
market value)
• you may want to consider investing your money in assets which are exempt from
creditors’ claims
• certain forms of RRSP investment may also be beyond the reach of creditors
• you may want to set up an Asset Protection Trust
Protecting the Company’s Profits
There are similar steps you can take to protect the profits of the business:
• Establish a holding company to hold the shares in the corporation. The business’ profits could
then be paid on a tax-free basis to the holding company through dividends on the shares. Those
profits could then be reinvested or loaned back to the corporation as a shareholder’s loan, which
would ensure that the business’ cash flow remains unaffected. The business can grant security
back to the holding company for repayment of the loan, making the holding company a secured
creditor. In addition, the holding company can purchase equipment or land otherwise needed by
the business and then lease it back to the business, at a profit. These assets could be out of reach
from business creditors.
• Establish a family trust. Any shares in the holding company could be transferred to the family
trust, and any funds paid by the holding company to the trust by way of a dividend would
belong to the trust for the benefit of the trust beneficiaries. These funds would not be available to creditors even if one or more of the beneficiaries signed personal guarantees, or have other
personal obligations.
All creditor proofing strategies require careful consideration of taxation issues so as to avoid income attribution problems or the unexpected triggering of capital or income gains. The above opportunities and strategies represent only a sample of what ought to be considered. Each circumstance will offer its own opportunities and restrictions on planning.
Monday, February 15, 2010
All in the family - How to successfully transfer corporate ownership to family members???
Did you consider using an estate freeze?
WHAT IS AN ESTATE FREEZE?
Simply stated, an estate freeze is a transaction or series of steps undertaken to allow future growth in the value of one or more assets to accrue to someone else, the beneficiary of the freeze. The beneficiary of the freeze is usually the person, or persons, who will ultimately become the beneficiary of the freezor's estate.
The freezor is the individual who initiates the freeze. The income generated by the frozen assets may be transferred to the beneficiaries, or the freezor could decide this on an ongoing basis. An estate freeze limits the value of the freezor's estate to the value at the date the freeze is implemented. The current value of the asset is usually retained by the freezor, although often in a varied form.
The term "freeze" refers to fixing the value of an asset at its current value. By freezing the values today, the freezor can accomplish a number of objectives. The freezor can quantify the tax liability, which will be triggered upon death or the disposition of a freezor's assets. The freezor can also take steps, in many circumstances, to actually work towards reducing those liabilities over a period of time. By limiting the value of the estate, the freezor also reduces the exposure to probate and other estate settlement costs
For those individuals with Qualified Small Business Corporations, the number of taxpayers who are shareholders, and most important, the estate can effect an orderly transition between generations, ensuring that an individual's assets go where they want them to go.
COMMON METHODS OF ESTATE FREEZING:
The following are the most common methods of estate freezing: When the property to be frozen are business assets, the assets may be transferred to a corporation utilizing the provisions of section 85 of the Income Tax Act in order to avoid the triggering of an immediate capital gain. The transferor will be issued "freeze" shares and a trust for the children will subscribe for the common shares.
If the property to be frozen are shares of an incorporated business or an investment holding corporation, a freeze will normally involve a tax-free reorganization of capital utilizing section 86. The transferor gives up his or her growth shares in return for "freeze" shares and a trust for the children will subscribe for the common shares. If the operating company is owned by a holding company, the operating company may declare a stock dividend to the holding company equal to the retained earnings. A trust for the children then subscribes for common shares. The freezor converts to "freeze" shares and a trust for the children subscribe for common shares.
The most often used methods of estate freezing are the section 85 and 86 freezes. The following is an example of a complete section 86 (1) estate freeze.
EXAMPLE
To understand what happens in an estate freeze situation, a simple example should clarify matters. X owns all of the common shares of X Corp. X's original share investment in X Corp. was $100.00, and it is now worth $400,000.00. X expects it to increase in value significantly over the next several years. X has two children, both in their early 20s, who work in the business.
First, X exchanges his common shares of X Corp., for 400 new preferred shares; this can be done as a corporate reorganization without triggering any income tax. The preferred shares are voting shares, thus allowing the freezor to continue to exercise control. They are also retractable at any time for $1,000.00 per share. In other words, X can demand that the corporation pay $400,000.00 for the shares at any time. Each of X's children then subscribe for 50 new common shares in X Corporation, paying $1.00 per share. Now assume X Corp. value rises to $900,000.00. X's preferred shares are still worth $400,000.00 and the common shares are now worth $500,000.00. X has thus transferred the "growth" in the corporation to his children at no tax cost to X.
As noted above, a properly implemented estate freeze will result in the maximizing of the value of the estate that will accrue to the freezor's beneficiaries. As an individual is generally deemed to dispose of property on death, resulting in a tax liability, reducing the value of one's estate that is subject to tax maximizes the value of the assets received by the beneficiaries. The estate freeze should be utilized by more individuals who own small, medium and especially large companies where there is expected growth for the business.
Using an estate freeze provides many advantages. To make sure that such a strategy meets all your objectives, it’s wise to consult experienced tax and legal advisors
WHAT IS AN ESTATE FREEZE?
Simply stated, an estate freeze is a transaction or series of steps undertaken to allow future growth in the value of one or more assets to accrue to someone else, the beneficiary of the freeze. The beneficiary of the freeze is usually the person, or persons, who will ultimately become the beneficiary of the freezor's estate.
The freezor is the individual who initiates the freeze. The income generated by the frozen assets may be transferred to the beneficiaries, or the freezor could decide this on an ongoing basis. An estate freeze limits the value of the freezor's estate to the value at the date the freeze is implemented. The current value of the asset is usually retained by the freezor, although often in a varied form.
The term "freeze" refers to fixing the value of an asset at its current value. By freezing the values today, the freezor can accomplish a number of objectives. The freezor can quantify the tax liability, which will be triggered upon death or the disposition of a freezor's assets. The freezor can also take steps, in many circumstances, to actually work towards reducing those liabilities over a period of time. By limiting the value of the estate, the freezor also reduces the exposure to probate and other estate settlement costs
For those individuals with Qualified Small Business Corporations, the number of taxpayers who are shareholders, and most important, the estate can effect an orderly transition between generations, ensuring that an individual's assets go where they want them to go.
COMMON METHODS OF ESTATE FREEZING:
The following are the most common methods of estate freezing: When the property to be frozen are business assets, the assets may be transferred to a corporation utilizing the provisions of section 85 of the Income Tax Act in order to avoid the triggering of an immediate capital gain. The transferor will be issued "freeze" shares and a trust for the children will subscribe for the common shares.
If the property to be frozen are shares of an incorporated business or an investment holding corporation, a freeze will normally involve a tax-free reorganization of capital utilizing section 86. The transferor gives up his or her growth shares in return for "freeze" shares and a trust for the children will subscribe for the common shares. If the operating company is owned by a holding company, the operating company may declare a stock dividend to the holding company equal to the retained earnings. A trust for the children then subscribes for common shares. The freezor converts to "freeze" shares and a trust for the children subscribe for common shares.
The most often used methods of estate freezing are the section 85 and 86 freezes. The following is an example of a complete section 86 (1) estate freeze.
EXAMPLE
To understand what happens in an estate freeze situation, a simple example should clarify matters. X owns all of the common shares of X Corp. X's original share investment in X Corp. was $100.00, and it is now worth $400,000.00. X expects it to increase in value significantly over the next several years. X has two children, both in their early 20s, who work in the business.
First, X exchanges his common shares of X Corp., for 400 new preferred shares; this can be done as a corporate reorganization without triggering any income tax. The preferred shares are voting shares, thus allowing the freezor to continue to exercise control. They are also retractable at any time for $1,000.00 per share. In other words, X can demand that the corporation pay $400,000.00 for the shares at any time. Each of X's children then subscribe for 50 new common shares in X Corporation, paying $1.00 per share. Now assume X Corp. value rises to $900,000.00. X's preferred shares are still worth $400,000.00 and the common shares are now worth $500,000.00. X has thus transferred the "growth" in the corporation to his children at no tax cost to X.
As noted above, a properly implemented estate freeze will result in the maximizing of the value of the estate that will accrue to the freezor's beneficiaries. As an individual is generally deemed to dispose of property on death, resulting in a tax liability, reducing the value of one's estate that is subject to tax maximizes the value of the assets received by the beneficiaries. The estate freeze should be utilized by more individuals who own small, medium and especially large companies where there is expected growth for the business.
Using an estate freeze provides many advantages. To make sure that such a strategy meets all your objectives, it’s wise to consult experienced tax and legal advisors
Save tax by using a family discretionary trust *
As previously mentioned, there are several advantages to setting up a family discretionary trust from tax, legal and personal perspectives. For one, managers can achieve a key objective: protecting personal assets from potential recourse by creditors. In today’s business climate, new regulations applicable to public companies (designed to increase public protection) require chief executive officers and chief financial officers to assume greater liability over the accuracy of financial information published by their corporations. They must personally certify the corporation’s financial statements, thereby exposing themselves to higher risk. Given these circumstances, setting up a family discretionary trust becomes an attractive way for such executives to ensure greater protection of their personal assets, as assets transferred to a trust constitute a distinct estate.
What is a family discretionary trust?
A family discretionary trust is an inter vivos trust created by and for the members of the same family. The inter vivos trust is a legal vehicle created through a contract (the trust deed) in which a person (the settlor) transfers assets to one or more persons (the trustees) to control those assets for the benefit of other persons (the beneficiaries). Settlors may transfer a variety of assets into the trust, including investment portfolios, shares from a family company, rental properties, a principal residence, etc. Then, according to the level of discretion described in the trust deed, the trustee may allocate trust revenues or capital to one or more of the beneficiaries. Beneficiaries might include the settlor’s spouse, children or grandchildren, or, subject to certain tax rules, the settlor himself.
Tax planning considerations
Before creating a family discretionary trust, one must examine any applicable asset transfer rules or attribution rules. From a tax perspective, transferring the settlor’s assets to a family discretionary trust results in a fair market value disposition of these assets, unless you satisfy specific conditions. Once transferred to the trust, the income generated by these assets will again be taxable at the highest marginal rate, which ranges from 46% in Ontario to almost 49% in Newfoundland and Labrador.
However, one can reduce this tax liability by attributing income to certain beneficiaries because revenues thus attributed are deducted from the revenues earned by the trust and taxable in the hands of the beneficiaries, to the extent that the attribution rules are not applicable. In effect, during the settlor’s lifetime, trust income attributed to a spouse, as well as trust income (except for capital gains) attributed to minor children, is taxable in the hands of the settlor because of attribution rules.
Thus, by attributing, during the settlor’s lifetime, the trust’s income to children of majority, or capital gains to minor children, it is possible to lower a family’s tax burden. For example, by attributing income generated from trust assets to a child of majority to pay for his or her university tuition, the family’s overall tax burden will be reduced, since the child of majority will be personally taxed on this income at a marginal rate that would likely be lower than the marginal rate of the parent. In such instances, to prevent tax authorities from questioning the attribution of income, it would be important to keep adequate records showing that the income was paid or payable to the beneficiaries.
To summarize, setting up a family discretionary trust provides many advantages. To make sure that such a strategy meets all your objectives, it’s wise to consult experienced tax and legal advisors.
please do not hesitate to contact me should you have any questions regarding the above.
* This article was prepared by Danielle Lacasse, a Deloitte partner in Montreal, in collaboration with Cindy Harvey.
What is a family discretionary trust?
A family discretionary trust is an inter vivos trust created by and for the members of the same family. The inter vivos trust is a legal vehicle created through a contract (the trust deed) in which a person (the settlor) transfers assets to one or more persons (the trustees) to control those assets for the benefit of other persons (the beneficiaries). Settlors may transfer a variety of assets into the trust, including investment portfolios, shares from a family company, rental properties, a principal residence, etc. Then, according to the level of discretion described in the trust deed, the trustee may allocate trust revenues or capital to one or more of the beneficiaries. Beneficiaries might include the settlor’s spouse, children or grandchildren, or, subject to certain tax rules, the settlor himself.
Tax planning considerations
Before creating a family discretionary trust, one must examine any applicable asset transfer rules or attribution rules. From a tax perspective, transferring the settlor’s assets to a family discretionary trust results in a fair market value disposition of these assets, unless you satisfy specific conditions. Once transferred to the trust, the income generated by these assets will again be taxable at the highest marginal rate, which ranges from 46% in Ontario to almost 49% in Newfoundland and Labrador.
However, one can reduce this tax liability by attributing income to certain beneficiaries because revenues thus attributed are deducted from the revenues earned by the trust and taxable in the hands of the beneficiaries, to the extent that the attribution rules are not applicable. In effect, during the settlor’s lifetime, trust income attributed to a spouse, as well as trust income (except for capital gains) attributed to minor children, is taxable in the hands of the settlor because of attribution rules.
Thus, by attributing, during the settlor’s lifetime, the trust’s income to children of majority, or capital gains to minor children, it is possible to lower a family’s tax burden. For example, by attributing income generated from trust assets to a child of majority to pay for his or her university tuition, the family’s overall tax burden will be reduced, since the child of majority will be personally taxed on this income at a marginal rate that would likely be lower than the marginal rate of the parent. In such instances, to prevent tax authorities from questioning the attribution of income, it would be important to keep adequate records showing that the income was paid or payable to the beneficiaries.
To summarize, setting up a family discretionary trust provides many advantages. To make sure that such a strategy meets all your objectives, it’s wise to consult experienced tax and legal advisors.
please do not hesitate to contact me should you have any questions regarding the above.
* This article was prepared by Danielle Lacasse, a Deloitte partner in Montreal, in collaboration with Cindy Harvey.
What is Income Splitting ??
Canada has a progressive income tax system - the more you earn the higher the rate of tax which you pay. Income splitting is a family tax planning technique designed to shift income from a high rate taxpayer to a lower rate taxpayer such as a spouse or children.
A number of different techniques can be used to accomplish this objective. However, you must be careful because Revenue Canada frowns on income splitting and there are provisions in the Income Tax Act designed to curtail it.
please contact me to see if you can benefit from this tax planning technique.
A number of different techniques can be used to accomplish this objective. However, you must be careful because Revenue Canada frowns on income splitting and there are provisions in the Income Tax Act designed to curtail it.
please contact me to see if you can benefit from this tax planning technique.
Do you qualify to split your pension income?
Do you qualify to split your pension income?
You (the Pensioner) and your spouse or common-law partner (the Pension Transferee) can elect to split your eligible pension income received in the year if you meet the following conditions:
- you are married or in a common-law partnership with each other in the year and are not, because of a breakdown in your marriage or common-law partnership, living separate and apart from each other at the end of the tax year and for a period of 90 days or more commencing in the year (see the note below); and
- you are are both resident in Canada on December 31 of the year; or
- if deceased in the year, resident in Canada on the date of death; or
- if bankrupt in the year, resident in Canada on December 31 of the year in which the tax year (pre- or post-bankruptcy) ends.
- you received pension income in the year that qualifies for the pension income amount.
* Note: You and your spouse or common-law partner will still be eligible to split pension income if living apart at the end of the year for medical, educational, or business reasons (rather than a breakdown in the marriage or common-law partnership).
Eligible pension income can only be split between you (the Pensioner) and your spouse or common-law partner (the Pension Transferee).
You are not prevented from splitting your eligible pension income because of the age of your spouse or common-law partner.
for more information, click here
You (the Pensioner) and your spouse or common-law partner (the Pension Transferee) can elect to split your eligible pension income received in the year if you meet the following conditions:
- you are married or in a common-law partnership with each other in the year and are not, because of a breakdown in your marriage or common-law partnership, living separate and apart from each other at the end of the tax year and for a period of 90 days or more commencing in the year (see the note below); and
- you are are both resident in Canada on December 31 of the year; or
- if deceased in the year, resident in Canada on the date of death; or
- if bankrupt in the year, resident in Canada on December 31 of the year in which the tax year (pre- or post-bankruptcy) ends.
- you received pension income in the year that qualifies for the pension income amount.
* Note: You and your spouse or common-law partner will still be eligible to split pension income if living apart at the end of the year for medical, educational, or business reasons (rather than a breakdown in the marriage or common-law partnership).
Eligible pension income can only be split between you (the Pensioner) and your spouse or common-law partner (the Pension Transferee).
You are not prevented from splitting your eligible pension income because of the age of your spouse or common-law partner.
for more information, click here
Holding Company - what is it?
Here is a great article written by Rolland Vaive, CA, TEP, CPA - an excellent accountant based in Ottawa (Orleans) and specializing in complicated tax matters.
Speak to any tax accountant for more than a minute and they'll surely be talking about holding companies, or HoldCo's for short. A holding company is not a term which is defined in the Income Tax Act. It is a term which is used to define a corporation which holds assets, most often income generating investment assets. It does not typically carry on any active business operations.
A HoldCo can arise for a variety of reasons. In the early 1990's, the personal marginal tax rate in Ontario was slightly higher than 53%, while the corporate rate of tax was considerably lower than that. High income individuals who had significant investment assets could realize a tax deferral by transferring their investment assets to a HoldCo, particularly in situations where they did not need the income which was being generated by the investments. This breakdown between the corporate rate of tax and the personal rate of tax lead to many HoldCo's being formed.
HoldCo's may also come about as an effective means of creditor proofing profitable operating companies, as a result of Canadian estate planning, or as a means of avoiding U.S. estate tax and Ontario probate fees. Regardless of their origins, the investment income generating HoldCo is taxed in an unusual manner, which I will attempt to explain. The underlying concept of HoldCo taxation is called "integration". In general terms, integration means that an individual should pay the same amount of tax on investment income if they earned it personally or if they earned it through a corporation and withdrew the after-tax income in the form of dividends. When we look at some real numbers, you will see that this in fact generally holds true. However, it is possible to exploit some breakdowns in integration, at which time it may become quite beneficial to earn your investment income through a HoldCo.
Let's look at the theory. We often hear about how corporations are taxed at low tax rates. In situations where a private company is earning income from active business operations carried on in Canada, that is quite true. In these situations, the rate of tax would be a flat tax rate of 18.620% if the company was resident in Ontario. The other provinces have similarly low rates of tax on "active business income". The low rate of tax does not apply to investment income, which is what the HoldCo would be generating.
For an Ontario resident private company generating investment income, the combined Federal and Provincial rate of tax would be a flat 49.7867% on all forms of investment income, other than dividends from other Canadian corporations. Bear in mind that only 1/2 of capital gains are included in income, so the effective corporate rate of tax on capital gains would be 24.8934%. A portion of the tax that HoldCo pays each year on its' investment income goes into a notional pool called the RDTOH pool. This is an acronym for "refundable dividend tax on hand". Of the 49% rate of tax that is paid by the corporation, 26.67% will go into the RDTOH pool each year and is tracked on the corporation's Federal tax return.
If HoldCo pays a taxable dividend to its' shareholders in a particular year, it gets back part of its RDTOH pool. More specifically, the company will get back $1 for every $3 of dividends that it pays. This RDTOH recovery is called a dividend refund, and would be a direct reduction of the corporation's tax liability for the year. If the corporation pays a large dividend to a shareholder, the dividend refund would also be large and may result in the company actually getting money back from the Canada Revenue Agency. In short, the HoldCo will pay a large tax liability on its investment income up front, but it can get a large portion of it back at a later date if it pays out dividends. The dividend refund is an attempt to compensate for the fact that the dividend will attract tax in the hands of the shareholder. Without this mechanism, the 48% rate of tax on investment income combined with the tax paid by the shareholder on the dividend that they receive would result in an onerous rate of tax. It is possible that a second notional tax pool may arise in HoldCo if it is generating capital gains on its' investment assets. You will recall that only 1/2 of capital gains are included in income. The other 1/2 portion of the capital gain which is not included in income will get added to the capital dividend account, or "CDA", of HoldCo. The CDA balance is something which needs to get tracked by the company on a regular basis, since it does not appear anywhere on the company's financial statements or tax returns. The CDA is important because it is possible for HoldCo to pay a dividend to a shareholder and elect to pay it out of the CDA balance, making the dividend tax-free to the shareholder.
If a company realizes a capital gain of $10,000 , only $5,000 will be included in taxable income, with the remaining $5,000 being added to the company's CDA balance. The company could then pay a $5,000 dividend to the shareholder. By electing to do so out of the CDA balance, the shareholder would not be taxed on the dividend. Lets look at this in conjunction with the RDTOH balance. If the company pas a dividend to a shareholder out of the CDA balance, it is tax free to the shareholder, but it is not going to generate a dividend refund to HoldCo. HoldCo only gets a dividend refund if the dividend is a taxable dividend to the shareholder. Armed with this theory, we can look at a live example of how this would work.
Lets consider the example of an Ontario resident individual who is holding shares that have an adjusted cost base (i.e. tax cost) of $1,000. These shares have experienced a dramatic increase in value, and are now worth $100,000. The individual is going to sell these shares and would like to know if there is any advantage to doing so through a HoldCo. The individual is in the highest marginal tax rate (currently 31.310 % on Canadian source dividends and 46.410 % on everything else).
The individual wants the after tax money, so they would withdraw everything from the HoldCo once the shares are sold. If they were to go the HoldCo route, they would elect to transfer their shares to HoldCo at their $1,000 tax cost prior to the sale (to transfer them at fair market value would defeat the purpose), and would have the capital gain realized within HoldCo. In the process of transferring the shares to HoldCo, they could arrange to have HoldCo issue a note payable to them equal to their original $1,000 tax cost. Integration tells us that selling the shares through a HoldCo should give us the same result as selling the shares personally.
If the individual wants to get the money out of the HoldCo following the sale of the shares, they would elect to take part of the proceeds from the share sale out of HoldCo as a non-taxable repayment of their $1,000 note and as a non-taxable payment our of the CDA balance. The remaining cash would be withdrawn from the company as a taxable dividend, leading to a dividend refund in HoldCo. As this example illustrates, there is no advantage to using the HoldCo to sell the shares even without considering the professional fees associated with the HoldCo. So why do it? Well, there may be some good reasons for doing it.
Firstly, the example assumes that the individual withdraws all of the cash from HoldCo in the year of the share sale, and at a time when they are in the highest marginal tax rate. If the cash from the sale was left in the corporation and withdrawn as a dividend a year or two later when the individual was not in the highest marginal tax rate, then the results may be quite good. The HoldCo would get the dividend refund at a rate of $1 for every $3 of dividends in that later year when the dividend is paid, and the shareholder may not incur a significant tax liability on the dividend that he or she receives. Alternatively, it may be possible to transfer the shares to HoldCo well before a sale is to happen.
In this way, future growth in the value of the shares could be shifted to other family members. When the shares are sold, the growth in value since the time of the transfer could be paid as a dividend to these other family members. If these family members are in a low marginal tax rate, they would not incur much tax on the dividend, and the results could be quite good when compared to the alternative where the shares continue to be held by the individual and sold by him or her personally.
There are a host of issues to be considered before embarking on such an exercise, including the corporate attribution rules and the tax on split income to name but a few. As always, seek professional advice before undertaking any steps.
Subscribe to:
Posts (Atom)