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.
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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.
Friday, July 22, 2011
Business Owners: 5 Myths that you should know about Family Trust!!
Over the past 3 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.
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.
Wednesday, July 20, 2011
What is the role of 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 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
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
Professionals: The Tax Advantages of Incorporating a Professional Corporation
The Tax Advantages of Incorporating for Professionals *
As a professional, there are tax planning opportunities that become available when you incorporate. Before you decide to incorporate to take advantage of these opportunities, however, there are a number of important considerations to make. Unlike business people in general, you must consider the specific rules that govern your profession when determining whether incorporation makes sense for you. In particular, you need to determine the ownership rules that apply, as certain provinces restrict who can own shares of a professional corporation (PC). You also need to determine what activities your profession will allow your PC to engage in. Both can impact on the tax planning available.
In this article, we will outline the main tax planning opportunities available along with the key considerations to make when deciding whether or not to incorporate.
Income Splitting
The ability to split income with a spouse or an adult child is one of the main benefits of incorporation for businesses. However, it is necessary for professionals to consider the ownership rules of their profession as this will determine whether income splitting benefits are available. In particular, you will need to consider who is allowed to hold shares of the PC. Certain provinces will allow shareholders of the PC to include the professional along with their family members, while other professions will allow only members of the profession to hold shares of the PC. Where family ownership is allowed, some provinces also restrict the use of trusts.
Where the rules allow, you can benefit from income splitting where your spouse and adult children are allowed to subscribe for shares of the corporation and receive dividends from the profits of the PC. The advantage here is the ability to have the dividends taxed in the hands of more than one person, which generally means that the overall tax on the dividends is lower. Note that due to the income-splitting tax (often referred to as the kiddie tax), the benefit of splitting dividend income with minor children is not available.
In the case of your spouse, you’ll also need to ensure you don’t run afoul of the corporate attribution rules. These rules may apply if you transfer property or make a low-interest loan to your PC where your spouse is or will become a shareholder. Where these rules apply, an imputed interest penalty will be included in your income and income splitting will not be achieved. Note, however, that the corporate attribution rules will not apply for any period that the corporation qualifies as a small business corporation (SBC). A corporation qualifies as an SBC if:
It’s a Canadian-controlled private corporation (CCPC); and
All or substantially all of its assets are used in an active business carried on primarily in Canada. The CRA interprets this to mean that assets representing at least 90% of the fair market value of all assets are used for business purposes.
The corporate attribution rules will be an issue for professionals who want to introduce a spouse as a shareholder to their PC and passive investments have already been built up in the PC. Also, keep in mind that even where a PC is currently an SBC, if passive assets accumulate in the PC, the corporate attribution rules can still become a problem.
The Small Business Deduction
The second main benefit of incorporation is the ability to access the small business deduction. A PC owned by a professional resident in Canada will be a CCPC, so that corporation may be able to obtain the benefit of the small business deduction. With this deduction, a CCPC’s federal and provincial tax on active business income is reduced, up to certain limits. Currently, a maximum of $500,000 of active business income qualifies for the federal small business deduction. The limit varies by province.
A benefit can be achieved where business income is instead retained in the corporation, and the additional personal tax that will be payable when dividends are paid is deferred. The lower corporate tax rate leaves greater after-tax dollars in the corporation to pay expenses and reinvest in assets. A smaller tax deferral will also be available for general rate business income (i.e. income not eligible for the small business deduction). In provinces that do not allow non-professionals to hold shares of a PC, the tax deferral will be the largest tax benefit.
When determining whether your PC can benefit from the small business deduction, you need to consider the following rules:
Partnerships – If you carry on business as a member of a partnership, the small business deduction rules will apply differently. The rules that will apply are known as the specified partnership income rules. Under these rules only one small business deduction will be available to reduce corporate tax on income from the partnership. In the case of a partnership of PCs, all of the PCs must share one small business deduction. For example, if your PC earns 1/4 of the income from a professional partnership, only $125,000 of the income (1/4 of $500,000) will be eligible for the federal small business deduction. Note that these rules effectively mean that partners of large partnerships do not get any significant small business deduction on their partnership income. Certain structures can be used to effectively allow PCs of partners in professional partnerships access to a full small business deduction limit, but they require careful planning to implement and generally require that non-competition clauses in partnership agreements be eliminated.
Personal Services Business – Generally, if you provide services through your corporation and if not for the corporation you could be considered an employee of the entity to which you provide the services, the corporation may be considered a personal services business (PSB) where certain exceptions do not apply. In other words, you would be considered an “incorporated employee”. Where the PSB rules apply, income from the PSB will not be eligible for the small business deduction. As well, deductions claimed by the PSB will be restricted. Consequently, to fully benefit from incorporation, you must ensure that you avoid the PSB rules. In most cases, this means that you have to be an independent contractor and not an incorporated employee. The PSB rules are not a concern for partners of a professional partnership who are generally not considered to be employees of the partnership.
Capital Gains Exemption for Qualifying Small Business Shares
The third significant tax advantage of incorporation that may be available is the capital gains exemption for qualifying small business corporation shares. Due to the nature of a PC as well as the restrictive ownership rules, selling shares and realizing a gain eligible for the exemption may be difficult. Purchasers may prefer to buy goodwill or client lists, rather than shares, and they may also have concerns about inheriting the professional liability of the vendor. An incorporated partner of a professional partnership will likely not be able to sell shares of his PC. However, if you or family members are able to sell shares of the PC, up to $750,000 of gross gains can be exempted (for each individual).
To qualify for the exemption, the following general conditions must be met:
At the time of the disposition, at least 90% of the corporation’s assets (on the basis of fair market value) must be business assets;
More than 50% of the corporation’s assets (on the basis of fair market value) must have been used in an active business carried on primarily in Canada throughout the 24-month period immediately before the sale; and
The shares must not have been owned by anyone other than the vendor or someone related to the vendor during the 24-month period immediately before the sale.
In addition to claiming the capital gains exemption on an actual sale of your shares, it may be possible to trigger a capital gain, claim the exemption and step-up the tax cost of your shares in anticipation of a future sale. This planning will be especially useful if you believe your corporation will lose its status as an SBC in the future.
Other Considerations
There are other benefits, as well as potential minor disadvantages, that you should consider if you want to incorporate.
Individual Pension Plan – Instead of contributing to an RRSP, another retirement savings option is available to you as a professional if you incorporate. Under the rules for defined benefit pension plans, an individual pension plan (IPP) can be set up for business owners who are employed and earning employment income. The benefits under an IPP are set by reference to your salary from your PC, and contributions are made to build sufficient funds to fund this defined pension benefit. For many individuals (generally, in their 50s or older), the use of an IPP can allow for greater contributions when compared to an RRSP. Additional benefits of an IPP include the ability to make up for poor investment performance and the possibility of making lump-sum contributions for past service.
Employment Benefits – If you incorporate, you may also be able to take advantage of employee benefits that have preferential tax treatment such as private health service plan benefits and benefits from the use of a leased company car. As a shareholder of your PC, it will be important to ensure that the benefit is received as an employment benefit and not as a shareholder benefit — otherwise preferential tax treatment will be lost.
Additional Compliance – One minor disadvantage of incorporation is that it does mean that you have additional paperwork. This will include preparing a corporate tax return and completing the appropriate tax filings for salaries or dividends paid by the corporation.
Payroll Taxes – Another potential disadvantage is that certain jurisdictions levy a payroll tax on remuneration paid to employees. Therefore, a payroll tax may apply to remuneration paid to employees of a PC.
There are many factors to consider when deciding whether or not incorporation makes sense for you as a professional. The provincial rules for your profession need to be balanced with the tax rules to ensure you benefit from the tax planning opportunities available from incorporation, given the additional costs you may incur. All factors considered, the decision can seem overwhelming, but your legal advisor can help you make the decision that is right for you.
*** this article published by the accounting firm BDO - www.BDO.ca ***
As a professional, there are tax planning opportunities that become available when you incorporate. Before you decide to incorporate to take advantage of these opportunities, however, there are a number of important considerations to make. Unlike business people in general, you must consider the specific rules that govern your profession when determining whether incorporation makes sense for you. In particular, you need to determine the ownership rules that apply, as certain provinces restrict who can own shares of a professional corporation (PC). You also need to determine what activities your profession will allow your PC to engage in. Both can impact on the tax planning available.
In this article, we will outline the main tax planning opportunities available along with the key considerations to make when deciding whether or not to incorporate.
Income Splitting
The ability to split income with a spouse or an adult child is one of the main benefits of incorporation for businesses. However, it is necessary for professionals to consider the ownership rules of their profession as this will determine whether income splitting benefits are available. In particular, you will need to consider who is allowed to hold shares of the PC. Certain provinces will allow shareholders of the PC to include the professional along with their family members, while other professions will allow only members of the profession to hold shares of the PC. Where family ownership is allowed, some provinces also restrict the use of trusts.
Where the rules allow, you can benefit from income splitting where your spouse and adult children are allowed to subscribe for shares of the corporation and receive dividends from the profits of the PC. The advantage here is the ability to have the dividends taxed in the hands of more than one person, which generally means that the overall tax on the dividends is lower. Note that due to the income-splitting tax (often referred to as the kiddie tax), the benefit of splitting dividend income with minor children is not available.
In the case of your spouse, you’ll also need to ensure you don’t run afoul of the corporate attribution rules. These rules may apply if you transfer property or make a low-interest loan to your PC where your spouse is or will become a shareholder. Where these rules apply, an imputed interest penalty will be included in your income and income splitting will not be achieved. Note, however, that the corporate attribution rules will not apply for any period that the corporation qualifies as a small business corporation (SBC). A corporation qualifies as an SBC if:
It’s a Canadian-controlled private corporation (CCPC); and
All or substantially all of its assets are used in an active business carried on primarily in Canada. The CRA interprets this to mean that assets representing at least 90% of the fair market value of all assets are used for business purposes.
The corporate attribution rules will be an issue for professionals who want to introduce a spouse as a shareholder to their PC and passive investments have already been built up in the PC. Also, keep in mind that even where a PC is currently an SBC, if passive assets accumulate in the PC, the corporate attribution rules can still become a problem.
The Small Business Deduction
The second main benefit of incorporation is the ability to access the small business deduction. A PC owned by a professional resident in Canada will be a CCPC, so that corporation may be able to obtain the benefit of the small business deduction. With this deduction, a CCPC’s federal and provincial tax on active business income is reduced, up to certain limits. Currently, a maximum of $500,000 of active business income qualifies for the federal small business deduction. The limit varies by province.
A benefit can be achieved where business income is instead retained in the corporation, and the additional personal tax that will be payable when dividends are paid is deferred. The lower corporate tax rate leaves greater after-tax dollars in the corporation to pay expenses and reinvest in assets. A smaller tax deferral will also be available for general rate business income (i.e. income not eligible for the small business deduction). In provinces that do not allow non-professionals to hold shares of a PC, the tax deferral will be the largest tax benefit.
When determining whether your PC can benefit from the small business deduction, you need to consider the following rules:
Partnerships – If you carry on business as a member of a partnership, the small business deduction rules will apply differently. The rules that will apply are known as the specified partnership income rules. Under these rules only one small business deduction will be available to reduce corporate tax on income from the partnership. In the case of a partnership of PCs, all of the PCs must share one small business deduction. For example, if your PC earns 1/4 of the income from a professional partnership, only $125,000 of the income (1/4 of $500,000) will be eligible for the federal small business deduction. Note that these rules effectively mean that partners of large partnerships do not get any significant small business deduction on their partnership income. Certain structures can be used to effectively allow PCs of partners in professional partnerships access to a full small business deduction limit, but they require careful planning to implement and generally require that non-competition clauses in partnership agreements be eliminated.
Personal Services Business – Generally, if you provide services through your corporation and if not for the corporation you could be considered an employee of the entity to which you provide the services, the corporation may be considered a personal services business (PSB) where certain exceptions do not apply. In other words, you would be considered an “incorporated employee”. Where the PSB rules apply, income from the PSB will not be eligible for the small business deduction. As well, deductions claimed by the PSB will be restricted. Consequently, to fully benefit from incorporation, you must ensure that you avoid the PSB rules. In most cases, this means that you have to be an independent contractor and not an incorporated employee. The PSB rules are not a concern for partners of a professional partnership who are generally not considered to be employees of the partnership.
Capital Gains Exemption for Qualifying Small Business Shares
The third significant tax advantage of incorporation that may be available is the capital gains exemption for qualifying small business corporation shares. Due to the nature of a PC as well as the restrictive ownership rules, selling shares and realizing a gain eligible for the exemption may be difficult. Purchasers may prefer to buy goodwill or client lists, rather than shares, and they may also have concerns about inheriting the professional liability of the vendor. An incorporated partner of a professional partnership will likely not be able to sell shares of his PC. However, if you or family members are able to sell shares of the PC, up to $750,000 of gross gains can be exempted (for each individual).
To qualify for the exemption, the following general conditions must be met:
At the time of the disposition, at least 90% of the corporation’s assets (on the basis of fair market value) must be business assets;
More than 50% of the corporation’s assets (on the basis of fair market value) must have been used in an active business carried on primarily in Canada throughout the 24-month period immediately before the sale; and
The shares must not have been owned by anyone other than the vendor or someone related to the vendor during the 24-month period immediately before the sale.
In addition to claiming the capital gains exemption on an actual sale of your shares, it may be possible to trigger a capital gain, claim the exemption and step-up the tax cost of your shares in anticipation of a future sale. This planning will be especially useful if you believe your corporation will lose its status as an SBC in the future.
Other Considerations
There are other benefits, as well as potential minor disadvantages, that you should consider if you want to incorporate.
Individual Pension Plan – Instead of contributing to an RRSP, another retirement savings option is available to you as a professional if you incorporate. Under the rules for defined benefit pension plans, an individual pension plan (IPP) can be set up for business owners who are employed and earning employment income. The benefits under an IPP are set by reference to your salary from your PC, and contributions are made to build sufficient funds to fund this defined pension benefit. For many individuals (generally, in their 50s or older), the use of an IPP can allow for greater contributions when compared to an RRSP. Additional benefits of an IPP include the ability to make up for poor investment performance and the possibility of making lump-sum contributions for past service.
Employment Benefits – If you incorporate, you may also be able to take advantage of employee benefits that have preferential tax treatment such as private health service plan benefits and benefits from the use of a leased company car. As a shareholder of your PC, it will be important to ensure that the benefit is received as an employment benefit and not as a shareholder benefit — otherwise preferential tax treatment will be lost.
Additional Compliance – One minor disadvantage of incorporation is that it does mean that you have additional paperwork. This will include preparing a corporate tax return and completing the appropriate tax filings for salaries or dividends paid by the corporation.
Payroll Taxes – Another potential disadvantage is that certain jurisdictions levy a payroll tax on remuneration paid to employees. Therefore, a payroll tax may apply to remuneration paid to employees of a PC.
There are many factors to consider when deciding whether or not incorporation makes sense for you as a professional. The provincial rules for your profession need to be balanced with the tax rules to ensure you benefit from the tax planning opportunities available from incorporation, given the additional costs you may incur. All factors considered, the decision can seem overwhelming, but your legal advisor can help you make the decision that is right for you.
*** this article published by the accounting firm BDO - www.BDO.ca ***
Tuesday, July 19, 2011
Why Family Trust are NOT only for Millionaire....
If you’re like most business owners, you probably think of trusts as powerful financial tools used by the ultra-rich. Well, you’d be wrong. They are powerful financial tools, but they’re not just for the rich. They’re used by all kinds of financially savvy business people who know about the benefits they offer and save a lot of money using them to their advantage.
You don’t have to have millions of dollars to take advantage of those benefits. As a business owners, the setup fees of a trust is usually worth while as you can save up to $35,000 per $100,000 of profit. You can set up a simple trust for a few thousand dollars.
In addition, did you know that if you have 2 wills drafted (personal & corporate) the corporate will allow you to avoid probate fee (taxes payable at death)and save you thousand of dollars. I highly recommend that you contact me if you wish to learn more.
The goal of this posting is simply to make you more aware of trusts and what they can do for you and your estate plan. Keep in mind that trusts can be very complex and that you definitely need the help of a professional to know how a trust would help you in your specific situation.
If you have any questions on the above, please contact me at hugues.boisvert@andrewsrobichaud.com
You don’t have to have millions of dollars to take advantage of those benefits. As a business owners, the setup fees of a trust is usually worth while as you can save up to $35,000 per $100,000 of profit. You can set up a simple trust for a few thousand dollars.
In addition, did you know that if you have 2 wills drafted (personal & corporate) the corporate will allow you to avoid probate fee (taxes payable at death)and save you thousand of dollars. I highly recommend that you contact me if you wish to learn more.
The goal of this posting is simply to make you more aware of trusts and what they can do for you and your estate plan. Keep in mind that trusts can be very complex and that you definitely need the help of a professional to know how a trust would help you in your specific situation.
If you have any questions on the above, please contact me at hugues.boisvert@andrewsrobichaud.com
Sunday, July 17, 2011
Business owner: Did you know that by having a proper Share Structure; you can save a lot of money??
Do you have a proper Share Structure??
For those who are about to incorporate and have yet to do so, it is important you give appropriate consideration to establishing a proper share structure. In doing so you will likely save time, money and administrative difficulties as your business grows. While you are only required, in law, to have one class of shares (common), it is best to provide additional classes of shares so that you will have the needed flexibility in the future to attract new investors; to afford an opportunity of income splitting between family members; and possibly to make use of a family trust. Ultimately, if truly successful, you will also be in a position to take advantage of significant tax savings if the appropriate classes of shares have been in existence and have been held by the shareholders for a sufficient period of time (2 years / capital gain exemption).
Putting in place the correct share structure provides a number of advantages:
- Income Splitting - This can be an effective tax saving device if you and your spouse hold different classes of shares. This affords you an opportunity to issue dividends and/or bonuses in a tax efficient manner.
- Key Employees - Issuing shares to key employees can promote and maintain loyalty to ensure ongoing involvement of top level employees. The shares to be offered to key employees can either be voting or non-voting common shares or voting or non-voting special shares so long as such shares are part of the share structure.
- Family Trusts - The use of family trusts and the issuing of the appropriate shares to beneficiaries of the family trust can be an effective tax and succession planning device.- Succession Planning - With the appropriate share structure in place it is possible to establish a cost effective and tax effective succession regime.
- Raising Investment Capital - While it is common that an investor will have certain requirements concerning the share structure, it is possible to envisage many, if not all such requirement in advance and this may facilitate a successful due diligence process.
- Administrative and Legal Fees - Establishing an appropriate share structure at the outset can avoid the time and expense of preparing needed Articles of Amendment in the future.
For those who are about to incorporate and have yet to do so, it is important you give appropriate consideration to establishing a proper share structure. In doing so you will likely save time, money and administrative difficulties as your business grows. While you are only required, in law, to have one class of shares (common), it is best to provide additional classes of shares so that you will have the needed flexibility in the future to attract new investors; to afford an opportunity of income splitting between family members; and possibly to make use of a family trust. Ultimately, if truly successful, you will also be in a position to take advantage of significant tax savings if the appropriate classes of shares have been in existence and have been held by the shareholders for a sufficient period of time (2 years / capital gain exemption).
Putting in place the correct share structure provides a number of advantages:
- Income Splitting - This can be an effective tax saving device if you and your spouse hold different classes of shares. This affords you an opportunity to issue dividends and/or bonuses in a tax efficient manner.
- Key Employees - Issuing shares to key employees can promote and maintain loyalty to ensure ongoing involvement of top level employees. The shares to be offered to key employees can either be voting or non-voting common shares or voting or non-voting special shares so long as such shares are part of the share structure.
- Family Trusts - The use of family trusts and the issuing of the appropriate shares to beneficiaries of the family trust can be an effective tax and succession planning device.- Succession Planning - With the appropriate share structure in place it is possible to establish a cost effective and tax effective succession regime.
- Raising Investment Capital - While it is common that an investor will have certain requirements concerning the share structure, it is possible to envisage many, if not all such requirement in advance and this may facilitate a successful due diligence process.
- Administrative and Legal Fees - Establishing an appropriate share structure at the outset can avoid the time and expense of preparing needed Articles of Amendment in the future.
Business owner: Are you a candidate for a Family Trust and save thousand of $$ in taxes?
As a business lawyer, I meet with entrepreneurs on a daily basis, and for many of them their most valuable asset is their corporation. For obvious reasons, their first priority is on income-earning activities, such as generating sales. Attention to such activities is, of course, a practical necessity and a hallmark of success. However, the utilization of a proper corporate structure to reduce tax exposure is often overlooked. Business owners must realize that a proper structure can save a substantial amount of taxes and can also be greatly beneficial for them and their family. The purpose of this article is to explain to you the benefits of using a Family Trust and to help you determine if you are a good candidate for implementing such a structure.
What is a Family Trust?
In essence, a trust is not a legal entity like a corporation, but rather a relationship that exists whenever a person, called a Trustee, holds property for the benefit of other individuals. The trust arrangement permits the legal ownership of the property to be held by the trustee while the benefits of ownership (income, capital gains) accrue to the beneficiaries. It is common practice for an entrepreneur and his or her spouse to act as Trustees of their Family Trust. Hence, entrepreneurs can still maintain control over their companies, while benefiting from a trust arrangement (subject to their fiduciary duties to act in the best interest of the beneficiaries).
How do I determine if I’m a good candidate to setup a Family Trust?
Here are some key indicators that you should consider a Family Trust:
Ø You are shareholder in a private corporation.
Ø Your business is profitable and generating profits.
Ø You have children(s) and you are paying/will pay for their education(s).
Ø You may want to sell your company in the future.
Would it be beneficial for me and for my family?
Some of the benefits of using a Family Trust structure are:
Ø Funding of your children’s education. The first and immediate benefit is the funding of your children's education. By having the trust own shares in the family company and having your children as beneficiaries of the trust, it is possible to fund as much as $32,000.00 per child over the age of 18 at a tax rate of approximately 14% through the trust as opposed to funding your child's education from your personal funds which are usually taxed at a substantially higher rate. If you are a high income earner you will be paying tax at approximately 48%. Basically, you can save as much as 34% of taxes (i.e. a potential saving of $34,000 for each $100,000 earned). This is a substantial savings for each of your children for each year that he/she is in school with little or no other source of income.
Ø Income splitting. A well-structured family trust allows for splitting the income earned by the trust among the various beneficiaries. If you are a high income earner you may be able to split your revenue to a lower income earner. (subject to the potential application of the attribution rules and the “kiddie tax”).
Ø Capital gains exemption. Once in your life time, you may be eligible to claim the $750,000 capital gains exemption. Basically, what it means it that an individual selling his/her shares of a Canadian Private Corporation (subject to a set of specific rules) can receive the first $750,000 on a tax free basis. 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.
Ø Reducing tax liability at death. Transferring assets to a trust may limit the size of the individual’s estate, such that tax liability at death is reduced. In addition, probate fees may be reduced.
As you can see, a Family Trust can offer business owners a great deal of flexibility and should be further explored. Any individual who is interested in setting up a corporate structure that involves a Family Trust should evaluate all the tax consequences and consult with a knowledgeable professional. For more personalized information regarding setting up a Family Trust please contact me via email.
What is a Family Trust?
In essence, a trust is not a legal entity like a corporation, but rather a relationship that exists whenever a person, called a Trustee, holds property for the benefit of other individuals. The trust arrangement permits the legal ownership of the property to be held by the trustee while the benefits of ownership (income, capital gains) accrue to the beneficiaries. It is common practice for an entrepreneur and his or her spouse to act as Trustees of their Family Trust. Hence, entrepreneurs can still maintain control over their companies, while benefiting from a trust arrangement (subject to their fiduciary duties to act in the best interest of the beneficiaries).
How do I determine if I’m a good candidate to setup a Family Trust?
Here are some key indicators that you should consider a Family Trust:
Ø You are shareholder in a private corporation.
Ø Your business is profitable and generating profits.
Ø You have children(s) and you are paying/will pay for their education(s).
Ø You may want to sell your company in the future.
Would it be beneficial for me and for my family?
Some of the benefits of using a Family Trust structure are:
Ø Funding of your children’s education. The first and immediate benefit is the funding of your children's education. By having the trust own shares in the family company and having your children as beneficiaries of the trust, it is possible to fund as much as $32,000.00 per child over the age of 18 at a tax rate of approximately 14% through the trust as opposed to funding your child's education from your personal funds which are usually taxed at a substantially higher rate. If you are a high income earner you will be paying tax at approximately 48%. Basically, you can save as much as 34% of taxes (i.e. a potential saving of $34,000 for each $100,000 earned). This is a substantial savings for each of your children for each year that he/she is in school with little or no other source of income.
Ø Income splitting. A well-structured family trust allows for splitting the income earned by the trust among the various beneficiaries. If you are a high income earner you may be able to split your revenue to a lower income earner. (subject to the potential application of the attribution rules and the “kiddie tax”).
Ø Capital gains exemption. Once in your life time, you may be eligible to claim the $750,000 capital gains exemption. Basically, what it means it that an individual selling his/her shares of a Canadian Private Corporation (subject to a set of specific rules) can receive the first $750,000 on a tax free basis. 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.
Ø Reducing tax liability at death. Transferring assets to a trust may limit the size of the individual’s estate, such that tax liability at death is reduced. In addition, probate fees may be reduced.
As you can see, a Family Trust can offer business owners a great deal of flexibility and should be further explored. Any individual who is interested in setting up a corporate structure that involves a Family Trust should evaluate all the tax consequences and consult with a knowledgeable professional. For more personalized information regarding setting up a Family Trust please contact me via email.
Corporation's Annual General Meeting (AGM)
The Canadian Business Corporation Act ("CBCA") states that a corporation "... must hold a shareholders' meeting on a date that is no later than 15 months after holding the last preceding annual meeting, but no later than six months after the end of its preceding financial year."
Alternatively, shareholders may pass a resolution in lieu of meeting. A resolution in lieu of a meeting may be useful for small corporations that have only one or a few shareholders. A resolution in lieu of meeting is a written resolution signed by all shareholders who would have been entitled to vote at the meeting that deals with all matters required to be dealt with at a shareholders' meeting. This resolution is just as valid as it would be if passed at a meeting of shareholders. This resolution should be retained in the corporation‘s records.
The shareholders' meeting (or resolution in lieu of a meeting) allows shareholders to obtain information about the corporation's business and to make appropriate decisions regarding this business. The date of the meeting, or of the resolution, must be indicated on your Annual Return.
Agenda
At minimum, the agenda of an annual meeting must include the following items:
- consideration of the financial statements;
- appointment of an auditor (or a resolution of all shareholders not to appoint an auditor); and
- election of directors.
Often, the agenda includes an additional item, "any other business." This portion of the meeting allows shareholders to raise any other issues of concern to them. If directors want shareholders to consider a matter, it should be listed in the agenda prior to the meeting and not raised as "any other business."
Calling a shareholders' meeting
The directors must notify voting shareholders of the time and place of a shareholders' meeting. They must do so no more than 60 days and no fewer than 21 days before the meeting date. For example, if the meeting is to be held on May 20, the notice of the meeting should be sent no earlier than March 22 and no later than April 30.
Unless otherwise provided by the by-laws or the articles, this notice can be sent electronically to shareholders if they have previously consented to receiving such notices electronically and if they have designated a system for receiving them.
Location of the shareholders' meeting
The annual meeting may be held in Canada at a place specified in the by-laws. Or, if the by-laws do not specify a location, directors may choose one. An annual meeting may be held outside Canada only in cases where the corporation's articles permit it or if all voting shareholders agree.
Also, where the corporation's by-laws permit it, the directors of a corporation may decide that a meeting of shareholders will be held entirely by means of a telephonic, electronic or other communication means that will permit all participants to communicate adequately with each other during the meeting. In such cases, it is the responsibility of the corporation to make these facilities available.
Unless otherwise provided by the by-laws, a corporation can allow shareholders to attend the meeting electronically. The communications system used must permit all participants to communicate adequately with each other during the meeting.
Other requirements of the shareholders' meeting
Quorum
Unless a quorum of shareholders is present or represented at annual or special shareholders' meetings, no business that is binding on the corporation can be conducted. A quorum is present at a meeting when the holders of a majority of the shares entitled to vote at the meeting are present in person or represented by proxy, regardless of the number of persons actually present at the meeting. Note, however, that a corporation's by-laws can provide for a different type of quorum.
Electronic voting
Unless the corporation's by-laws specifically forbid it, electronic voting is allowed, as long as it is possible to verify the vote without knowing how each shareholder voted.
Minutes of the meeting
The corporation must keep a written record of the meeting. This record usually includes such information as:
where and when the meeting was held;
who attended; and
the results of any voting.
Alternatively, shareholders may pass a resolution in lieu of meeting. A resolution in lieu of a meeting may be useful for small corporations that have only one or a few shareholders. A resolution in lieu of meeting is a written resolution signed by all shareholders who would have been entitled to vote at the meeting that deals with all matters required to be dealt with at a shareholders' meeting. This resolution is just as valid as it would be if passed at a meeting of shareholders. This resolution should be retained in the corporation‘s records.
The shareholders' meeting (or resolution in lieu of a meeting) allows shareholders to obtain information about the corporation's business and to make appropriate decisions regarding this business. The date of the meeting, or of the resolution, must be indicated on your Annual Return.
Agenda
At minimum, the agenda of an annual meeting must include the following items:
- consideration of the financial statements;
- appointment of an auditor (or a resolution of all shareholders not to appoint an auditor); and
- election of directors.
Often, the agenda includes an additional item, "any other business." This portion of the meeting allows shareholders to raise any other issues of concern to them. If directors want shareholders to consider a matter, it should be listed in the agenda prior to the meeting and not raised as "any other business."
Calling a shareholders' meeting
The directors must notify voting shareholders of the time and place of a shareholders' meeting. They must do so no more than 60 days and no fewer than 21 days before the meeting date. For example, if the meeting is to be held on May 20, the notice of the meeting should be sent no earlier than March 22 and no later than April 30.
Unless otherwise provided by the by-laws or the articles, this notice can be sent electronically to shareholders if they have previously consented to receiving such notices electronically and if they have designated a system for receiving them.
Location of the shareholders' meeting
The annual meeting may be held in Canada at a place specified in the by-laws. Or, if the by-laws do not specify a location, directors may choose one. An annual meeting may be held outside Canada only in cases where the corporation's articles permit it or if all voting shareholders agree.
Also, where the corporation's by-laws permit it, the directors of a corporation may decide that a meeting of shareholders will be held entirely by means of a telephonic, electronic or other communication means that will permit all participants to communicate adequately with each other during the meeting. In such cases, it is the responsibility of the corporation to make these facilities available.
Unless otherwise provided by the by-laws, a corporation can allow shareholders to attend the meeting electronically. The communications system used must permit all participants to communicate adequately with each other during the meeting.
Other requirements of the shareholders' meeting
Quorum
Unless a quorum of shareholders is present or represented at annual or special shareholders' meetings, no business that is binding on the corporation can be conducted. A quorum is present at a meeting when the holders of a majority of the shares entitled to vote at the meeting are present in person or represented by proxy, regardless of the number of persons actually present at the meeting. Note, however, that a corporation's by-laws can provide for a different type of quorum.
Electronic voting
Unless the corporation's by-laws specifically forbid it, electronic voting is allowed, as long as it is possible to verify the vote without knowing how each shareholder voted.
Minutes of the meeting
The corporation must keep a written record of the meeting. This record usually includes such information as:
where and when the meeting was held;
who attended; and
the results of any voting.
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