Are you thinking about buying a business? Lots to think about before you buy a business!

Buying a business is one of the biggest projects you can sign up for. Business ownership involves an incredible contribution of time, money and hard work. More importantly, you have to constantly balance various demands and risks to ensure that your business is growing steadily. A crucial factor is to make sure that you do not rush into things, and do the appropriate homework and be diligent with your research to make sure that you make the right decisions and follow the right process before you even get started with pursuing your entrepreneurial dreams. Below are the five key steps you should take when you are about to buy a business:

1. Do Your Research - "Kick the tires and see what is under the hood"

The first step is to properly research each prospective business to get a very clear sense of the business’ strengths and weaknesses and what exactly you will be buying.

 Things you need to request from the company:

• Financial statements;
• List of employees, including a breakdown of salaries and years of service;
• Details of any major contracts necessary for the operation of the business, including the lease of any premises; 
• List of all equipment and assets of the business;
• Any related debts, licenses and liabilities;
• Lists of customers and suppliers.

One thing to keep in mind is that before the owner shares any detailed information with you with respect to his/her business, the seller may insist that you sign a non-disclosure agreement to prevent you from using it  for any purpose other than buying the business. Such an action is a common practice by sellers, especially by those who are represented by lawyers. Therefore, any documents you are asked to sign at this early stage should be shown to a lawyer to ensure that you are not making any unwise legal commitments.

When reviewing the content, use the available government resources to verify any information the information provided is correct. These searches will show, for example, whether there are any liens on the business assets; whether there are unpaid taxes; whether there are ongoing lawsuits or human rights complaints; and whether certain buildings or motor vehicles are in fact owned by the seller.

2. Decide on a Structure for the Purchase

The structure of the purchase means the most basic aspects of the deal: who will be buying and selling; whether shares or assets will be bought; what price will be paid; and when and how that amount will be given to the seller.

A. Who Will be Buying and Selling, and will it be Shares or Assets?

Most businesses are operated by private companies.  This means that, in most cases, all the important items associated with any business – like the inventory, the trademark, and so on –will be owned by a company.  As a result, when you buy a business you will first need to decide:  

• who will be buying the business – will it be you personally or you through your own company; and
   
• what will be bought – will your buy the shares of the company that owns the business or the business assets directly.

In nearly every case, it makes sense for a buyer to make the purchase through a company. There are tax benefits to operating a business through a company.  It also limits the business risks to whatever else is owned by the company while putting your personal assets out of reach of creditors of the business.

Assets Vs Shares

One of the main advantages of buying the assets of a business is that it gives you a better sense of the specific assets and liabilities you will have when you have completed the transaction; instead of getting a company that may or may not have unknown or undisclosed liabilities. It also gives you more flexibility and control in what you are buying; for example, you can decide that only certain employees or business assets will be transferred to you. The downsides of buying the assets include that certain one-time transaction costs connected to the purchase might be more expensive.

Additionally, buying the assets means you will be in a contract with the company that owns the business, while buying the shares means you will be in a contract with the person or people who own the company, which requires a high level of trust on information given by the seller.  There is also a risk that if the business goes sideways, the seller, as a private company, may have no other assets.  You will therefore need to be compensated. One way to deal with this risk is to insist on ongoing commitments or responsibilities – commonly called “indemnities” – from the person or people who own the company.

B. What Price will be Paid, and When and How will that Amount be Given to the Seller?

Arriving on a dollar amount for the value of a business is only one element of the price, and it is rarely as simple as deciding on a price and paying that to the seller in a particular sale date.

The business will probably be active around the sale date, which means inventory, accounts receivable and other items will be in flux.  Also, a cautious buyer may insist that a portion of the price be held back for a certain period to ensure that information given by the seller is in fact correct or that profit expectations are met.  Finally, you may be unable to pay the price in a lump-sum and will need to pay in monthly or annual instalments.

3. Negotiate the Other Terms

Contract terms are not just about the structure of the purchase, sale date and whether there will be a personal indemnity if the seller is a company.  However the number and type of other terms to be negotiated can vary depending on the risks associated with the business.  

For example, in an asset sale of a business with many employees, the seller may insist that you take on all of the employees, while you may want only a handful of them. The seller may also refuse to fire the employees on the eve of the purchase. Even if you intend to re hire the employees after you have purchased the business, this is an important process to go through as it can influence the amount of severance you might have to pay an employee should things do not work out after the change in ownership 

To prevent the seller, or the owner of the seller (if the seller is a company), from creating a competitor business after the sale, you should insist that he or she sign a “Non-Competition Agreement”.

4. Have the Legal Documents Prepared

The buyer is generally responsible for preparing the legal documents, which are often complex and lengthy and are sent to the seller’s lawyer for review before being finalized. The first legal document, though, is short and simple; it is commonly called a “Letter of Intent” (or a “Term Sheet”) and is used to record the basic aspects of the deal early on. This helps to prevent misunderstandings and avoids having to renegotiate any key terms very close to the sale date.

The main legal document is called a “Purchase Agreement”. This covers everything connected to the purchase.  It builds on the content of the Letter of Intent and includes, as efficiently as possible, the significant details of what the buyer and seller are actually agreeing to, and anticipates the situations where things may not go as planned.  One of the most important parts of this agreement for you will be the seller’s “representations and warranties”. This effectively puts the seller on the hook for the information given to you about the business and aims to ensure that you are getting what you are paying for.  The description of the business assets and liabilities related to the business that you will assume are another important part of this document.  They are usually included in “schedules” attached to the main agreement.

Many purchases will also involve a document showing the consent of the landlord or franchisor, each of which might be necessary for the deal to move forward.  Depending on the type of sale and individual situation of the business, there may also be other documents which your lawyer will need to prepare including the above mentioned Non- Competition Agreement.

5. Final Tips to Keep in Mind

Buying a business is a very complicated event.  Here are some final tips to keep in mind that will reduce the likelihood of an exciting opportunity turning into a nightmare:

• Know what to focus on when.  Keep perspective by taking one thing at a time. Before committing to the purchase make sure you have done the proper research. Once that stage is complete and you understand the risks involved, come to an agreement with the seller on the basic terms and then spend the time on the details. Write a list of your priorities and concerns and refer back to them or revise them as the sale date nears. Do not let the seller control the process or keep you in the dark or uncertain about any issue that is important to you.
   
• Get the right advisors, and rely on them. Nobody can do everything on their own, and there are experts in an area for a reason.  Good advice can be worth far more than it costs, and it would be foolish to make an enormous commitment without spending a relatively small amount to ensure the right pair of eyes are involved in helping to direct you toward success.
   
• Know when to walk away.  The process of buying a business costs money and time. But if the information from the seller does not add up, or the risks involved are simply too great, it may be more advantageous to walk away rather than pay a considerable amount of money for a business riddled with problems that will cost you even more.

For more information on the above, please do not hesitate to contact HazloLaw Business Lawyer, Hugues Boisvert, at 613-747-2459 x 304 or hboisvert@hazlolaw.com 

CRA's interpretation on the Income Tax Act (ITA) for the understanding of the Residency of a Corporation

What is a Canadian corporation?

Section 89 of the ITA defines a Canadian corporation as one that is resident in Canada and was:

• incorporated in Canada; or
• resident in Canada from June 18, 1971, to the present.

A corporation formed by a corporate reorganization is a Canadian corporation due to incorporation in Canada only if:

• the reorganization happened under the laws of Canada or a Canadian province or territory; and
• each of the involved corporations was, just before reorganization, a Canadian corporation.

Residency of a corporation

The ITA does not define residency. Generally, we determine a corporation's residency using common-law principles. In addition, there are statutory provisions that deem a corporation to be either resident or non-resident under certain circumstances.
A corporation can be resident in Canada without being a Canadian corporation.
To determine if a corporation is resident in Canada, we first consider the deeming provisions of the ITA.

Deemed resident - Subsection 250(4)

A corporation is deemed to have been resident in Canada throughout a tax year if:

• it was incorporated in Canada after April 26, 1965; or
• it was incorporated in Canada before April 27, 1965, and, during any tax year after April 26, 1965, it:
  • was resident in Canada under the common-law principles discussed below; or
  • carried on business in Canada.

If a corporation is not deemed resident under the ITA, it may still be a resident of Canada under common law.

Common law

Common law has generally established that a company is resident in the country in which its central management and control is exercised. British courts have rejected the place of incorporation as the one test of residence of a company because this is only a circumstance like the birth of an individual. Other factors such as the place where the principal business is done, books and records are located, the company seal is kept, bank accounts are maintained, and where the directors reside have been considered by British courts as useful, but not conclusive.
British courts have emphatically stated that the true rule in determining the residence of a company for purposes of income tax is "where the company's real business is carried on." In the opinion of the courts, "the real business is carried on where the central management and control abides...This is a pure question of fact to be determined, not according to the construction of this or that regulation or by-law, but upon a scrutiny of the course of business and trading."
Usually central management and control abides where the members of the board of directors meet and hold their meetings. Relevant to the residence of a company is not where central management and control is exercised according to the articles of incorporation, but where it is actually exercised. It may well happen that actual control is exercised by directors resident in one country, while directors resident in another country who ought to have exercised control stood aside from their directorial duties.
Income tax treaties often include a definition of residence for the particular treaty. Since treaties override the ITA whenever a corporation is considered resident in more than one country, including Canada, reference must be made to any treaty that applies.

Deemed non-resident - Subsection 250(5)

Where a corporation that would otherwise be resident in Canada is, under a tax treaty between Canada and another country, resident in the other country, subsection 250(5) deems such corporation to be non-resident in Canada. This would be the case where a corporation is considered resident in Canada for the purposes of the ITA under common law but is, under a tax treaty between Canada and another country, resident in the other country.
A corporation may be deemed to be resident in Canada due to incorporation in Canada. However, the same corporation may also claim to be a resident of a treaty country if it meets the residence definition in a treaty. The tiebreaker rules (usually within Article IV) in tax treaties generally provide that if a corporation is a resident of both contracting states, it is deemed to be a resident of the state in which the corporation was created.
A corporation that claims to be a resident of a treaty country must establish, for the treaty to apply, that it is taxed comprehensively in the treaty country (Crown Forest Industries Limited [95 DTC 5389]). The fact that the corporation's worldwide income is subject to a preferential tax rate, or enjoys a tax holiday in the treaty country would not, in or by itself, disqualify the corporation from being treated as a resident of the treaty country.
A corporation may be deemed to be resident in Canada by virtue of its original incorporation in Canada. However, the same corporation may be naturalized in another jurisdiction by the granting of articles of continuance (or similar constitutional documents) in its new home. Such action is described as corporate continuance or continuation. The tiebreaker rules in tax treaties generally state that the corporation will be treated as a resident of the treaty country into which it has continued, not the country of original incorporation.
Corporations with dual residency issues should contact the International Tax Section of the nearest tax services office.

Continued corporation - Subsection 250(5.1) - Emigrant

Subsection 250(5.1) relates to the tax consequences where a corporation already organized and incorporated under the laws of one country continues into a new jurisdiction under granting articles of continuance in the new jurisdiction. The basic principle of subsection 250(5.1) is that a corporation that has been granted articles of continuance in a particular jurisdiction will be deemed as having been incorporated in that jurisdiction until the time, if any, that it continues in a different jurisdiction.
For example, a corporation that was originally incorporated in Canada but was later continued abroad, will no longer be treated as if it was incorporated in Canada, and will no longer be deemed to be resident in Canada under subsection 250(4). However, the corporation may remain resident in Canada under common law by keeping its central management and control in Canada. Similarly, a corporation originally incorporated in a foreign jurisdiction but later continued into Canada is deemed to be incorporated in Canada from the date of the continuance. It will also be deemed to be resident in Canada under subsection 250(4) of the ITA.
A corporation that earlier continued abroad and later continued to a particular jurisdiction will be deemed incorporated in that particular jurisdiction, not in any other jurisdiction.
In the event of dual residence of a corporation to which a tax treaty applies, the issue of residence will be resolved by referring to the tax treaty.
When a corporation stops being a Canadian resident, it will be subject to taxes after its emigration.

Residency of an international shipping corporation - Subsection 250(6)

A corporation that is incorporated outside Canada is deemed to be a non-resident throughout a tax year if certain requirements are met. One requirement, in subparagraph 250(6)(a)(i), is that the corporation's principal business in the year be the operating of ships in international traffic. A second requirement, in subparagraph 250(6)(b)(i), is that all or almost all of the corporation's gross revenue for the year be from shipping operations. For this provision, international traffic, as defined in subsection 248(1), may include shipping between points along the St. Lawrence River or the Great Lakes. For more information, see Interpretation Bulletin IT-494, Hire of Ships and Aircraft From Non-Residents.
A foreign incorporated international shipping corporation may place its ships in one or more separate wholly owned subsidiaries. Wholly owned in this context means 100% owned by the parent or through a chain of 100% owned corporations. For 1995 and later tax years, this deeming rule is extended, by subparagraph 250(6)(a)(ii), to parent corporations that hold throughout the year shares of one or more subsidiaries provided they are wholly owned non-resident subsidiaries.
Each of the subsidiaries has to meet the business and gross revenue tests described in the first paragraph of this section. If a parent corporation is operating through subsidiaries as described above, the parent corporation need not meet the principal business test itself, as long as the total cost amount to the parent corporation of its shares in such subsidiaries is throughout the year at least half the total cost amount of all its property.
For 1995 and later tax years, subparagraph 250(6)(b)(ii) includes in international shipping revenue a parent corporation's dividends received from its wholly owned subsidiaries. However, the wholly owned subsidiaries must have been resident in a foreign country throughout each of the parent corporation's tax years that began after February 1991, and before the last time at which dividends were paid.
The deeming provisions contained in subsection 250(6) do not apply in a tax year where a corporation formed outside Canada was granted articles of continuance in Canada before the end of the year.

Emigrant corporations

When a corporation is no longer a Canadian resident under common law, statute, or treaty, and becomes a non-resident in a year, the ordinary rules for becoming a non-resident apply.
The ordinary rules include:

• subsection 128.1(4) - Deemed changes to its tax year, deemed changes to its fiscal period, and deemed disposition of its property;
• Part I tax, plus departure tax, under section 219.1 of Part XIV. For 1996 and later tax years, the departure tax liability for the tax year that is deemed to have ended applies to all corporations that stop being resident in Canada and not merely to those that stop being Canadian corporations.

For later tax years, tax liabilities may include:

• subsection 115(1) - Liability under Part I;
• more Part XIV tax, known as additional tax on non-resident corporations, under section 219 on income referred to under subsection 115(1); and
• Part XIII withholdings - Liability on certain kinds of Canadian-source income.

Departure tax - Section 219

There is a 25% departure tax liability under section 219.1 that applies for the tax year considered to have ended because the corporation emigrated from Canada to take up residence in a new jurisdiction. This liability is not affected by any treaty that Canada may have signed with the corporation's new country of residence, because for the referenced year the corporation is resident in Canada only.
Any additional tax on non-resident corporations that may apply to the non-resident corporation under section 219 is subject to any overriding provisions in an applicable tax treaty.

How to Avoid 5 Common Tax Mistakes by Business Owners

A super helpful repost by the King Group: 

Entrepreneurs are often so focused on what they do best that they fail to adequately plan how to structure the business itself. In particular, failing to make use of a corporation and to monitor its operation can lead to significant forgone benefits and potential liabilities.

This list covers five of the most important tax and estate issues most entrepreneurs may face.

1. Failure to incorporate slows business growth

If your client runs a sole proprietorship, she will be personally taxed on the income, ranging from 39% to over 50% at top bracket, depending on province. After tax, this means the amount available for reinvestment in the business annually is almost half or less than what was originally earned.

By comparison, a small business corporation is entitled to a flat rate of tax below 20% on its first $500,000 of active business income. (The provincial tax threshold is only $400,000 in Manitoba and Nova Scotia.)

When the accumulated income (the retained earnings) is reinvested in the business, each dollar the business earns will generate in excess of 80 cents in useable capital.

2. Failure to incorporate means losing tax-free capital gains value

A business earns income from year-to-year, and it also grows in value itself to the extent that earnings are retained within it. If the business is run as a sole proprietorship, upon sale the owner will have to pay tax on the growth in the business’s value, which is the capital gain.

By comparison, every person is entitled to a $750,000 exemption from tax on the capital gains associated with qualifying small business corporation shares. This amount will rise to $800,000 in 2014, and be indexed annually thereafter.

If the same business is run as a corporation under these rules, the owner can save about $150,000 (or more) in tax on the disposition or sale, including a deemed disposition on death.

3. Failure to incorporate means exposure to creditors

Launching a business is often a risky endeavor in at least two respects. It exposes the client to:

• banking and trade creditors who have provided financial backing to the enterprise;


• liability claims under contract and tort (e.g., negligence) in the normal course of business operations.

If a person runs a business as a sole proprietor, both these liabilities will be imposed directly upon that person, and his assets will be subject to claim by such creditors.

A corporation is a separate legal entity from the shareholders who own it, so liabilities that arise within the corporation do not flow up to the owners of the corporation. Unless the shareholder has executed personal guarantees on behalf of the corporation, or has otherwise personally acted in a way to attract liability, the only personal asset at risk for the shareholder will be the investment in the corporation itself.

4. Holding investment money in a small business corporation

The small-business tax rate is only available on a corporation’s active business income—earnings generated from its actual commercial activities.

By contrast, passive income arises out of excess corporate cash being placed in portfolio investments, including bank interest, GICs or marketable securities.

Passive income is taxed at the regular corporate rate, and it is also charged an additional refundable tax that results in a total immediate tax payment close to 50%. Rather than face these complications, a shareholder may want to issue herself dividends, pay the tax on the dividend, and invest the net funds personally.

Alternatively, if the owner would prefer to defer those dividends, she should pay attention to the type of returns generated on those continuing corporate-held investments. Generally this means trying to achieve tax-deferred returns such as unrealized capital gains, or using the sheltering capacity of exempt life insurance in qualified circumstances.

5. Paying personal expenses out of a corporation

A small business owner who pays personal expenses with corporate money is in for a rude awakening. Such payments will likely be deemed as shareholder benefits and be taxed at the shareholder’s marginal tax rate.

The proper procedure would be to issue dividends from the corporation to the owner. The net effect of the gross up and tax credit procedure is an effective tax rate about a third less at top bracket, and significantly lower at more modest bracket levels.

Business Record-Keeping - Very Important!

This is information from the Canada Revenue Agency with regard to Record-keeping for Businesses:

Here is a listing of the ways that you can keep records:

• books, records, and supporting documents produced and kept in paper format;
• books, records, and supporting documents produced on paper, and later converted to and stored in an electronically accessible and readable format; and
• electronic records and supporting documents produced and kept in an electronically accessible and readable format.

Supporting documents are required for each of the above methods and may be kept in either paper or electronic format (including electronic imaging format).
Your books and records:

• must be kept in Canada unless our permission is granted to keep them elsewhere;
• must be made available to our representatives upon request; and
• include electronic records that are created and maintained by computerized record-keeping systems.

For more information about requirements for corporations, trusts, registered charities, registered Canadian amateur athletic associations, registered agents for registered political parties, official agents for candidates in a federal election, agents authorized under the Senate Appointment Consultation Act, hospitals, non-profit organizations and other qualified donees, see Guide RC4409, Keeping Records.

You have to keep all records in paper format, unless you keep them in an acceptable microfiche, microfilm, or electronic image format. Electronic imaging software is a popular method of keeping scanned images of paper documents, books, and records.

We consider you to have electronic records if you create, process, maintain, and store your information in an electronic format.

You have to keep your electronic records in an electronically readable format, even if you have paper printouts of those records.

If any of your source documents are first created, transmitted, or received electronically, you have to keep them in an electronic format.

Scanned images of paper documents, records, or books of account that are kept in electronic format are acceptable if proper imaging practices are followed and documented.

Employment Opportunity / HazloLaw – Business Lawyers is seeking a full time Bilingual Receptionist.

Employment Opportunity / HazloLaw – Business Lawyers is seeking a full time Bilingual Receptionist. HazloLaw Professional Corporation is a leading Boutique Business law firm headquartered in the   vibrant by-ward market in Ottawa, Ontario. Our business law firm provides entrepreneurs and business owners with strategic, effective and tailored solutions for their legal and business needs. As the first glimpse of HazloLaw, the successful candidate will be professional with a cheerful disposition. Your duties will include answering a multi-line phone, greeting clients and others, making appointments, as well as other administrative duties. Must have a strong working knowledge of MS Word & Outlook and have excellent communication skills. The position will appeal to someone looking for personal growth and opportunities to develop technical skills. Please forward your resume in strict confidence to Hugues Boisvert at hboisvert@hazlolaw.com Ref. #201363

"Shareholder Agreements" - The essentials

When a company is first created, its founding shareholders determine how a company will be owned and managed. This is when a "shareholders agreement" kicks in. The shareholders agreement may be amended when new shareholders enter the picture for various reasons, i.e. new shareholders may want to add new terms before they become part of the team. Not having such an agreement can lead to serious legal ramification, and future disputes arising amongst shareholders may create irreconcilable harm to the overall well-being of a company.

The incorporation of a company must be in compliance with the law that governs the corporations. Companies are incorporated in a particular jurisdiction (e.g. provincial or federal) and must adhere to the applicable legislation, e.g. the Canada Business Corporations Act, or the Ontario Corporations Act. This legislation lays out the ground rules for corporate governance, i.e. what you can and cannot do, who can be a director, can a company issue shares, how can you buy or sell shares, etc. When a company is formed, it files a Memorandum and Articles of Incorporation (depending on jurisdiction) which are public documents filed with the Registrar of Companies. A shareholders agreement, however, is confidential and its contents need not be filed or made public.

When a company is formed, its shareholders may decide on a set of ground rules over and above the basic legislation that will govern their behaviour. For example, how do you handle a shareholder who wants to sell his or her shares? Should it be possible to buy out a shareholder? How are disagreements resolved? Who can sit on the Board? Who has the decision-making authorities? Can a shareholder (the founder of a company) be fired? 

There is no need for a Shareholder Agreement if the company has only one owner. However, if there are more than one owner, it is very crucial to create a Shareholder Agreement. Each company should have its own tailored Shareholder Agreement depending on the mission & vision and business goals of the owners. When a company  becomes a "public" company, such an agreement is no longer needed, and the relevant law and securities regulations will become applicable.

What to include in a Shareholder Agreement?
(This is a non-exhaustive list)

• what is the structure of the company? 
• how equity is divided amongst the shareholders?
• how are the parties to the agreement?
• are there any vesting provisions? for example shares may be subject to cancellation if a shareholder/manager quits)
• are shareholders allowed to pledge their shares?
• who is on the Board? 
• who are the officers and managers?
• what constitutes a quorum for meetings?
• what are the restrictions on new equity issues?
• how are ownership buyouts to be resolved? 
• how are disputes to be resolved among shareholders? (* very important to review the dispute resolution clause(s)with your lawyer?)
• how are share sales done?
• what are a shareholders' obligations and commitment?
• what are shareholders' rights? 
• what happens in the event of death/incapacity?
• how is a share valuation determined 
• what are the operating guidelines or restrictions (budget approvals, spending limits banking, etc)
• what types of decisions require unanimous board and/or unanimous shareholder approval?
• compensation issues - remuneration of officers & directors, dividend policies
• are other agreements required as well, e.g. management contracts, confidentiality agreements, patent rights, etc?
• should there be any restrictions on shareholders with respect to competing interests?
• what could trigger the dissolution of the company?
• what is the liability exposure and is there any corporate indemnification?
• are there any financial obligations by shareholders (bank guarantees, shareholder loans, etc)?

Some Do's & Don'ts:

• don't confuse shareholder issues with management issues
• don't confuse return on capital with return on labour (i.e. cash investment vs founders' time commitment)
• don't get caught up in legalese - decide what you want, then have your lawyer put it in proper form
• do make sure everyone's objectives and visions are compatible 
• do separate the roles of shareholders, directors, and managers
• do talk to others who have gone through this process
• do ask yourself what the downside is - the most practical question is: what's the worst that can happen to you under the agreement?
• do get some tax advice. It is very important that some tax planning be done early to avoid a headache later when you've made millions. e.g. you want to make sure that you are not compensated by being given shares, you want to make sure you own shares early so that you can use the small business lifetime capital gains exemption, maybe a family trust or holding company should own your shares.

MOST IMPORTANTLY: DO HIRE A LAWYER! 

Joint Tenancies in Estate Planning

Estate planning centres on finding ways to ensure as much of an estate as possible goes to the intended beneficiary with minimal loss to provincial Estate Administration Taxes and taxation.

Estate Administration Taxes (EATs) are calculated on the value of the assets someone passes on to beneficiaries through an estate, usually by way of a will. By carefully planning the distribution of assets among beneficiaries before death, people can minimize or defer taxes.

 

Paying some or all provincial EATs can often be avoided if parents register assets in joint tenancy with one or more of their adult children. The primary advantage of joint ownership is that the interest of the deceased co-owner does not pass though the estate but flows directly to the surviving joint tenant or tenants and so is not subject to EATs. Further, in passing outside of an estate, parties attempt to ensure that the asset in question will not be affected by claims against the estate pursuant to the Wills Variation Act. Typically, when someone transfers assets before death to be held jointly with a spouse or adult children, the transferor intends to retain partial or complete control over the use of the asset until death.

 

However, the act of registering assets in joint tenancy is only one part of the process. A number of factors can affect whether a joint tenancy is achieved.

    

As the two Supreme Court of Canada cases—Pecore v. Pecore and Madsen Estate v. Saylor—show, joint tenancies are not without problems. A transferring owner can, for example, lose control over the property and not be able to change his or her mind over its disposition or succession. In some cases, the property could be exposed to claims made by the new joint tenant’s creditors, including family claims if he or she becomes involved in a divorce or separation. And there could be tax implications in the case of real property such as a family home; future growth of the joint tenant’s interest in the residence would be subject to capital gains tax unless the joint tenant is the owner’s spouse or the owner’s child who is still living at home.

In Pecore, an aging father transferred financial assets consisting of bank and investment accounts into the joint names of himself and his daughter, who was one of his three adult children. He had been told by a financial planner that, by this action, he would avoid EATs and make after-death dispositions less expensive and cumbersome. Because he had been told that the transfers could trigger a capital gain, he wrote letters to the financial institutions holding the accounts stating that he was the 100% owner of the assets and that they were not being gifted to his daughter. The father made all the deposits and continued to use and control the accounts. He paid all of the taxes on the earned income. The daughter made some withdrawals. 

    

The father made out a will in which he left specific bequests, including one to the daughter’s ex-husband, but did not mention the particular assets that had been transferred into the joint names. After the father’s death, the ex-husband claimed that the daughter held the assets in trust for the benefit of her father’s estate (which totalled almost $1 million) and consequently they should be distributed according to the will. The trial judge found the father intended to give his daughter the ownership of the assets by transferring them into joint ownership. He continued to manage and control them on a day-today basis before his death. The SCC found the presumption of resulting trust was the general rule for such transfers and that the onus was placed on the daughter to demonstrate that a gift was intended. The outcome was the same, however, as the daughter did demonstrate the transfer was intended to be a gift and accordingly she retained the assets in question. 

    

In Madsen Estate v. Saylor, a father also transferred his investments into joint bank and investment accounts with his daughter. The father used and controlled the joint accounts and paid income tax on all of the income from the investments during his lifetime. The daughter did not make any withdrawals from the joint account during her father’s lifetime, although he did give her a power of attorney to allow her to manage his finances. 

    

The value of the joint accounts on the father’s death was about $185,000. He had made all of the contributions to the accounts. The daughter claimed the funds in the joint accounts by right-of-survivorship. But her brother and sister disagreed. Under their father’s will, he had directed his estate trustee to divide his estate into two—with one half divided among his three children and the other among his eight grandchildren. The siblings claimed that the daughter was holding title to the joint accounts as trustee for their father’s estate. In contrast to the Court’s decision in Pecore, the Court in Madsen agreed with the siblings and ordered the daughter to pay the $185,000 in the joint accounts back to her father’s estate, to be distributed in accordance with his will.

The common law has previously presumed that an asset other than land is owned as joint tenancy. However, Pecore, which has been cited with approval in British Columbia, spoke to the common law in three respects:

1. The distinction between joint tenancies in land and personal property has given way to a more modern approach whereby all assets are presumed to be held in trust for the estate.
2. Transfers between parents and adult children, dependent or independent, will be presumed to be for the purposes of holding the assets in trust for the estate.
3. If the presumption is rebutted, even when the deceased retained control over the asset, the transfer will be considered to have vested at the time of the transfer so the asset will not be considered part of the estate and subject to EATs.

It remains up to the surviving joint owner to rebut the presumption by providing evidence that the asset was intended to be a gift. 

    

While there are certainly occasions where putting property into joint names can be an easy and effective estate planning tool, such a transaction should only be entered into after appropriate advice has been received regarding the possible ramifications. It is also important to note that expenditure due to litigation over an estate is typically considered a cost of estate administration and therefore payable from the estate. As Pecore and Madsen demonstrate, it is critical not to leave intentions about estates open to interpretation in order to avoid unpleasant financial consequences.


Article reproduced from its original publication by Roger E. Holland and Elizabeth (Betsy) Segal of Singleton Urquhart LLP dated September 1, 2007.

Interesting Read: When a Will Turns into a Drama!

Lesson to be learned from the following celebrities' dramatic "wills and estate planning" stories: FIND A GOOD LAWYER & HAVE A WELL-DRAFTED WILL!

James Gandolfini and his $70 – million estate

Mr. Gandolfini, known for his role as tough but conflicted mobster Tony Soprano on the HBO series The Sopranos, died at 51, leaving most of his estimated $70-million estate to his 13-year-old son and infant daughter. This means a large portion could be subject to estate taxes; taxes would not be due if he had transferred his estate to his spouse.

Mr. Gandolfini’s son, Michael, is to get the largest chunk through a trust set aside for him until he turns 21. He’ll split his father’s Italian property with his half-sister, eight-month-old Liliana, when she turns 25.

The newspaper says the remainder of Gandolfini’s estate will be split among his wife, sisters and daughter. He left $200,000 each to his personal assistant and secretary.

Beneficiaries – from cats and dogs to doorman and nurse

If you type “millionaire leaves money” into the Google search bar, several beneficiaries appear: dog, cat, doorman, nurse. Hotel mogul Leona Helmsley left $12-million to “Trouble,” her Maltese (it was dropped to $2-million after her family contested). Italian property tycoon Maria Assunta left $13-million worth of cash and properties to her cat. Reclusive copper-mining heiress Huguette Clark left her private nurse $34-million and a doll collection. Music tycoon Alan Meltzer gifted $1-million to his former chauffeur and $500,000 to his doorman of 15 years. He divorced his wife, Diana who says “If he wants to give it to the bums, he can give it to the bums. He can give his money to whoever he wants. We’ve divorced. The man is dead.”

Millionaire died with no heirs and no will

Roman Blum, a Holocaust survivor and New York real estate developer, died without heirs or surviving family members, reportedly leaving his almost $40-million estate to, well, no one. Mr. Blum apparently had no will after he died in 2012 at the age of 97. If no relatives are identified, his money will pass to the state of New York.

“I have 400 emails from all over the world, even from Canada, most of them claiming to be relatives and making elaborate stories of how they got out of Poland,” Gary Gotlin, the New York public administrator handling the case says, “Somebody’s lying. He can’t have 40 daughters and 25 sons.”

Two alleged wills, one from a non-relative, another from Poland, have surfaced; the former will has been submitted to the courts. The public administrator’s office continues the global search for heirs.

This article was reproduced from its original publication on Financial Post dated Oct. 25, 2013 by Melissa Leong. 

Death and taxes: Leave your assets to your heirs instead of the CRA (article by Jamie Golombek of CIBC Private Wealth Management)

A great article written by Jamie Golombek of CIBC Private Wealth Management in Toronto published on October 25, 2013 in the Financial Post.  

Unlike the U.S., Canada no longer has any form of estate or inheritance tax. Yet despite this, death can trigger a significant income tax bill that, if not properly planned for, can leave an unexpected liability when a loved one passes away. Here is what happens to your non-registered and registered assets when you die:

Non-Registered Assets

The general rule for non-registered assets is that a taxpayer is deemed to have disposed of all his or her property, such as stocks, bonds, mutual funds and real estate immediately before death at their fair market value (FMV).

When the FMV exceeds the property’s adjusted cost base (ACB), the result is a capital gain, half of which is taxable to the deceased and must be reported in the deceased’s final tax return, known as the “terminal return.” There is an exception for the capital gain arising on the deemed disposition upon death of your principal residence, which is generally exempt.

For example, let’s say you die with a portfolio worth $1,000,000 that had an ACB of $400,000. The capital gain on the deemed disposition at death would be $600,000. Since only half the gain is taxable, tax would be owing on a $300,000 taxable gain. Assuming a 45% marginal tax rate for the year of death, $135,000 of taxes would be payable on the terminal return as a result of this deemed disposition.

If you own qualified small business corporation (QSBC) shares, a qualified farm or fishing property upon death, you can claim on your terminal return any remaining lifetime capital gains exemption (currently $750,000 but rising to $800,000 in 2014) against any capital gains arising from the deemed disposition of that property.

Perhaps the best way to avoid or at least defer this deemed disposition upon death is to transfer the property to the deceased’s spouse or partner, where applicable. When property is transferred in this way, the transfer can be done without triggering any immediate capital gains and the associated tax liability can be deferred until the death of the second spouse or partner (or until that spouse or partner sells the property, if earlier.)

So, continuing the example above, if you had left your portfolio to your surviving spouse, he or she would be deemed to inherit the portfolio at your original ACB of $400,000, deferring the $600,000 capital gain to the future.

Another opportunity to eliminate the tax arising from the deemed disposition at death is to consider leaving appreciated marketable securities to a registered charity through your will. The capital gains tax is completely eliminated when appreciated publicly listed shares, mutual funds or segregated funds are donated in-kind to charity.

For example, let’s say Warren owned publicly traded shares that were worth $30,000 as of the date of his death and had an ACB of $6,000. If he had willed those shares to his favourite charity, the capital gains tax would be eliminated on the $24,000 accrued gain, yielding tax savings of about $5,000, assuming a marginal capital gains tax rate of approximately 20%.

In addition, a charitable donation receipt for the FMV of the shares donated upon death ($30,000) would be issued which could produce a tax savings on the terminal return (or in the prior year’s return) of at least 40% ($12,000), depending on his province of residence.

Registered Plans

For many Canadians, however, the largest tax liability their estate will face is the potential tax on the FMV of their RRSP or RRIF upon death. The tax rules require the FMV of the RRSP or RRIF as of the date of death to be included on the deceased’s terminal tax return with tax payable at the deceased taxpayer’s marginal tax rate for the year of death.

This income inclusion can be deferred if the RRSP or RRIF is left to a surviving spouse or partner, in which case tax will be payable by the survivor at his or her marginal tax rate in the year in which funds are withdrawn from the RRSP or RRIF.

Alternatively, an RRSP or RRIF may be left to a financially dependent child or grandchild and used to purchase a registered annuity that must end by the time they reach age 18. The benefit of doing this is to spread the tax on the RRSP or RRIF proceeds over several years, allowing the child or grandchild to take advantage of personal tax credits as well as graduated marginal tax rates each year until he or she reaches the age of 18. If the financially dependent child or grandchild was dependent on the deceased because of physical or mental disability, then the RRSP or RRIF proceeds can be rolled to the their own RRSP or RRIF.

EVENT ANNOUNCEMENT: Invitation from HazloLaw - Business Lawyers “How to Set up Your U.S. Business” - Wednesday, November 6th

HazloLaw – Business Lawyers would like to invite you to join us for an exclusive presentation by our U.S. Business Lawyer, Ms. Renate Harrison on “How to Set up Your U.S. Business” at the Chateau Laurier on Wednesday, November 6^th at either 8:30AM or 2:30PM.

This is a great opportunity for entrepreneurs and professionals to find out more about the legal and practical aspects on setting up a business in the United States, the tax-related advantages and disadvantages of each type of business structure, and the legal implications of setting up a business in a particular state.

It is also a rare networking opportunity for you to meet other entrepreneurs and professionals from across the Greater Ottawa region.

Date: Wednesday, November 6, 2013

Time: 8:30am until 10am OR 2:30pm until 4pm

Location: Tudor Room, Chateau Laurier, 1 Rideau Street, Ottawa, K1N 8S7

Please RSVP before Friday, November 1 to admin@hazlolaw.com. In your email, please kindly indicate which time you wish to attend. If you wish to bring a guest, please provide us with the name of your guest. 

Raising Funds for Your Business

Corporate Financing

When starting a business, an entrepreneur has many factors to consider and important decisions to make early on. Those decisions will subsequently dictate the company’s operations and ownership structure. One of the most fundamental decisions to make early on revolves around financing, and how investors will be compensated for their monetary contributions. There exists many different ways of structuring the deal, however suitability is pivotal because these early decisions have lasting repercussions.

As a general rule, money is invested in a company with the goal of generating additional revenue. Depending on investor preference, risk tolerance and company outlook, an investor may look to structure the deal as a loan, as an exchange for company equity, or both. Every situation requires its own unique solution, and we will now analyze in further detail the different possibilities.

Debt:

 

An investor may elect to structure the deal as a loan, with interest payments due on the principal loaned to the company. This type of deal shows up on the company’s balance sheet as a liability, and the lender does not acquire any company ownership by virtue of the loan.

This can be advantageous for a corporation in its infancy, as company equity does not have any true value backed by assets or cash flow. As a consequence, the business owner will generally have to give up a larger portion of equity to compensate for the inherent risks of the loan. The disadvantage is that as opposed to issuing equity and bringing on a partner into the business, this type of deal is such that money is owed to a third-party creditor, who’s interest is repayment, not necessarily long-term company outlook. This translates into a more structured and rigid payback scheme, with significantly less negotiating power than if the lender was a part owner as well.

Equity:

• Common Stock: Issuing common equity in exchange for financing is seen very often in everyday business, and constitutes the sale of a portion of the business in exchange for money, good or service. If we focus in on the financing side of this type of deal, it is imperative that a business owner, especially at the early stages of operations, have a long-term business plan to structure the sale of common stock accordingly. For example, a business owner should validate whether the long-term goal is the sale of the company, whether the investor should be issued shares with voting rights, whether compensation will come in the form of dividends, capital appreciation of common stock etc. The idea behind long-term planning is to define a payout structure that matches investor and owner’s objectives, and to avoid punishment at a later stages due to excessive dilution.  
• Warrants: A stock warrant is very similar to a stock option, in that it grants the holder the option to purchase securities (usually equity) from the company at a specific price in a fixed time frame. Warrants are often included in new debt issue to entice investors.
  A note of caution, warrants will generally be exercised if the value of the company's stock is greater than the fixed price contained in the warrant. Giving out too many warrants early on can dilute share structure later, once the company starts generating positive value.

Hybrids:

• Preferred Stock: Preferred shares are the form of equity most similar to a debt-loan, as it carries many of the same characteristics. Preferred shares dividends are paid out before any other class of shares, but rank after bonds (debt) during liquidation. They contain no voting rights. The price and dividend of a preferred share is fixed, and does not appreciate or depreciate in value as common stock does. A corporation can structure their preferred shares with numerous different features. The preferred shares may be cumulative (entitled to dividends for periods where dividends were omitted), callable (company can buy back shares at a fixed price by a fixed date) or convertible. These different options can be used to structure the right deal based on the company’s needs.

•  Convertible Debenture:
  A convertible debenture is a type of loan issued by a company that can be converted into stock. Generally, because of the convertibility option, the company will pay a lower percentage of interest on the loan, compared to if there was no option to convert.
  
  An important point to distinguish between a convertible debenture and a convertible bond is that the debenture is unsecured, meaning that in the event of bankruptcy, a convertible debenture holder would be paid out after other debt holders (bonds, loans etc.)
   

 

There are many ways to structure your business financing. The most important part of the question, however, is picking the right one to suit your needs. All of the above options can be individual solutions, or coupled together to meet the company and investor's needs. Briefly, here is a general list of pros and cons to the different forms of financing:

 

Equity Financing:

• Advantages
• Less risky than a loan, as it dos not need to be paid back
• Investors take a long-term view, and generally don't expect a return on their investment immediately
• More cash on hand for expanding the business
• No requirement to pay back the investment if the business fails 
• Disadvantages
• The required rates of return from investors may be higher than the cost of a bank loan
• The investor will require some form of ownership
• The business will need to consult the investor before big decisions (and potentially routine ones)
• It takes time and effort finding the right investor for your company

Debt Financing:

• Advantages
• The lender has no say in company operations, as there is no ownership
• The business relationship ends once the money is paid back
• The interest on the loan is tax deductible
• Loans can be short or long term
• principle and interest are known figures, making it easier to structure the business's budget.
• Disadvantages
•  Money must be paid back within a fixed amount of time
• Carrying too much debt is seen as "high risk" by potential investors, potentially making it more difficult to raise capital later on
• Assets of the business can be held as collateral to the lender.

 



How does "Spousal Rollover" help you in tax-planning?

In King Group's most recent Newsletter, they cited an article written by Mr. John Mill, a Succession Tax Counsel called "Spousal Rollover - the Most Valuable Tax Plan?" Mr. Mill did a fantastic job outlining the benefits in tax planning with regards to spousal rollovers. Please see below for the article:

Much of the world’s wealth is created through capital gains. A capital gain is the increase in the value of an asset over time. The taxation of capital gains has two “top secret” wealth building features:

1)  Tax is deferred so that the compounding train stays on track;

2)  Only ½ of the increase in value is subject to tax – the other ½ of the increase in value is tax free.

But all good things come to an end – capital gains are harvested on the sale of the asset or the death of the owner. The tax on death arises as a result of a “deemed disposition”. When we say “deemed” we mean that there is no actual sale; instead CRA pretends there is a sale and then demands “pay up buster, or else!!”.  This somewhat insensitive demand creates two problems:

1)   The compounding train is knocked off the track;

2)   The lack of cash to satisfy CRA’s demand creates a liquidity problem.

Fortunately, if there is a surviving spouse, the Income Tax Act provides an automatic solution called a “spousal rollover”. A rollover means that the property can be gifted to the spouse and the tax will once again be deferred: the compounding train continues to chug along, and CRA ceases and desists with its demands.

When you consider that: there can be a multi-decade lag in the life span of spouses, and that this rollover applies automatically to everyone — the spousal rollover probably is the most valuable tax plan of all time. Whether or not that is true it is clear that spousal roll-overs are an important part of the succession planning tool kit. The purpose of this post is to take a quick jog through the key points of spousal rollovers so they may be more firmly held in mind.

The most important point is that the spousal rollover provisions are very generous and interpreted very broadly to include rather than exclude transactions. It is not often that CRA will raise issues with spousal rollovers. One famous case was the Supreme Court case of Lipson. In that case the lower income spouse used a spousal rollover to attribute losses to a higher income spouse, the Supreme Court found this to be a reversal of the purpose of the attribution rule and therefore abusive.

Spousal rollovers apply to gifts during lifetime and bequests on death. The difference is that any income generated during the life of the spouse making the gift is attributed back to them — attribution of income ends on the death of the spouse making the gift.

The definition of “spouse” is very wide including common-law and former spouses.

All depreciable and non-depreciable capital property is automatically rolled over to the spouse unless they elect out of the rollover. There is no form for such an election, instead you the election is made by reporting the disposition on the tax return of spouse who made the gift. This results in tax to pay; however the spouse receiving the gift gets an increase in the adjusted cost base of the asset meaning there will be less tax to pay when they sell or die.

In determining the extent to which it may be beneficial to elect out of the rollover and trigger tax in order to increase the adjusted cost base, the succession planner would consider whether the deceased has:

• personal credits and low marginal tax rates;
• net capital losses or non-capital losses that would otherwise expire;
• a capital gains deduction for qualified farm property or qualified small business corporation shares;
• donation credits or carry forward amounts; or
• alternative minimum tax credits carried forward from prior years

In addition to capital properties there are other properties including: inventories, resource properties, and registered plans (RRSPs, RRIFs) that qualify for spousal rollover treatment. The spousal rollover applies to almost any form of transfer to a spouse: court order; disclaimer; release; or surrender; and, may apply to jointly held property if each spouse rolls over their own interest in the property.

The spousal rollover can be to a “spousal trust”. The topic of spousal trusts will be the subject of a future post as there are many considerations, but the following discussion covers the basics.

Spousal trusts settled during the life of the gift giving spouse are taxed at the top marginal rate; whereas testamentary trusts made as a consequence of death are taxed at graduated rates resulting in a tax savings of about $15,000 per year. Also the 21 year deemed disposition rule does not apply to qualified spousal trusts. Once again over a potential multi-decade span a qualified spousal trust can be very valuable.

CRA has a set three conditions for a qualified spousal trust. These conditions seem confusing at first but they are really straightforward if you consider that these conditions are designed to mimic what would happen if the spouse owned the property without a trust:

   

• The first condition is that the property must “vest indefeasibly” within 36 months. A lot of confusion is caused by the fancy phrase “vest indefeasibly” but it simply means: there cannot be any future condition that would cause you to lose the property. In other words you can’t say: “… this property goes to my spouse until my daughter graduates from school”. If you think of normal property ownership the “vesting indefeasibly” concept is perfectly simple: you would never buy a car that is yours until a daughter graduates — it just wouldn't make any sense.
• Secondly all of the income must go to the spouse during their life. Once again this is what would happen if the spouse owned the property. Once the spouse receives this income they could do anything with it including giving it away.
• Thirdly none of the capital can be distributed to anyone other than the spouse during their lifetime. If you owned a bank account you would expect that the money in that account could be given away by someone else.

An important ‘heads up” for business succession planning is that a shareholder agreement requiring a partner to purchase and pay for shares directly from the estate instead of from the surviving spouse results in no rollover and potential loss of that spouses’ capital gain.

An important limitation of the spousal rollover is that you must be a Canadian resident to qualify. This means non-residents do not qualify; however, the Canada/US tax treaty extends Canadian spousal rollover privileges to US residents with Canadian spouses.