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.

Business transition via Employee Share Ownership Plans

Question: I would like information on Employee Share Ownership Plans (ESOPs) as a means of business succession. I am especially interested in ESOPs from a tax perspective. Answer: Generally an ESOP allows qualifying employees to purchase shares in their employer's company, with or without monetary assistance from the company. Many companies are using ESOPs as a form of succession when there is no other successor apparent. Whether an ESOP plan is created for succession or employee loyalty purposes, the plan must have a high participation rate to be effective. The type of business is also relevant. If it involves manufacturing and physical assets, valuations are easier to determine. The plan must be administered, which requires some work. That is why many ESOPs involve union structures that can help with administration. ESOPS also have many tax and legal implications for companies and their owners, so anyone considering them should seek professional help. Lawyers, accountants and some BDC consultants can help companies navigate the tricky route to establishing an ESOP.

Business owners: Did you review the "buy-sell" clause in your Shareholders Agreement?

It is wise for corporations and their shareholders to consider amending their shareholders' agreements periodically, as they can become out-dated over time. In particular, the structure of the buy-sell component of shareholders' agreements evolves regularly as a result of new tax legislation and interpretations of the law by the Canada Revenue Agency (CRA). This is particularly evident in connection with spousal rollovers after death. Under normal circumstances, when a spouse dies, all property of the deceased can pass to the surviving spouse as a tax-free rollover as long as the property vests in the spouse (i.e. unconditional ownership). The CRA now takes the position that a mandatory buy-sell of the shares of a company from a deceased's estate negates the ability to use the spousal rollover rules. The mandatory buy out, in the CRA's view, prevents the shares from vesting. There is thus no spousal rollover and the full capital gain will have to be reported on the deceased's final return. This result poses no problem if the shares are eligible for the capital gains exemption and the deceased had enough capital gains exemption to eliminate the gain. However, if these factors are not present, the lack of a spousal rollover eliminates the ability of the surviving spouse to use his or her capital gains exemption on a sale. To alleviate this problem, modern shareholders' agreements include what are commonly referred to as put/call provisions. Such provisions give the deceased's estate the right to require the shares to be purchased from the estate, and give the surviving shareholders the right to purchase the shares from the estate. Both parties have the option to buy and sell, but neither is obligated to do so. Buy-sell provisions should also provide enough flexibility to allow either for the company to purchase the shares from the estate, resulting in a deemed dividend, or to have the surviving shareholder(s) purchase the shares directly from the estate, resulting in a capital gain. Shareholders should inquire of their advisors regarding the tax consequences that result from these options. When structuring agreements, it is important to predetermine the buy/sell prices on an ongoing basis rather than using pre-determined valuation formulas, which can often be misleading and not representative of fair market value. Ideally, predetermined prices should be updated annually. Where shareholders are related (non-arm's length), a valuation may be required to support the value, though the CRA might question and challenge a valuation in these circumstances. Although the CRA can challenge an agreement to value between two unrelated shareholders, it is less likely to do so. In any event, no valuations are required until a shareholder dies. It is thus prudent to have a mechanism in place to determine fair market value, ideally by an independent business valuator. Notwithstanding any of the above strategies, care should be taken in implementing any changes to shareholders' agreements. Some older agreements have been maintained in their original form specifically to preserve certain tax advantages that might remain valid even though more current tax laws have changed. For any questions regarding the above and/or if you wish to discuss your situation, please do not hesitate to contact me.

Business owners: Lets talk about Family Trusts

In the past 3 years, I spent a considerable amount of time blogging about the use of Family Trust for business owners. Family Trusts are a great and effective way to save taxes. Today, I would like to have a closer look at the fine print on Family Trusts.

1. Establishing the trust. There will be a problem under our tax law if the settlor of the trust (the person who creates the trust by transferring assets to it) has the ability to take back the assets placed in the trust, has the right to name additional beneficiaries of the trust after its creation, or has the ability to control dispositions of the trust assets. If any of these conditions apply, the income, gains or losses of the trust will be reported on the settlor’s tax return. To avoid this outcome, it’s important to make sure that the settlor is not also the sole trustee (or a trustee with veto power over what is done with the trust assets) or sole beneficiary. The best approach is to have another family member – perhaps a parent or grandparent – be the settlor of the trust. This family member can “settle” the trust with a small asset such as a silver coin or $20 bill. The trust can then acquire other assets by, for example, borrowing money from you or others to acquire investments, shares in a private company, a vacation home, or other assets.

2. Transfers to the trust. If you transfer assets other than cash to a trust you’ll be deemed to have sold those assets at fair market value, so if they’ve appreciated in value, you could trigger a taxable capital gain. Be sure to count this cost first. You may be able to shelter from tax a capital gain on transferring assets to a trust if you have, for example, capital losses to use up, or some other tax deductions or credits available. And if you transfer a principal residence to a trust, you might be able to use your principal residence exemption on the transfer to avoid a tax hit.

3. Income of the trust. The income of the trust can be taxed in the hands of the trust, or one or more of the beneficiaries. Where the beneficiaries are minors, or your spouse, the attribution rules in our tax law could apply to cause the income to be taxed in your hands – that is, the hands of the settlor or someone who may have transferred assets to the trust. You can avoid this problem by lending money to the trust instead and charging the prescribed rate of interest (currently 1 per cent). You should also know that where a trust receives certain types of income, such as dividends from private companies, or rent or business income earned from a property or business carried on by a person related to minor beneficiaries, and an attempt is made to have that trust income taxed in the hands of minor beneficiaries, the “kiddie tax” rules can apply to cause the child to pay tax at the highest marginal tax rate. The kiddie tax won’t apply to second-generation income (that is, income on income), so it’s still possible for the trust to receive income subject to this tax, and use the cash to build up investments over time, and avoid the kiddie tax on any second-generation income.

4. Distributions from the trust. The assets, or capital of the trust, can generally be distributed from the trust on a tax-free basis to the beneficiaries of the trust who have a right to the capital. In this case, the beneficiaries inherit the adjusted cost base of the trust and may pay tax later on any income or gains on those assets they receive.

5. Twenty-one years later. Be aware that on every 21st anniversary of the trust there will be a deemed disposition of the assets of the trust, which could trigger taxable capital gains. There are various ways to plan for this tax hit (a topic for another day).

6. Asset protection benefits. Finally, assets can often be protected from potential creditors when placed in a trust where the trustee has discretion to distribute the assets to beneficiaries as the trustee sees fit. However, there are laws in place to protect the rights of creditors, so speak to a lawyer about these.

And be sure to speak to a tax lawyer before setting up a trust.

Tax Matters: In estate planning, know the hazards of joint ownership

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

Tax Matters: In estate planning, know the hazards of joint ownership

I recall a number of years ago that the New Haven (Conn.) Register newspaper reported a story about a local woman, Joanne Kamerling, who had decided to change the ownership on two acres of land that she owned in Weber County, Utah. She placed the property into the joint names of a group of people that included a physical therapist, a prominent local attorney, the former Louisiana Ku Klux Klan leader David Duke, and O.J. Simpson. She didn’t know these people personally, none of them knew each other, and they weren’t looking to become owners. Ms. Kamerling continued to pay the property taxes. Weird.

Yet when it comes to tax planning, Canadians often do something similar: They regularly place assets into joint names with right of survivorship. Okay, so there aren’t many of us adding O.J. Simpson to the title on our homes, but the end result is often about as effective. You see, while joint ownership can reduce probate fees and make for an efficient transfer of assets at the time of death, there can be drawbacks. Consider these 10:

1. A tax liability might be triggered. When you add another individual as a joint owner, you will often be creating a change in beneficial ownership. The result? When adding anyone other than your spouse as a joint owner, you may be deemed to have disposed of that ownership interest at fair market value, which could trigger a tax hit.

2. Your estate distribution might be inappropriate. If you’re hoping to leave an asset to, say, all of your children equally when you die, but have perhaps named just one as a joint owner to avoid probate fees, there is no requirement for your joint-owner child to share the asset with the others. This may not be your intention.

3. Family or legal disputes could result. Continuing with the scenario in number 2 above, those children who are effectively disinherited may dispute the unequal distribution of your estate, and there is no shortage of court cases dealing with these types of battles. Make your intentions clear, in writing, if you do choose to put assets in joint names.

4. You may not save tax. If you think you’ll save tax by placing assets into joint names, perhaps with your spouse, think again. Any income earned by your spouse on his or her half of the assets will generally be attributed back to you unless you charge interest at the prescribed rate. Further, owning assets jointly with a child will not allow you to escape tax on your share of the asset when you die.

5. Exclusive control over assets will be lost. If you add another person as a joint owner on an asset, you’ll no longer have sole control over the asset.

6. Assets could be attacked by creditors. If the individual who jointly owns an asset with you faces the attack of creditors, the full value of the asset you jointly own could be subject to the claim of those creditors.

7. Testamentary trusts will be impossible. It is possible, when you die, to leave income-producing assets to a trust established in your will for your heirs. This trust can pay the tax on the income earned annually after you’re gone. This can save your heirs tax. Any assets held jointly, with right of survivorship, will pass directly to the surviving owner or owners and there will be no opportunity for those assets to be place in a trust upon your death.

8. Portfolio risk profile may not be appropriate. If two or more people jointly own an investment account or portfolio it may be difficult to invest the capital in a manner that meets the risk profile of all owners on the account, particularly when there are large age differences between the owners.

9. A principal residence could become taxable. If you decide to place your principal residence into joint names with, say, a child, it may be necessary for both you and your child to designate that property as your respective principal residences in order to avoid tax on a disposition of the property later. This could be a problem if your child has, or will have, another property that he or she owns; it may expose your child’s other home to tax.

10. Joint tenancy may be permanent. Forget about undoing the joint ownership unless the other owner or owners agree to change things.

Be sure to ask yourself whether you should be concerned about each one of these potential drawbacks. This will help you to evaluate whether joint ownership is right for you.

Careful estate planning can stave off legal battles!

below is a good article written by Thane Stenner and published in the Globe and Mail.

Last week I had a working lunch with “Bill,” a client who had sold a significant portion of his family-held business about two years ago.

Over the course of our discussion, Bill told me a close friend from his university days had called him last month. The friend's father passed away back in March, leaving a sizable estate. Unfortunately, that estate was now in the process of an extensive legal battle, as four siblings (from two different marriages), a widow, and an ex-spouse bickered and fought over their share of the pie.

•Why you need an estate plan
•It's time to have 'the talk' with mom and dad
•Planning for your estate

“What a mess,” Bill said, shaking his head as he waited for his grilled salmon. “When I go, I want things to be well-organized – easy to deal with.” Bill paused for a moment before looking at me and adding: “And I want everybody to know exactly what I want done with my money.”

Bill's concern is well founded. In my experience, there's a direct relationship between the size of one's estate and the potential for conflict. The higher the stakes, the higher the chances for litigation.

Unfortunately, as I told Bill, there is no such thing as a litigation-free estate. Even the most well-organized, well-constructed estate may be challenged by disgruntled heirs or creditors. That said, there are things high-net-worth individuals can do to discourage litigation, and diffuse inter-family conflict before it leads to courtroom drama.

Start the process early

Estate planning can be detailed, complicated work. By starting early, high-net-worth individuals have the time to seek professional counsel and consider options carefully. This in turn clarifies intentions, and makes ambiguities and disagreements less likely, which should help deter claims against the estate.

For business owners like Bill, an early start is even more critical. Succession plans need put in place well in advance of the owner's retirement date, particularly if the intention is to groom a particular family member to take over the business.

Avoid ‘surprises’

Most estate litigation is born from what I call the “awful surprise”: an heir discovers they've been left much less than they thought they would, or have not been recognized as an owner of certain assets (the family business, for example). The news generates shock, alienation and anger. The desire to see justice done leads the heir to challenge the will, regardless of the ultimate chance of success.

Most high-net-worth individuals work hard to avoid this kind of dynamic. They communicate their estate intentions to heirs, and, if appropriate, to business partners and associates. If they know their family situation is explosive, they set up a family meeting or formal conference – using a professional mediator, if necessary –to let heirs know what their estate intentions actually are.

Use trusts

Trusts are an extremely flexible, extremely effective tool for organizing high-net-worth estates. Properly written, trusts can accomplish a number of important estate planning goals: They can reduce taxes, increase privacy, protect assets from creditors, protect family assets from future divorces, and structure an ongoing charitable contribution.

Trusts can also be an excellent way to avoid estate litigation. By putting a portion of your assets/estate into a trust, you can ensure an inheritance passes to specific people (adult children from a first marriage, for example). Another possibility is to put a family asset (the family cottage) into a trust instead of bequeathing it to a specific individual. That way all family members can enjoy it without bickering about who owns it. Ultimate ownership should still be completed though.

Assign a professional trustee

As the “manager” of an estate, the trustee wields a tremendous amount of financial power. While appointing a family member has its advantages, it’s unlikely the average person has the time, the knowledge, or even the inclination to properly administer a multi-million dollar estate at the same time they’re grieving for a loved one.

One way to get the best of both worlds is to appoint two estate trustees: (a) a family member, and (b) a financially competent professional (typically a CA, lawyer, or a trustee from a respected financial institution) who knows the family well. By appointing a trustee from outside the family who is legally bound to act in the interests of all beneficiaries, you can eliminate claims of bias or conflict of interest before they happen.

Update your will

Changes in business or family relationships can create friction among heirs. By regularly updating their wills, high-net-worth individuals can avoid making that friction boil over into legal challenges and/or inter-family disputes.

Reviewing a will every two years is usually a good rule of thumb. Such a review needn’t take more than an hour – the idea is to check to see whether everything is still in order. If a significant life or financial change takes place earlier than that (a marriage, a divorce, a liquidity event, etc.), a more frequent update may be warranted

Business owners: In trusts you can trust to find tax savings...

Trusts are wonderful tools for the wealthy, but business owners should use them, too. They can be worthwhile for amounts of money or assets of $150,000 – even less in some circumstances. The cost of setting up a simple testamentary trust – a trust set out in a will that takes effect when you die – can be an initial $2,000 to $3,000, mainly for legal fees.

The classic family trust is a form of living, or inter-vivos, trust, one that takes effect while you’re still alive. A testamentary trust forms part of a will and so takes effect only after you are gone. Which one you choose depends on how willing and able you are to give up ownership of some of your assets now.

“If you have enough, you might be okay with giving it up today,” says Allison Marshall, financial advisory consultant at RBC Wealth Management in Toronto. But if think you might need your savings, you’ll take the prudent approach and pass on whatever is left in a will, she says.

Perhaps the simplest trust is one you set up during your lifetime for the education of your children or grandchildren. Often people will put enough money into a registered education savings plan to take advantage of the federal government grants, and then put money into a trust with the children as beneficiary.

An education trust is more flexible than an RESP, Ms. Marshall says. One of the children or grandchildren might decide to go to a technical school or theatre school that is not approved by the Canada Revenue Agency; an education trust will allow them to. The trust money can be used to pay for the child’s living expenses or even to buy a car.

Given the large number of people in second or third marriages, spousal trusts are growing in popularity as a way to protect the interests of the children from a first marriage, experts say.

Often in a second marriage, a person will naturally want to provide for the new spouse but will worry about disinheriting children from a first marriage, says Keith Masterman, associate vice-president, trusts, at TD Waterhouse in Toronto. Rather than leaving everything to a second spouse, who may in turn leave it to his or her own family, Mr. Masterman advises clients set up a spousal trust as long as he or she lives. When the second spouse dies, the assets will go to the client’s children from the first marriage.

In this case, the choice of trustee becomes complicated, Mr. Masterman points out, because choosing either a child or the second spouse would put either in a conflict of interest. This can be resolved by hiring a professional trustee.

But trusts have other advantages.

For example, spousal trusts, like family trusts, can be used to split income, thereby lowering income taxes. By setting up a spousal trust, you are creating a second taxpayer because trusts are a separate legal entity. So, if you split your income with your spouse now, you can continue to do so after you are gone by setting up a trust and having the trust foot part of the tax bill.

You can spread your largesse around, using “sprinkler” trusts to split your income with your spouse, your children and their children, giving the trustee the discretion to allocate income from the trust however he or she sees fit – that is, to best tax advantage.

Naturally, the Canada Revenue Agency will scrutinize such arrangements closely, so the trust has to be set up properly, Ms. Marshall cautions. While parents retain control of the monies lent to the trust, “you have to look at whose money is generating the income.” It must belong to the children.

Keep it private

If privacy or probate is an issue, consider a trust.

When you die and your will is probated, your assets and your beneficiaries are on the public record. Anyone can see your will by paying a small fee. The details of a trust, in contrast, are confidential.

“Anyone” might include family members with an axe to grind or even charities hoping to approach your beneficiaries.

“Certain charities look at the affluent,” says Allison Marshall, financial advisory consultant at RBC Wealth Management in Toronto. “They want to follow up with the beneficiaries looking for donations.”

Another reason some people choose trusts is to avoid probate fees, which vary from province to province and are comparatively high in Ontario.

Family successions: managing the emotions.....

You’re about to retire, and the ambitious daughter you hoped would be an ideal successor announces she wants out of the business. Your brother jumps at the opportunity to run the company, but you don’t feel he’s got what it takes. Resentment boils over, and family turmoil threatens to sink your firm.

This is a typical scenario at many family-owned companies, according to Theodore Homa, Senior Partner, BDC International Consulting Services.

“Emotional issues can create a volatile dynamic in family businesses,” Homa says. “These entrepreneurs often have made personal sacrifices to keep their companies afloat, so it’s hard for them to separate business and personal relationships,” he says. “In the end, those emotions can get in the way of making decisions that are good for the business.”

Unresolved family issues, such as sibling rivalry, put a strain on business successions. According to the Canadian Federation of Independent Business, 33% of family businesses survive in the first generation and only 15% survive the second.

Homa provides these pointers to help business owners proactively manage emotional issues in family successions:

•Give yourself a lot of lead time to plan and execute – realistically at least 2 years. Family business transitions take much longer than one realizes.
•Formalize your family succession plan to avoid disagreements down the road. Maintain an open dialogue with family members about your plans and get them involved. Keeping them out of the loop can simply sow family discord.
•Create trust in your decisions, especially when it comes to the transfer of leadership. When you choose who will take over the helm, communicate a clear action plan to family members and employees. Reassure them that you have the mentoring and training in place to develop your successor in all aspects of the business.
•Define roles and responsibilities and even put them in writing. For instance, a family member might be a stakeholder in the business, but that doesn’t mean that he or she automatically has the right to be involved in daily operations. By clarifying these roles, especially in areas such as what is the purview of management in running the business on a daily basis versus what is required for governance of the business, you can avoid unnecessary misunderstandings.
•To address potential conflicts in the hiring of relatives, be sure you have clearly defined job profiles that outline exactly what you need in terms of experience, skills and education. After all, you don’t want to feel obliged to hire family members to do a job if you believe they are ill-equipped. At the same time, you don’t want to pressure family members to accept jobs that they aren’t suited to or interested in.

Seek external advice to resolve issues objectively. Experienced consultants can give you a third-party perspective that is invaluable. You can also turn to an advisory board, or even a formal board of directors, to provide a neutral point of view and help you through the various steps of the transition.

Q & A: Minimizing taxes due to share transfers

QUESTION:

I want to gradually transfer my shares to my 18-year-old son. How can I transfer these shares to minimize personal and corporate income tax?

ANSWER:

You should ask a tax expert such as an accountant, but I can provide a general overview of the tax system. In this case, your corporation will likely be unaffected from a tax point of view by any transfer of shares if you hold all the shares. The transfer becomes largely a personal tax issue for you and your son.

Transferring shares to your son can be done in two ways – as gifts or as sales. In both cases the shares must be assigned a value, which can be determined by an accountant or lawyer who specializes in this field. This value will be affected by the earnings of your company and whether the shares have been paying you dividends, among other issues.

If you give the shares to your son, there may be tax implications for you. If the shares are deemed as having been "sold" at the time, you may be taxed on your capital gains. However, for any income incurred by these shares, your son will be taxed.

If you sell the shares to your son, the effects would be roughly the same, but the numbers may change for each of you. Your personal capital gains tax may be lower, and your son's capital cost base will be higher, so this may be a way of deferring his tax owed to the future.

You plan to transfer shares gradually, but there will be a point where your son has a sizeable financial interest in the company. If you hope that he will one day take over management of the company, ensure you've taken the standard steps involved in succession planning. Is he competent or willing to take over, and do you have a proper training program to ensure the company will not be damaged by the succession?

Also, there may be a need for an interim manager to run the company until your son is ready. If that is the case, this manager may also want some financial stake in the company, such as a percentage of shares.

Holding Company 101: What is it and Why do you need one?

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.

Two wrong reasons for not having an estate plan...

You may be wondering, if estate planning is so important, why doesn’t everyone have an estate plan? The answer is part human nature and part misconception.

Human nature prevents us from talking, even thinking about our own mortality. We don’t like to say to ourselves: “Someday I will die or become incapacitated.” For the sake of our loved ones however, we have to deal with this. And because it can happen anytime, we should deal with it now, regardless of age.

People also wrongly believe that estate planning is only for the super-rich. The word “estate” somehow implies great wealth. But the fact is, an estate can be a house and several thousand dollars or a mansion and several million.

It’s simple. Whatever your age, whatever the size of your estate, a proper estate plan will ensure that it is passed along as you desire, with minimum taxes and with no complications or delays for your heirs.

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

Example of the Operation of A Family Trust

Scenario 1: Income Splitting

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

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

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

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

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

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

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

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

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

Scenario 2: Capital Gains Splitting

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

What are the benefits of an Estate Freeze?

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

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

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

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

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

Family Trust Audits Highlight Need for Proper Trust Records

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

Family Trust Audits Highlight Need for Proper Trust Records

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

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

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

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

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

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

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

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

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

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

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

The Truth about Family Trusts.

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

Myth #1: They are inflexible.

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

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

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

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

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

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

Myth #4: You lose control.

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

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

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

Something everyone should do right now: The estate List

Here is a great article written by Benoit Poliquin, CFA, CFP & VP / Portefolio Manager at Pallas Athena Investment Counsel:

Yes, that is right. Tonight, while you are watching your favourite television program, once the kids have gone to bed and you are thinking whether you should turn on your laptop and catch up on work, clean your Inbox or finish that book you started....don't! Instead, make the following list: The Estate List.

As a portfolio manager, I am called in at the best of times (when someone or a family) comes into large amounts of capital, or at the worst of times (death or illness). Well, recently, I have been helping a client through some difficult family health issues. During these trying times, the simplest of task becomes much more complex.

To make things easy, here is the list:

Will and Power of Attorney: Make sure you have an updated will, and make sure your executors know that they are indeed executors, and where they can find the will. Do you have a power of attorney in case you are unable to make decisions for yourself? Call your lawyer this week and get it sorted out.

Insurance: Do you have any? Is it sufficient? Where are the policies? Do you have all of them ? If you are uncertain, contact a competent insurance professional for an insurance audit. As for the copies of the policies, keep them in a safe yet accessible place.

Safety deposit box: Do you have one? more than one? Could your executor find the key? Could they have access to the box? Get that sorted this week!

Passwords: In this day of online security...we all have a collection of passwords. What if you were not around to make that monthly bank transfer? Make sure your online banking does not breakdown because you are not around.

Advisors: Chances are your lawyer, your accountant, your insurance advisor and your investment advisor don't know each other, and most certainly don't speak to each other on a regular basis. Does your executor and your loved ones know who they are, and how to reach them?

Accounts: You might have banking relationships for business and personal accounts at different institutions. Is this know by your executor and loved ones? Are your bank accounts listed in a central place?

Business Assets: You might own a business, a building or units in a limited partnership. Is this a known fact? Is this reflected in your will? What would happen to these assets if you were unable or worse, not around, to make decisions?

In short, you are trying to make things easier for your loved ones who depend on you. Make this list, and make it known to those that it concerns....and keep this list current!