The Importance of the Capital Gains Exemption for Owner-Managers *
Since 1985, the capital gains exemption has been available to Canadian business owners.The concept is simple—if you sell shares of a qualifying corporation for a profit, the first $750,000 of your gain on a lifetime basis can be received on a tax-free basis. The rules are complicated and it is quite possible that your shares may not qualify by not meeting one of the detailed conditions that apply. While shares of some corporations may never qualify for the exemption (for example, shares of many investment companies won’t qualify), other share investments that are currently offside can be put back on track with advance planning. Since the conditions are detailed, very simple steps can often make the difference between qualifying and not qualifying for the exemption when you dispose of your shares.
How do I qualify for the Capital Gains Exemption?
If you sell shares of a small business corporation (SBC), and meet the conditions for the exemption, then the gain from the sale of your business will qualify for the capital gains exemption.
To qualify for the exemption, the first condition is that your corporation must be an SBC at the time of sale. That means that it must be a Canadian-Controlled Private Corporation (or CCPC) and all or substantially all of its assets must be used in an active business carried on primarily in Canada. The Canada Revenue Agency interprets “all or substantially all” to mean that assets representing at least 90 per cent of their fair market value of all corporate assets must be used for business purposes.
If you hold shares of an SBC, there is a second set of conditions which you must meet to qualify for the exemption:
1) More than 50 per cent of the corporation’s assets (again on the basis of fair market value) must have been used in an active business carried on primarily in Canada throughout the 24-month period immediately before the sale; and
2) The shares must not have been owned by anyone other than you or someone related to youduring the 24-month period immediately before the sale.
* this article was written by Bruce Ball, CA, CFP, TEP - Bruce is a Partner in the National Tax practice of BDO Dunwoody LLP, where he develops tax planning strategies for clients. He is also a co author of the Guide to the Family Business, Canadian Edition.
Monday, July 20, 2009
Monday, July 13, 2009
5 Benefits of using a family trust
5 Benefits of using a family trust
The following are some benefits of using a family trust structure.
1. Income splitting. Trusts can be an effective way to achieve income splitting, particularly with children (subject to the potential application of the attribution rules and the “kiddie tax”).
2. Capital gains exemption. Beneficiaries may be eligible to claim the $750,000 enhanced capital gains exemption on the capital gain allocated to them from the disposition of certain types of shares. Both the beneficiary and the corporation must meet all relevant tests at the time of disposition, and the trustee must allocate the capital gains to the beneficiaries. As a result, the $750,000 capital gains exemption may be multiplied by the number of family members who are beneficiaries of the trust, without direct share ownership.
3. Creditor protection. Trusts offer some degree of creditor protection when the beneficial ownership of assets shifts to other beneficiaries.
4. Capital gains splitting. Trusts can be used to transfer appreciation in capital property, such as shares, to other family members, especially children. Generally stated, there is no attribution of taxable capital gains earned by minors. In this circumstance, the minor beneficiaries would be subject to tax on the capital gains at their marginal rates.
5. Reducing tax liability at death. Transferring assets to a trust may limit the size of the individual’s estate, such that tax liability at death is reduced. In addition, probate fees may be reduced.
The following are some benefits of using a family trust structure.
1. Income splitting. Trusts can be an effective way to achieve income splitting, particularly with children (subject to the potential application of the attribution rules and the “kiddie tax”).
2. Capital gains exemption. Beneficiaries may be eligible to claim the $750,000 enhanced capital gains exemption on the capital gain allocated to them from the disposition of certain types of shares. Both the beneficiary and the corporation must meet all relevant tests at the time of disposition, and the trustee must allocate the capital gains to the beneficiaries. As a result, the $750,000 capital gains exemption may be multiplied by the number of family members who are beneficiaries of the trust, without direct share ownership.
3. Creditor protection. Trusts offer some degree of creditor protection when the beneficial ownership of assets shifts to other beneficiaries.
4. Capital gains splitting. Trusts can be used to transfer appreciation in capital property, such as shares, to other family members, especially children. Generally stated, there is no attribution of taxable capital gains earned by minors. In this circumstance, the minor beneficiaries would be subject to tax on the capital gains at their marginal rates.
5. Reducing tax liability at death. Transferring assets to a trust may limit the size of the individual’s estate, such that tax liability at death is reduced. In addition, probate fees may be reduced.
Thursday, June 11, 2009
Corporate Reorganization - Estate Freeze
I previously wrote about an estate freeze happening during the course of a corporate reorganization. Today, I would like to share a great article written by Tim Cestnick from the Globe and Mail:
SECTION 86, Income Tax Act - Estate Freeze
THE CONCEPT
What in the world is an estate freeze?
It's the process of taking certain assets you own today and freezing them at their current values. The idea is that the future growth of those assets will accrue to anyone you choose – your children or other heirs, for example. So, why would anyone consider a freeze? There are a few potential benefits.
Cutting the tax bill on death. When a freeze is completed, all future growth between the date of the freeze and your death will accrue in the hands of your heirs. That future growth will otherwise be taxed in your hands at the time of your death, if not sooner, if the freeze isn't done.
Deferring the ultimate tax bill. By passing the future growth in the asset's value to your heirs, you can defer income tax on that growth until a much later time. Although your heirs will eventually pay tax, these taxes may not be due, for example, until your heirs pass away. Establishing the tax bill on death. By freezing the value of an asset today, you'll be able to establish, pretty accurately, what your tax bill will be upon death. This makes planning for those taxes much easier. You could, for example, consider buying life insurance to cover the tax liability.
Utilizing the capital gains exemption. A freeze may allow you to take advantage of the lifetime capital gains exemption where you own shares of a qualified small business corporation or qualified farm or fishing property. This exemption could shelter up to $750,000 of capital gains on these types of assets.
Splitting income with family members. In the process of completing a freeze, you'll be placing certain assets (often private company shares) in the hands of your heirs, either directly or indirectly through a trust. These assets can provide regular income to your heirs that will be taxed in their hands – not yours.
Protecting assets from creditors. It may be possible to protect certain assets from creditors by transferring their ownership to your heirs or, better still, a family trust, as part of a freeze.Protecting assets from spouses. If your kids (or you) own valuable and growing assets prior to marriage, it may be possible to use a freeze to minimize the claims of future spouses or ex-spouses through planning that can be done prior to marriage. Reducing probate fees. A freeze will restrict the growth of the frozen assets in your hands. This means that you'll generally own less in your hands at the time of your death than you would have without the freeze, which will minimize probate fees.
Minimizing annual taxes. Freezing assets typically requires a corporation to be set up. Corporations that carry on an active business are entitled to very low rates of tax (about 18 per cent) on the first $400,000 of active business income. It may be possible to take advantage of these rates, depending on the assets you're freezing.
Maintaining control over the property. You can enjoy the first nine benefits without having to give up control over or use of the assets during your lifetime.
THE CANDIDATES
An estate freeze is most commonly undertaken by those who own active businesses. The shares of a growing private company can give rise to a substantial tax bill at the time of death, and where there's a desire to pass the business to the kids or other heirs, a freeze can facilitate this nicely since you'll be able to issue new growth shares (common shares) to anyone you'd like. Other assets can be frozen as well, but it's not as commonly done.
Before undertaking an estate freeze, you should be confident in a couple of things: (1) That you're happy with the amount of growth you've received to date, and you're happy to see the future growth accrue to someone else; (2) That there will be sizable growth in the assets in the future.
If there isn't going to be much future growth in the assets you're freezing, then there won't be much growth to have taxed in the hands of your heirs; it may not be worthwhile freezing in this case.
* Published in the Globe and Mail, July 3rd, 2008
As business lawyer, I suggest this option to a lot of my clients - with an estate freeze and a corporate reorganization they can save a substantial amount of money. As usual, if you have any questions, please do not hesitate to contact me.
SECTION 86, Income Tax Act - Estate Freeze
THE CONCEPT
What in the world is an estate freeze?
It's the process of taking certain assets you own today and freezing them at their current values. The idea is that the future growth of those assets will accrue to anyone you choose – your children or other heirs, for example. So, why would anyone consider a freeze? There are a few potential benefits.
Cutting the tax bill on death. When a freeze is completed, all future growth between the date of the freeze and your death will accrue in the hands of your heirs. That future growth will otherwise be taxed in your hands at the time of your death, if not sooner, if the freeze isn't done.
Deferring the ultimate tax bill. By passing the future growth in the asset's value to your heirs, you can defer income tax on that growth until a much later time. Although your heirs will eventually pay tax, these taxes may not be due, for example, until your heirs pass away. Establishing the tax bill on death. By freezing the value of an asset today, you'll be able to establish, pretty accurately, what your tax bill will be upon death. This makes planning for those taxes much easier. You could, for example, consider buying life insurance to cover the tax liability.
Utilizing the capital gains exemption. A freeze may allow you to take advantage of the lifetime capital gains exemption where you own shares of a qualified small business corporation or qualified farm or fishing property. This exemption could shelter up to $750,000 of capital gains on these types of assets.
Splitting income with family members. In the process of completing a freeze, you'll be placing certain assets (often private company shares) in the hands of your heirs, either directly or indirectly through a trust. These assets can provide regular income to your heirs that will be taxed in their hands – not yours.
Protecting assets from creditors. It may be possible to protect certain assets from creditors by transferring their ownership to your heirs or, better still, a family trust, as part of a freeze.Protecting assets from spouses. If your kids (or you) own valuable and growing assets prior to marriage, it may be possible to use a freeze to minimize the claims of future spouses or ex-spouses through planning that can be done prior to marriage. Reducing probate fees. A freeze will restrict the growth of the frozen assets in your hands. This means that you'll generally own less in your hands at the time of your death than you would have without the freeze, which will minimize probate fees.
Minimizing annual taxes. Freezing assets typically requires a corporation to be set up. Corporations that carry on an active business are entitled to very low rates of tax (about 18 per cent) on the first $400,000 of active business income. It may be possible to take advantage of these rates, depending on the assets you're freezing.
Maintaining control over the property. You can enjoy the first nine benefits without having to give up control over or use of the assets during your lifetime.
THE CANDIDATES
An estate freeze is most commonly undertaken by those who own active businesses. The shares of a growing private company can give rise to a substantial tax bill at the time of death, and where there's a desire to pass the business to the kids or other heirs, a freeze can facilitate this nicely since you'll be able to issue new growth shares (common shares) to anyone you'd like. Other assets can be frozen as well, but it's not as commonly done.
Before undertaking an estate freeze, you should be confident in a couple of things: (1) That you're happy with the amount of growth you've received to date, and you're happy to see the future growth accrue to someone else; (2) That there will be sizable growth in the assets in the future.
If there isn't going to be much future growth in the assets you're freezing, then there won't be much growth to have taxed in the hands of your heirs; it may not be worthwhile freezing in this case.
* Published in the Globe and Mail, July 3rd, 2008
As business lawyer, I suggest this option to a lot of my clients - with an estate freeze and a corporate reorganization they can save a substantial amount of money. As usual, if you have any questions, please do not hesitate to contact me.
Monday, June 1, 2009
SHAREHOLDERS AGREEMENT - What is a “Piggyback” Rights ?-
“Piggyback” Rights – designed to apply where a shareholder proposes to sell shares to a third party; if invoked by other shareholder, piggyback rights clause will prohibit the share transfer unless third party offers to purchase their shares at the same price and on the same terms as offered to the selling shareholder. Primary purpose is to protect minority shareholders.
SHAREHOLDERS AGREEMENT - What is a “Carry-Along” Rights ?
“Carry-Along” Rights – permits majority shareholder(s) to force minority shareholder to sell their shares where a bona fide offer has been received from an arm’s length party to purchase all of the shares of the corporation. Purpose is to increase majority shareholder’s flexibility to sell the business.
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