Tax Tip Management Fees and Salaries

Below is an excellent article written by Andrews & Co, Chartered Accountants, they are located in Ottawa, Canada:

Tax Tip Management Fees and Salaries

It is important to remember that management fees and salaries paid by taxpayers, usually corporations, must be reasonable to be deductible.

Companies will often “bonus down” profits to the limit of the Small Business Deduction, $500,000, to avoid paying higher rate tax on excess profits.

The Canada Revenue Agency can challenge such bonuses or management fees if in their opinion, the fees are not reasonable. It has been CRA’s assessing practice to allow bonuses or management fees where it is a corporations general practice to distribute profits in this manner AND the recipient of the income is active in the business and has special knowledge, skills etc that helped to earn the income.

In the Neilson Development Company case decision, the Court provided the criteria required to successfully bonus down and the fees to be considered reasonable. In this case, management fees of $300,000 per year were disallowed when paid to a corporation controlled by a spouse. The taxpayer successfully appealed but only because they could prove that the taxpayer met the criteria. The facts won the case, not legal arguments. The circumstances included:

- The management fees included services for budgeting, planning, marketing and being involved in the "hands on" operation
- Management was on site
- How the company operations compared to similar companies
- The effort to earn the fees
- The profitability of the company
- The presence or absence of a contract

It is important that when declaring material or substantial bonuses or management fees, that the facts be documented, there is a contract and the decision is recorded in the corporate Minutes.

What is tax avoidance?

What is tax avoidance? How does it differ from tax planning and aggressive tax planning?

Tax avoidance and tax planning both involve tax reduction arrangements that may meet the specific wording of the relevant legislation. Effective tax planning occurs when the results of these arrangements are consistent with the intent of the law. When tax planning reduces taxes in a way that is inconsistent with the overall spirit of the law, the arrangements are referred to as tax avoidance. The Canada Revenue Agency's interpretation of the term "tax avoidance" includes all unacceptable and abusive tax planning. Aggressive tax planning refers to arrangements that "push the limits" of acceptable tax planning.

Tax avoidance occurs when a person undertakes transactions that contravene specific anti-avoidance provisions. Tax avoidance also includes situations where a person reduces or eliminates tax through a transaction or a series of transactions that comply with the letter of the law but violate the spirit and intent of the law. It was to address these latter situations that the general anti-avoidance rule was enacted in 1988.

How does tax avoidance differ from tax evasion?

Under federal tax laws, taxes may have to be paid, but the laws also provide credits, benefits, refunds, and other entitlements. While in layman's terms tax avoidance and tax evasion would seem to be synonymous, there is a definite distinction under Canadian tax law.
Tax avoidance results when actions are taken to minimize tax, while within the letter of the law, those actions contravene the object and spirit of the law.

Tax evasion typically involves deliberately ignoring a specific part of the law. For example, those participating in tax evasion may under-report taxable receipts or claim expenses that are non-deductible or overstated. They might also attempt to evade taxes by wilfully refusing to comply with legislated reporting requirements. Tax evasion, unlike tax avoidance, has criminal consequences. Tax evaders face prosecution in criminal court.

Business owners: Are you a candidate for setting up a Family Trust?

As a business lawyer, I meet with entrepreneurs on a daily basis, and for many of them their most valuable asset is their corporation. For obvious reasons, their first priority is on income-earning activities, such as generating sales. Attention to such activities is, of course, a practical necessity and a hallmark of success. However, the utilization of a proper corporate structure to reduce tax exposure is often overlooked. Business owners must realize that a proper structure can save a substantial amount of taxes and can also be greatly beneficial for them and their family. The purpose of this article is to explain to you the benefits of using a Family Trust and to help you determine if you are a good candidate for implementing such a structure.

What is a Family Trust?

In essence, a trust is not a legal entity like a corporation, but rather a relationship that exists whenever a person, called a Trustee, holds property for the benefit of other individuals. The trust arrangement permits the legal ownership of the property to be held by the trustee while the benefits of ownership (income, capital gains) accrue to the beneficiaries. It is common practice for an entrepreneur and his or her spouse to act as Trustees of their Family Trust. Hence, entrepreneurs can still maintain control over their companies, while benefiting from a trust arrangement (subject to their fiduciary duties to act in the best interest of the beneficiaries).

How do I determine if I’m a good candidate to setup a Family Trust?

Here are some key indicators that you should consider a Family Trust:

Ø You are shareholder in a private corporation.
Ø Your business is profitable and generating profits.
Ø You have children(s) and you are paying/will pay for their education(s).
Ø You may want to sell your company in the future.

Would it be beneficial for me and for my family?

Some of the benefits of using a Family Trust structure are:

Ø Funding of your children’s education. The first and immediate benefit is the funding of your children's education. By having the trust own shares in the family company and having your children as beneficiaries of the trust, it is possible to fund as much as $32,000.00 per child over the age of 18 at a tax rate of approximately 14% through the trust as opposed to funding your child's education from your personal funds which are usually taxed at a substantially higher rate. If you are a high income earner you will be paying tax at approximately 48%. Basically, you can save as much as 34% of taxes (i.e. a potential saving of $34,000 for each $100,000 earned). This is a substantial savings for each of your children for each year that he/she is in school with little or no other source of income.

Ø Income splitting. A well-structured family trust allows for splitting the income earned by the trust among the various beneficiaries. If you are a high income earner you may be able to split your revenue to a lower income earner. (subject to the potential application of the attribution rules and the “kiddie tax”).

Ø Capital gains exemption. Once in your life time, you may be eligible to claim the $750,000 capital gains exemption. Basically, what it means it that an individual selling his/her shares of a Canadian Private Corporation (subject to a set of specific rules) can receive the first $750,000 on a tax free basis. Hence, the $750,000 capital gains exemption may be multiplied by the number of family members who are beneficiaries of the trust, without direct share ownership.

Ø Reducing tax liability at death. Transferring assets to a trust may limit the size of the individual’s estate, such that tax liability at death is reduced. In addition, probate fees may be reduced.

As you can see, a Family Trust can offer business owners a great deal of flexibility and should be further explored. Any individual who is interested in setting up a corporate structure that involves a Family Trust should evaluate all the tax consequences and consult with a knowledgeable professional. For more personalized information regarding setting up a Family Trust contact Hugues Boisvert.

How can you get $750,000 TAX FREE??

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.

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.