Business owners: Are you a candidate for a corporate reorganization and, in the process, eligible to save thousand of dollars in taxes?

by Hugues Boisvert Business Lawyer, HazloLaw P.C. As a business lawyer, I work with entrepreneurs and business owners on a daily basis. For the vast majority of them, their most valuable asset is their corporation. For obvious reasons, their number one 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, unfortunately, often overlooked. Remember, as the old saying goes, “It is not what you make, but what you keep.” Business owners must realize that a proper structure can save a substantial amount of taxes, which will greatly benefit themselves, their family and their business. Further, the costs of implementing these types of structures are usually easily justified by the annual tax savings. The purpose of this article is to explain to you the benefits of a corporate reorganization and to help you determine if you are a good candidate for implementing such structure. What is a Corporate Reorganization? A Corporate Reorganization is a legal way to reorganize and restructure your company so that you can reap the rewards of the existing tax regulations - often resulting in annual tax savings in amounts upwards of tens of thousands of dollars. Why do I need a Corporate Reorganization? As a business lawyer, I sometime see situations where businesses are set up with a certain structure to take advantage of particular circumstances that were relevant at the time they were set up. But as we all know, situations change over time. It is common that the conditions which resulted in a particular corporate structure no longer reflect what is best for the corporation or its owners, resulting in a somewhat cumbersome and inefficient structure, particularly from a tax point of view. Every day, I work with companies, who are in this situation and help them to reorganize and restructure their affairs, which, in turn, allows them to save a substantial amount of money. There are many situations where a corporate reorganization is recommended, such as, corporate tax planning, creditor proofing or in order to reach other organizational goals. Sometimes this process will even involve the transfer of assets on a tax-deferred basis from one entity to another, or from one corporation to another. Every person and corporation is different. Accordingly, when analyzing whether or not a corporate reorganization is appropriate, it is important to investigate all relevant options thoroughly. Given the complexities and technicalities of such an undertaking, it is highly recommend one obtains qualified profession help. This ensures the business owner obtains proper advice and implements the best possible plan to meet the their objectives. Based on my experience, there are many reasons companies may need to be reorganized. Some of the common reasons, which may apply to you, are as follows: (1) To implement a proper share structure; Having the right structure allows flexibility in terms of tax planning. While you are only required, by law, to have one class of shares (common), it is always best to provide for the possibility of additional classes of shares. This allows a corporation the flexibility to modify its ownership structure, should the need arise. For example, in order to save on taxes, you might want to take advantage of income splitting available to eligible family members. Or you might need to issue a new class of shares in order to attract new investors. Or you might want to make use of a family trust, discussed further below. (2) To establish and implement a Family Trust; If you have children and/or are married, serious consideration should be given to owning the shares of your business through a discretionary Family Trust. The benefits of a family trust include: (a) Income splitting: A well-structured family trust allows for the splitting of income earned by the trust among the various beneficiaries; (b) Funding of children’s education at a potential tax rate of 15.5% instead of 48% (a savings of up to $32,500 per $100,000 of profit); and, (c) Multiply uses of the one-time capital gains exemption, should you sell your company, allowing the $750,000 capital gains exemption to be multiplied by the number of family members who are beneficiaries of the trust, without direct share ownership. (3) To create holding companies for tax and creditor-proofing reasons; Generally, a “holding company” is a corporation which is placed between a business, the “operating company”, and the individual shareholder. One of the foremost principles of Canadian taxation is that dividends are allowed to flow on a tax-free basis from one corporation to another. Accordingly, after-tax profits accumulated in the operating company can be distributed to the holding company as tax-free dividends. Funds transferred to the holding company in this manner are better protected from claims made by any of the operating company’s creditors. No one ever expects to face such a claim; however, the reality is that, for a variety of different reasons, creditor claims are made on a daily basis. As a result of these claims, many unprepared business owners have seen a lifetime of accumulated profits vanish, often due to a single claim. It is for this reason that use of a holding company is especially attractive to companies where the risk of lawsuits or litigation is significant. Additionally, if necessary, funds held in a holding company can be lent back to the operating company on a secured basis in order to retain protection from creditors. (4) To carry out and implement a succession plan through an estate freeze (by using Section 86 of the Income Tax Act). For business owners, tax minimization is central to any plan. One popular tool is an estate freeze. An estate freeze is part of a corporate reorganization 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 under the deemed disposition rules upon their death and provides a deferral mechanism of taxes. A freeze in combination with the creation of a discretionary trust can provide a flexible framework that can lead to further tax minimization. If you think you are a candidate for a corporate reorganization or would like to know more, please feel free to contact me. I can advise on whether a corporate reorganization is required and the benefits of such reorganization, as well as manage its implementation and execution. As you can imagine, a corporate reorganization has many tax and legal implications for companies and their owners, so anyone considering it should seek professional help.

Tax Planning for Business Owners...

Salary/Dividend Planning Many factors must be considered in determining the most beneficial combination of remunerating the owner-manager of a closely-held corporation. As with other planning, each case must be examined separately and no one "rule of thumb" can apply to all situations. Here are a few factors that should be taken into consideration: The tax rate of the corporation The marginal tax rate of the individual Exposure to Alternative Minimum Tax The ability to benefit from child care expenses and paternity/maternity benefits and to make RRSP and CPP/QPP contributions, which are all based on salary and not dividend income Wage levies applicable to salaries, such as the Ontario Employer Health Tax and Quebec's Health Services Fund and 1% Training Tax (if the payroll exceeds $1,000,000) Quebec restrictions on the deductibility of investment expenses by individuals where expenses exceed investment income Whether eligible dividends can be paid to shareholders Full or partial loss of the dividend credit if taxable income is not high enough Higher net income with a dividend than with a salary, since dividend income is grossed up by 41% in 2011 (38% in 2012) for eligible dividends or 25% for non-eligible dividends, which can have an impact on certain credits and benefits Some planning techniques include: If the corporation has Refundable Dividend Tax on Hand (RDTOH), the payment of a dividend will result in a refund of 33 1/3% of the dividend payment up to a maximum of the RDTOH balance Remuneration that is accrued and expensed by a corporation must be paid to the employee within 179 days of the corporation's year-end. When a year-end falls after July 5, the corporation can cause the owner-manager's remuneration to fall into either the current or subsequent calendar year Freeze or Refreeze? An estate freeze is used to ensure that future growth in the value of a company accumulates in the hands of a shareholder's heirs. This is accomplished by "freezing" the current fair market value of the company in the form of preferred shares. If the value of a business subsequently decreases, the benefits of freezing may not be fully realized and it may be advantageous to consider "unfreezing" and "refreezing" a company. Refreezing enables taxpayers to exchange their old preferred shares, obtained at the time of the initial freeze, for new shares with a lower redemption price. Any future gains in value will then be passed on to the holders of common shares. This type of planning helps reduce tax on the death of taxpayers by lowering the redemption price of their preferred shares and transferring more value to their heirs. Income Splitting Investment income earned by an individual who invested money borrowed at low or no interest from a related person will be attributed back to the lender. Subject to a purpose test, this rule does not apply where the loan is to a related person other than a spouse or minor child. Nor will it apply where the loan is to a spouse or minor child if interest is charged at the prescribed rate in effect at the time the loan is made (the prescribed rate for the fourth quarter of 2011 is 1%). When utilizing this exception, interest must be paid no later than 30 days after the end of the year to avoid attribution of income. For instance, the high-income spouse could lend investment funds to the low-income spouse at the current 1% rate and receive (and pay tax on) the interest income each year, for as long as the loan remains outstanding. The low-income spouse would pay tax on the income generated by the funds and deduct the interest paid to the high-income spouse. Since the attribution rules are complex, caution is advised when contemplating a transfer of property or a loan to a spouse or a child (including transfers indirectly through a corporation or a trust). Some other basic planning ideas would include: Gifting growth assets to a minor child, as the resulting capital gain is not attributed to the donor; however, certain exceptions were proposed in the 2011 federal budget Gifting property to a child who is not a minor Segregating and re-investing "attributed" income of a spouse or minor child Deposit Canada Child Tax Benefit (CCTB), Universal Child Care Benefit (UCCB) and Quebec Child assistance payments (CAP) directly into accounts opened in the children's names Use the income of the spouse with the higher income to pay all the family's expenses so that the spouse with the lower income has more capital available for investment Using a trust for the benefit of family members to hold shares of a closely-held corporation. However, there are restrictions in regard to income-splitting with minor children Spouses can choose to share their QPP and CPP retirement pensions Have your spouse as your business partner or pay reasonable salaries to your spouse or children Shareholder Loans Any loan granted by a corporation to an individual who is a shareholder or to a person with whom the shareholder does not deal at arm's length will be taxable in the year in which the loan is advanced, unless a particular exception applies. If the loan meets one of these exceptions, the shareholder will be required to pay to the corporation interest at a rate at least equal to the prescribed rate no later than January 30 each year. If a shareholder loan exists at any time during the year, a taxable benefit must be calculated based on the prescribed interest rate, less the interest actually paid. When a loan is repaid, the shareholder may claim a deduction up to the amount that had been included in income. It might be worthwhile for a corporation to make a loan to an adult child of the shareholder at a time when the child does not have much income. The loan may be repaid in a subsequent year, when the child's marginal tax rate is higher. Since shareholder loans are not deductible from a corporation's income and do not generate refunds of RDTOH it is recommended that shareholders verify whether it would be more advantageous to be paid a salary or a dividend. It is very important that any loan contract between a corporation and one of its shareholders be adequately documented. Capital Gains Exemption A capital gains exemption is available for individuals to use in relation to gains realized on qualified small business corporation shares and some other properties. The maximum lifetime capital gain exemption is $750,000. Be aware of the possible disadvantage of selling investments eligible for the $750,000 capital gains exemption and investments with losses in the same year. Capital losses realized in the year must be offset against capital gains of that year including "exempt" gains. Consider selling investments with losses the following year. Subject to certain conditions, an individual may defer capital gains on eligible small business investments to the extent that the proceeds are reinvested in another eligible small business. The reinvestment must be made at any time in the year of disposition or within the first 120 days of the following year. Acquisition of Assets Accelerate the acquisition of depreciable property used in carrying on a business otherwise planned for the beginning of the next year. This will allow additional depreciation (CCA) to be claimed in the current year. The "available-for-use rules" should be considered (generally requiring the depreciable property to be used in operations for the depreciation deduction to be allowed). Conversely, consider delaying until the subsequent year the acquisition of depreciable property in a class that would otherwise have a terminal loss in the current year. Machinery and equipment acquired after March 18, 2007 and before 2012, primarily for use in Canada for the manufacturing and processing of goods for sale or lease is currently eligible for a temporary accelerated CCA rate of 50% and subject to the half-year rule. Otherwise, a CCA rate of 30% would apply and be subject to the half-year rule. The 2011 federal budget proposed to extend this temporary incentive for two years, to eligible machinery and equipment acquired before 2014. Death Benefit A corporation can make a onetime tax free payment of up to $10,000 to the spouse or heirs of a deceased employee. This payment will not be taxable to the recipient and will be fully deductible by the corporation. * provided by BGK -Chartered Accountants - more info at www.BGK.ca

How an honest mistake beat a $6-million tax bill **

Some mistakes can be costly. Consider the story of Andrew Espey from Jackson, Minn. According to KEYC-TV, Mr. Espey was fined $2,000 (U.S.) and sentenced to 90 days in jail for improperly shingling his house (he affixed the new shingles without first removing the old ones). I just hope that same building inspector doesn’t show up at my place to examine the poor job I did of hanging our new screen door. While a home improvement faux pas can be bad enough, other mistakes – particularly tax mistakes – can cost even more. How about $6-million more? Today I want to share the story of siblings who found that they owed the taxman that much. The good news? The tax bill was the result of a mistake made by these siblings, and the court was sympathetic to them. This could be good news for other taxpayers. The story Ashok and Saroj Arora are siblings who owned and operated a business by the name of Stone’s Jewellery Ltd. In 1996, Stone’s entered into an agreement to purchase a parcel of land in Springbank, Alta., for $500,000. The closing date was delayed until 2004 at which time the property was worth about $4-million. The Aroras were advised at the time of closing to register the property in their personal names rather than in the name of Stone’s in order to protect the property from potential creditors of the business. The advice they received was that this transaction would be tax-free. Then, in 2006, the Aroras transferred the property to a wholly owned corporation on the advice of their advisers. The property was worth about $6-million at the time of this transfer, and the transfer was to be treated as a tax-free transfer (by taking advantage of section 85 of our Income Tax Act which allows certain transfers to a corporation to be made tax-free). Here’s the problem: The Canada Revenue Agency argued that there were two taxable transfers here: the one in 2004 when the Aroras took possession of the property personally (CRA called this a taxable transfer by Stone’s to the Aroras), and again in 2006 when the property was transferred to the new corporation (CRA argued that section 85 was not applicable to the transfer since this was “land inventory,” or land held for resale). CRA also argued there was a taxable shareholder benefit that arose when the land was placed in the names of the Aroras. The total tax bill owing by Stone’s and the Aroras was about $6-million. This issue ended up in court (Stone’s Jewellery Ltd. v. Arora, 2009 ABQB 656) and the Court of Queen’s Bench of Alberta rendered a decision that may help other taxpayers. The decision In their application, the taxpayers argued that they were entitled to relief based on three different principles. One of these was the principle, or doctrine, of mistake. The court summarized the doctrine of common law mistake by saying that a mistake must be fundamental, going to the identity of the contract, where the contracting party obtained something other than what was intended. This should be distinguished from a situation where the contracting party did receive what was intended but it turned out to be less valuable than expected. In this latter case, the mistake is not considered to be fundamental. In a case where a mistake is fundamental, the contract can be rendered by the court to be void from the very beginning. It shouldn’t be surprising that CRA opposed the taxpayers’ application, arguing that (1) other legal remedies were available and (2) the parties should not be allowed to undertake retroactive tax planning. The court dealt with the 2006 transfer first. Although the court acknowledged that it didn’t have the power to order that the transfer take place under section 85 of the Income Tax Act, it did say that all of the parties held the mistaken belief that the transaction could be done on a tax-free basis – a fundamental mistake that went to the root of the contract. The court said the transfer was therefore void from the beginning. As for the 2004 transfer, the court said that there was a common mistaken belief by the parties, based on the advice of their advisers, that there would be no negative tax consequences to registering the property in their personal names. This too was a fundamental mistake that went to the essence of the agreement, and the transaction was rendered void from the outset. This is, of course, good news for taxpayers who may be in a similar situation where an honest and fundamental mistake results in taxes owing. * written by Tim Cesnick and published in the Globe and Mail.

The importance of preparing Annual Resolutions for your Company.

The Canadian Business Corporation Act ("CBCA") states that a corporation "... must hold a shareholders' meeting on a date that is no later than 15 months after holding the last preceding annual meeting, but no later than six months after the end of its preceding financial year." Alternatively, shareholders may pass a resolution in lieu of meeting. A resolution in lieu of a meeting may be useful for small corporations that have only one or a few shareholders. A resolution in lieu of meeting is a written resolution signed by all shareholders who would have been entitled to vote at the meeting that deals with all matters required to be dealt with at a shareholders' meeting. This resolution is just as valid as it would be if passed at a meeting of shareholders. This resolution should be retained in the corporation‘s records. The shareholders' meeting (or resolution in lieu of a meeting) allows shareholders to obtain information about the corporation's business and to make appropriate decisions regarding this business. The date of the meeting, or of the resolution, must be indicated on your Annual Return. Agenda At minimum, the agenda of an annual meeting must include the following items: - consideration of the financial statements; - appointment of an auditor (or a resolution of all shareholders not to appoint an auditor); and - election of directors. Often, the agenda includes an additional item, "any other business." This portion of the meeting allows shareholders to raise any other issues of concern to them. If directors want shareholders to consider a matter, it should be listed in the agenda prior to the meeting and not raised as "any other business." Calling a shareholders' meeting The directors must notify voting shareholders of the time and place of a shareholders' meeting. They must do so no more than 60 days and no fewer than 21 days before the meeting date. For example, if the meeting is to be held on May 20, the notice of the meeting should be sent no earlier than March 22 and no later than April 30. Unless otherwise provided by the by-laws or the articles, this notice can be sent electronically to shareholders if they have previously consented to receiving such notices electronically and if they have designated a system for receiving them. Location of the shareholders' meeting The annual meeting may be held in Canada at a place specified in the by-laws. Or, if the by-laws do not specify a location, directors may choose one. An annual meeting may be held outside Canada only in cases where the corporation's articles permit it or if all voting shareholders agree. Also, where the corporation's by-laws permit it, the directors of a corporation may decide that a meeting of shareholders will be held entirely by means of a telephonic, electronic or other communication means that will permit all participants to communicate adequately with each other during the meeting. In such cases, it is the responsibility of the corporation to make these facilities available. Unless otherwise provided by the by-laws, a corporation can allow shareholders to attend the meeting electronically. The communications system used must permit all participants to communicate adequately with each other during the meeting. Other requirements of the shareholders' meeting Quorum Unless a quorum of shareholders is present or represented at annual or special shareholders' meetings, no business that is binding on the corporation can be conducted. A quorum is present at a meeting when the holders of a majority of the shares entitled to vote at the meeting are present in person or represented by proxy, regardless of the number of persons actually present at the meeting. Note, however, that a corporation's by-laws can provide for a different type of quorum. Electronic voting Unless the corporation's by-laws specifically forbid it, electronic voting is allowed, as long as it is possible to verify the vote without knowing how each shareholder voted. Minutes of the meeting The corporation must keep a written record of the meeting. This record usually includes such information as: where and when the meeting was held; who attended; and the results of any voting.

Startup funding: A closer look at FedDev!

Today, I would like to share a great article written by Mark Evans and published in The Globe and Mail. Over the past few months, a relatively unknown player has been sprinkling seed money on a growing number of startups, providing the ecosystem with a source of much-needed capital. So what is FedDev Ontario and why the flurry of investments? FedDev is a federal agency created in 2009 to support the southern Ontario economy to “mitigate and overcome economic challenges, as well as position the region to compete globally.” Translation: It is looking to jump-start economic development and create jobs. Well, that certainly sounds ambitious, doesn’t it? So why the focus on startups, which tend to be risky ventures that could support economic development but could also flame out after a short time? To get the scoop on FedDev, I asked a few questions to FedDev spokesman Kevin Miller. Q: What role does FedDev Ontario play within the investment and startup ecosystem? A: Consultations with stakeholders in southern Ontario after the launch of the agency revealed the business community faces real challenges when it comes to productivity, competition and innovation. In particular, startup companies lack access to capital and investors to help them bring promising ideas and innovations into the market. Through Investing in Business Innovation, FedDev Ontario is focusing on early-stage businesses that are recognized as having the potential for high growth and a net long-term economic benefit for southern Ontario. IBI also provides funding to help angel organizations attract new investors and encourage the growth of angel investment funds. Q: Who's eligible for the program and how does FedDev Ontario decide who gets money? A: Eligible recipients under this initiative are startup businesses, defined as companies with less than 50 employees, not-for-profit angel investor networks, and not-for-profit organizations representing angel investor networks. FedDev Ontario assesses applications based on specific criteria, as outlined in the program guidelines. Q: What's the range of investment made by FedDev Ontario in a particular company? A: Startups in southern Ontario may request up to $1-million in repayable contributions. Angel investor network applicants may request one-time, non-repayable funding of up to $50,000 to help them attract new investors. Organizations representing southern Ontario angel networks may request non-repayable funding of up to $2-million to support investment attraction and other development activities. Q: Are there any limitations on how the money can be spent or when it needs to be spent? A: Funding needs to be spent by March 31, 2014 Q: Are all contributions repayable? A: Contributions to startup companies are repayable. Contributions to not-for-profit angel investor networks and organizations representing southern Ontario angel networks are non-repayable. Q: How many companies have received financing so far? A: To date, FedDev Ontario has announced investment in funding for projects with the following organizations: Powernoodle, Nulogy, Guardly, Miovision Technologies, Maintenance Assistant Inc., Chango Inc., Wave Accounting Inc., gShift Labs Inc., Ultimate Kiosk Inc. and the Niagara Angel Network. Q: How big is the program and how long will it last? A: FedDev Ontario has notionally allocated up to $190-million until March 31, 2014 for Investing in Business Innovation. However, all project activities must be completed by that date.