Tax planning for business owners june 2014 Sean Rheubottom - United Financial

Sean Rheubottom, B.A., LL.B, TEPRegional Vice President, Wealth PlanningUnited Financial, a division of CI Private Counsel LP

Tax Planning for Business Owners:wealth planning overview

AbbotsfordJune, 2014

Corporate and personal tax rates and tax saving opportunities

Taxation and integration of corporate and personal income

Interest, Salary,

Business Income

Capital Gains Dividends (Non-Eligible)

Dividends (Eligible)

43.7% 45.8% 21.85% 22.9% 33.71% 37.99% 25.78%

28.68%

Active business income < $500K

Active business income > $500K

Interest, Rent (passive)

Capital Gains

Portfolio Dividends

13.5% 26% 45.67%50% taxable, as interest 33.33%

Increased from 25% in April 2013

- Increased from 44.67% in April 2013- Taxable income subject to 26.67% refundable tax (so 19% permanent tax)

Refunded on payment of

dividend

Corporate tax rates in BC 2013 and 2014

Personal tax rates in BC 2013 / 2014 (top rates)

Integration in BC 2013 / 2014: cost or savingActive business income < $500K

Active business income > $500K

Interest, Rent (passive)

Capital Gains

Portfolio Dividends

1.04% 0.58% 1.38% 1.42% 2.61% 3.97% 1.3% 1.99% Neutral

Tax deferral

Active business income below $500K: Personal rate if paid as salary: 45.8% of $500K =$229,000 Corporate rate if retained: 13.5% of $500K =$ 67,500 Maximum tax deferral in one year: 32.3% of $500K =$161,500

Active business income above $500K: Personal rate if paid as salary: 45.8% Corporate rate if retained: 26% Maximum tax deferral in one year: 19.8%

Interest or rent (passive) income: Personal rate if earned personally: 45.8% Corporate rate if earned corporately: 45.67% (26.67% refundable)

0.13% no deferral

Power of a tax deferral (using 43.7% personal tax rate)

$500,000 business income in Year 1… 5 years to save, then spend it

1. Pay out to shareholder as salary / bonus (or if no corporation) After 43.7% tax, $281,500 remains

Invest $281,500 for 5 years at 5% $359,273 Liquidate account after year 5, pay tax on the capital gain

Available to spend after tax, after 5 years: $342,280

$500,000 business income in Year 1… 5 years to save, then spend it

1. Pay out to shareholder as salary / bonus (or if no corporation) After 43.7% tax, $281,500 remains

Invest $281,500 for 5 years at 5% $359,273 Liquidate account after year 5, pay tax on the capital gain


2. Retain in corporation for 5 years After 13.5% corporate tax, $432,500 remains

Retain / invest $432,500 for 5 years at 5% $551,992 Liquidate account after 5 years and pay all cash out to individual Corp realizes and pays tax on the capital gain Individual pays tax on cash extracted as non-eligible dividend and capital dividend


Tax deferral results in absolute tax savings.

Power of a tax deferral (using 43.7% personal tax rate)

Accessing the capital gains exemption

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$800,000 lifetime capital gains exemption on the disposition of QSBC shares

What is a QSBC share?

Share of a CCPC

90% asset test

50% asset test (24 months)

Excess cash / investments don’t qualify

24-month ownership test shares newly issued are deemed not owned by related person

Capital Gains Exemption (“CGE”):“Qualified Small Business Corporation” (“QSBC”) Shares

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Problem: Shares do not qualify for the CGE

OpcoOpco

Jack

100%

Total value: $3,000,000

Jack’s business is successful

– Owns $1 mil cash / investments

– retaining more each year

– When sold (or at death), will not meet 90% test - all gains would be taxable

– Tax at 22.9%: $687,000

Operations $2,000,000 Cash & investments $1,000,000

10

“Purify”: Move passive assets out of Opco

Problem: removing assets from a corporation causes tax

capital gains to corporation taxable dividends to shareholder

Simple or complex methods Repay s/h loans Use available tax accounts Non-arm’s length butterfly Safe income strip

Purification

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Capital gains exemption:“Butterfly” type purification

Transfer passive assets to Investco without triggering gains

Very common planning

Complex rules apply; potential negative tax consequences

Experienced advice is important

OpcoOpco

Jack

100%InvestCoInvestCo100%

Cash & investments $1,000,000

Operations $2,000,000

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Capital gains exemption and purification:Purify sooner, not later

Purify sooner rather than later!

24-month 50% test to qualify for capital gains exemption

ITA 55(2) anti-avoidance rule - may apply with very negative effect where “butterfly” done in contemplation of sale

“Safe income” dividends may shelter from 55(2) Simpler to purify early and on ongoing basis

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Jack’s shares will qualify for the $800,000 capital gains exemption

Dividends flow tax-free to InvestCo Preserves deferral of small business rate

Simple example of advance sale preparation

Can add a freeze to this structure

Ongoing purification – simple structure

Dividends

InvestCoInvestCo

Jack

OpcoOpco

100% common shares

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Protection against potential future creditors

Secured loan back to Opco

Use InvestCo for creditor protection

InvestCoInvestCo

Jack

OpcoOpco

100% common shares

Loan

Investment Holdco Issues

Investment holdco issues:“Corporate attribution”

• Express exceptions• “SBC” 90% test• 74.4(4) trust

• CRA administrative exception• “pro rata” transfer exception

• Advance planning to avoid it• Stock dividend freeze• “Drop down” freeze

• Must be considered in cases where asset sale is anticipated

• Incorporated professionals need to plan around it

InvestCo

Mr. A Freeze and issue shares to spouse, children, or to a trust for them?

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Investment income of a private corporation:Integration failureExtra cost of earning interest income through a private

corporation: 2.61% in BC in 2013 3.97% in BC n 2014

Can we avoid or defer this extra cost? Seek a portfolio structure that defers taxable distributions

Extra cost of realizing capital gains in a private corporation: 1.3% in BC in 2013 1.99% in BC in 2014 Can we avoid or defer this extra cost? Seek a portfolio structure that defers taxable distributions

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Portfolio dividends received by a private corporation

InvestCo receives portfolio dividend (eligible dividend) InvestCo pays Part IV tax at 33% - to RDTOH of InvestCo

InvestCo can pay eligible dividend to Mr. A refund of RDTOH at $1 for every $3 paid (33%) Mr. A pays 28.68% tax on the eligible dividend

4% tax “win”…

Problem: no chance to defer tax Can we defer somehow? Seek a portfolio structure that defers taxable

distributions defer Part IV tax and dividend tax

Jack

Opco

InvestCo

Part IV tax 33%

Portfolio dividends (eligible dividends)

Tax-preferred income: dividends and capital gains even if portfolio includes exposure to interest, foreign income increase your after-tax income

Defer income by minimizing distributions (tax slips) deferral of tax results in absolute savings over time

Switch or “rebalance” investment strategy without incurring tax

Tax-efficient retirement cash flow Trigger capital gains rather than interest income Works well with a corporate account

Investment income (corporate or individual)Consider tax aspects

Corporate “freeze” structure

Our Financial Analysis confirmed that Jack and wife Sheila are financially “more than sufficient”

Is there a better way to:

split income with spouse and pay for children’s expenses?

minimize the tax in the event of sale or death?

Corporate freeze structure

BC Family Law Act and discretionary trusts: a welcome update

OLD (March 18 2013)Section 85 “excluded property”:

…(f) property held in a discretionary trust…of which the spouse is a beneficiary

But:

Susec 84(2) : Family property includes:

…(g) the amount by which the value of excluded property has increased [during the spousal relationship]

NEW (in force May 26 2014)Section 85 “excluded property”:

…(f) a spouse's beneficial interest in property held in a discretionary trust…

Appears we are back to valuing an interest in a discretionary trust difficult to value!

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InvestCoInvestCo

Jack

OpcoOpco

100% preference shares$2,000,000

Beneficiaries:Jack, spouse, children, future grandchildren, corporation

Family Trust

Family Trust

100% common shares$100 Jack does not give up control (voting p/s)

Growth accrues to Family Trust

Income splitting through Family Trust

Shares held by Trust can roll to child

If Jack retires, switch from salary/bonus to dividends – redeem shares

100% common shares

Reversible freeze

Potential “tax free” dividends in BC in 2014: Cash eligible dividends: $49,289Cash non-eligible dividends: $22,289

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InvestCoInvestCo

Jack

OpcoOpco


Beneficiaries:Jack, spouse, children, grandchildrencorporation

Family Trust

Family Trust

100% common shares$100

Caution: corporate attribution

Solution: maintain “purity” of Opco

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A better freeze structure

InvestCoInvestCo

Jack

OpcoOpco



Family Trust

Family Trust

100% common shares$100

InvestCo as beneficiary of Family Trust InvestCo may also be frozen to the Family

Trust assuming no prior contaminating transfer to

InvestCo for corporate attribution purposes

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After the freeze – redemption program for freeze shares

Jack

OpcoOpco



Family Trust

Family Trust

100% common shares$100 Jack’s freeze shares may be redeemed

over time Redemption payments are deemed

dividends Determine redemptions annually based on

other income and tax Achieve income smoothing over time Reduce capital gain at death

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Accessing multiple capital gains exemptions

$800,000 CGE x 4 $3,200,000 in capital gains sheltered from tax $699,200 potential tax saving (using 21.85% tax rate) Timing of freeze less than optimal?

$800K CGE

$800K CGE

$800K CGE

$800K CGE

Family Trust

Family Trust

OpcoOpco

Preference shares$2,000,000

100% common shares

child Sheila

Jack

child

Shareholders’ agreements; Death buy-sell;Post-mortem planning

Share purchase v. Share redemptionFor succession planning or arm’s length death buy-sell

Corporately-held insurance

Share redemption strategy to extent insurance is available

Share purchase for value in excess of insurance

Liquidation of deceased’s shares: spousal “roll and redeem” strategy to avoid stop loss rules

A tax-free buy-out?

Use of life insurance in post mortem planning

OpcoOpco

XX JackJack

X Hco X Hco J Hco J Hco

FTFT

Will planning:

Tax saving using trustsdespite high flat-rate tax?

Testamentary Trusts: Income Splitting with Low Rate Beneficiaries

$1,000,000 in trust for your adult Daughter (high income earner) and her 3 young children

investments produce $50,000 income each child requires $10,000 per year for education expenses = $30,000 children have no other income Tax the remaining $20,000 in the trust

Tax each child pays:$10,000 x 0% = $ 0 tax$10,000 x 0% = $ 0 tax$10,000 x 0% = $ 0 tax

Tax the trust pays:$20,000 x 45.8% = $ 9,160 tax

Compare tax to Daughter on $50,000 with no trust:

$50,000 x 45.8% = $22,900

Annual tax saving: $13,740

Alter-Ego and Joint Partner Trusts – achieve the above while avoiding probate fees

TrustTrust

Her childHer child Her childHer child Her childHer child

Pay children’s expenses out of trust income

Adult daughter

This material is general in nature and subject to change without notice. Every effort has been made to compile the information from reliable sources, however no warranty can be made as to its accuracy or completeness. The information provided within this presentation is for illustrative purposes only. Before acting on any of the information contained herein, please seek professional advice based on your personal circumstances.

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