SUCCESSION PLANNING AND THE FAMILY FARM

Transcription

1 SUCCESSION PLANNING AND THE FAMILY FARM SPONSORED BY: SCOTIA PRIVATE CLIENT GROUP SCOTIABANK, WINKLER Presented by: Larry H. Frostiak, FCA, CFP, TEP Thursday, April 7, 2011

2 Succession Planning and The Family Farm Contents 1. Tax and Estate Planning Objectives 2. Uncertainties 3. What are the issues? 4. Tools of the Advisor 5. Trusts 6. Succession Planning

3 Succession Planning and The Family Farm Example 1 Direct Gift Example 2 Conventional estate freeze Example 3 Downstream freeze Example 4 Using a trust / OPCO Example 5 Using a trust / HOLDCO 7. Equalizing Estate Value Example 1 Will Gifts Example 2 The All-In Solution Example 3 Using Life Insurance

4 Tax and Estate Planning Objectives Transfer of Family Farm Business Wealth preservation Minimize tax Flexibility / control

5 The Two Certainties Death Taxes

6 Farm Succession Planning - Uncertainties Succession to next generation / sale to third party Determination of successor / successors Timing of succession

7 What are the issues? Maintaining control Extracting cash flow from the farm Tax efficiency Treating children fairly (active vs. nonactive) Creditor proofing concerns

8 Tools of the Advisor Will Trusts Life Insurance

9 Trusts What is a Trust? Why is a Trust Useful?

10 Trust A Trust is a relationship Settlor Trustees Beneficiaries Separation of Legal vs. Beneficial Ownership

11 Trusts The 3 Certainties Intention Subject Matter Objects (persons; purpose)

12 Trust Planning A Trust is Useful as a: Conduit / Retains Nature of Income Income Splitting Capital Gains Splitting Tax Deferral Preservation of Assets Control

13 Income Splitting A personal Trust created by a living person is an Inter-Vivos Trust Income earned by an Intervivos Trust and not paid to a beneficiary is taxed in the Trust at the highest Personal Tax Rates Important the Trust pays out net Trust income received zero income retained in Trust

14 Income Splitting (continued) In a properly structured Discretionary Family Trust, the Trustees can pay any amount of any type of income to any income beneficiary Major Consideration Minor beneficiaries subject to Split-Income tax or Kiddie tax on dividends from a private corporation or business income provided by partnership or Trust to a related person or corporation

15 Income Splitting (continued 2) Income subject to Split-Income tax taxed at highest personal tax rate (38.5% in 2010 for dividends in Manitoba)

16 Income Splitting (continued 3) Example Farm Corporation has pretax income of $25,000 after payment of owner remuneration Corporation will pay corporate taxes of approximately $2,750 or approximately 11% Assuming all after tax income paid as dividend to Trust ($22,250), adult beneficiary with no other income will pay approximately $1,430 in personal income taxes

17 Income Splitting (continued 4) Taxes Paid Corporate $2,750 Personal 1,430 Total $4,180 Effective tax rate (on pretax income) 16.72%

18 Income Splitting (continued 5) Trust must pay the amount to the beneficiary or issue demand promissory note to the beneficiary Beneficiary has legal right to enforce payment of note May decide to limit amounts paid or payable to amounts required by beneficiaries to fund short term cash flow requirements such as education costs

19 Capital Gains Splitting A discretionary Trust can allocate capital gains to a beneficiary Multiply access to $750,000 capital gains exemption for capital gains on the sale of a qualified farm property

20 Capital Gains Splitting (cont d) Qualified farm property includes shares of the capital stock of a Family Farm Corporation Throughout any 24 month period prior to sale, more than 50% of the fair market value of the property owned by the corporation attributed to property used principally in the course of carrying on a farming business in Canada in which the individual was actively engaged on a regular and ongoing basis.

21 Capital Gains Splitting (cont d 2) At the time of sale, all or substantially all of the fair market value of the Property was attributed to property used principally in carrying on the business of farming in Canada. Opportunity to multiply access to $750,000 exemption

22 Succession Planning How accomplished? Example 1 Direct gift to a child/grandchild of: Qualified farm property or Shares of a qualified farm corporation BEFORE AFTER Parents 100% Children 100% FARMCO FARMCO

23 Example 2 conventional estate freeze BEFORE AFTER Parents Parents Children 100% Preferred shares Common shares FARMCO FARMCO

24 Succession Planning Example 3 Downstream Freeze Parents Parents 100% Retains Land, Equipment FARMCO Children FARMCO Owns land equipment and operating assets NEWCO Pfd shares & debt 85(1) rollover of operating assets Common shares

25 Example 4 Using a Trust / OPCO Parents FARMCO 100% Pfd shares Parents 100% common FARMCO Sec 86(1) freeze in favour of a trust Family Trust Children / grandchildren

26 Example 5 Using a Trust / HOLDCO Parents Children / Grandchildren Parents FARMCO 100% Retains Land, Equipment Pfd shares & debt FARMCO NEWCO 85(1) rollover of operating assets Family Trust Common shares

27 Equalizing Estate Value Methods Will gifts to active and non-active children The all-in solution (Let the children figure it out!) Using life insurance

28 Example 1 Will Gift on Last to Die 2 children (son active in farm/daughter not) Solution? Assets of Parents ($ 000 s) Shares in FARMCO $1,000 Condo in Florida 300 RRSP 300 Non-registered investments 400 Farm shares to son? All other assets to daughter? TAX IMPLICATIONS NOT EQUAL! $2,000

29 Example 2 The All-In Solution (Estate freeze undertaken) Parents Son $1,000,000 in pref shares FARMCO New common shares (nominal value) Will leaves all assets 50/50 to son and daughter including the $1.0 million in freeze shares

30 Example 3 Using Life Insurance 2 children (son active in farm / daughter not) Assets of Parents ($000 s) Shares in FARMCO $1,000 No other significant assets Solution Farm shares to son? Life insurance to equalize estate with daughter

31 Example 3 Using Life Insurance (cont d) Will Gift of Shares Parents Son Daughter $1,000,000 in pref shares New common shares CDA/pref shares redeemed FARMCO CDA in corp Life insurance proceeds $1.0 million of corporately owned last-to-die life insurance on parents

32 Use of Life Insurance and CDA Why? Basis of financing buy-out on death Meet capital gains tax liability Tax-free access to capital dividend account Equalize estate values

33 BUSINESS PARTNERS Structuring Life Insurance Example 1 X OPCO Assumptions: X, Y both insured OPCO owns policy and pays premiums OPCO is the beneficiary Y 50% 50%

34 Example 1 (cont d) Problems / Issues What if there is no Shareholder Agreement? What happens to life insurance proceeds received by OPCO? What if surviving shareholder difficult to deal with even if agreement? Proceeds could be tied-up in OPCO for some time

35 Example 2 X Y XCo 50% 50% YCo Assumptions:! X, Y both insured 50% OPCO 50%! OPCO is the owner of the policy! Xco and Yco respectively are designated as the beneficiaries

36 Example 2 (cont d) Issues Structure would necessitate an agreement in place (otherwise HOLDCO would receive life insurance and continue to own shares) Advantage: structure ensures that Life Insurance is paid to deceased shareholder s HOLDCO. Tax-free proceeds Disadvantage: Use of LCGE or sale to surviving shareholder more complex to structure. No step up in ACB

37 Example 3 Criss-Cross Structure X Y XCo YCo Assumptions:! X, Y insured! OPCO is the owner of the policy! Shareholder Agreement in place! Xco beneficiary on Y s death 50% 50% OPCO! Yco beneficiary on X s death

38 Example 3 (cont d) Issues HOLDCO of surviving shareholder receives tax-free life insurance proceeds Proceeds used to acquire shares of HOLDCO, or possibly OPCO from deceased shareholder Tax consequences to Estate (disposition at FMV) CDA stays with surviving shareholder s HOLDCO Two acquisition scenarios (see below)

39 Example 3 (cont d) X Y XCo YCo Assumptions:! Y dies 50% 50% OPCO! Xco receives life insurance proceeds! Shareholder Agreement in place

40 Example 3 (cont d) Scenario 1 (Xco buys OPCO shares) X Cash Estate Tax Implications 100% XCo CDA Sells OPCO! Yco reports gain on sale of OPCO shares! No LCGE to Yco! Taxable distribution to estate! Xco gets step-up in ACB! CDA stays with XCo YCo

41 Example 3 (cont d) Scenario 2 (Xco buys YCo shares) X Cash Estate Tax Implications XCo! Estate reports gain on sale of Yco shares! Possible use of LCGE! Double tax eliminated to Estate! Xco gets step-up in ACB 100% OPCO YCo CDA 50% 50%

42 Questions? Thank-you! Larry H. Frostiak, FCA, CFP, TEP