Recent Developments in Corporate Taxation Post-Mortem Tax Planning A Case Study

Transcription

1 Recent Developments in Corporate Taxation Post-Mortem Tax Planning A Case Study 2017 Pamela Cross, Borden Ladner Gervais, LLP David Mason, Deloitte June 7, 2017, OTTAWA

2 Agenda - Post Mortem Planning 1. Why is it important? 2. What are the tools in the tool-box and how do they work? 3. The Case Study 2

3 Post-Mortem Planning Why is it important? To ensure that assets cannot be passed from one generation to the next, there is a deemed disposition of assets on death (subject to certain exceptions and/or deferrals such as the spousal rollover) For the vast majority of individuals, the deemed disposition is a one time event, and little or no post-mortem planning is necessary. The most common exception is where assets decline in value after death For individuals holding private company shares, there is a potential for double (or worse) taxation on the same value (tax on the deemed disposition, tax in the company on a liquidation of its assets, and tax on a deemed dividend extracting value from the corporation) 3

4 Post-Mortem Planning: Tools in the Tool Box Surprisingly, given the significance of the issue, there is no specific post-mortem regime in the Income Tax Act (the Tax Act ) to deal with private company shares Three main strategies are used (all statutory references are to the Tax Act): S. 164(6) Loss Carryback Pipeline Transaction Para. 88(1)(d) Bump Planning (for certain capital property owned by the company other than ineligible assets ) 4

5 S. 164(6) Loss Carryback - Mechanics Deemed disposition of shares on death, increasing adjusted cost base of shares to Estate Shares held by Estate of Deceased are redeemed before first year-end of the Estate, triggering deemed dividend to Estate (ss. 84(3)) Deemed dividend excluded from proceeds of disposition of shares (para. 54(j)), resulting in capital loss to Estate (subject to stop-loss rules) Carryback of capital loss to terminal return to eliminate capital gain reported on deemed deposition Result: Double tax avoided, but tax paid on dividend (at dividend rates), not capital gain (at capital gains rates) 5

6 S. 164(6) Loss Carryback Selected Considerations Corporate tax attributes (capital dividend account (CDA), refundable dividend tax on hand (RDTOH), ability to pay eligible dividends can reduce the effective tax cost of the rate differential (dividends/capital gains) Creating additional tax attributes? Corporate owned life insurance: confirm adjusted cost basis of policy and amount available to be added to CDA. Consider limiting capital dividend to 50% of full dividend to avoid grind of capital loss under ss. 112(3.2). Will Estate be affiliated with Corporation after redemption (ss. 40(3.6) & (3.61)). Spousal roll and redeem strategy available? Redemption of shares or wind up of company (IT-126R2) One taxation year deadline. Estate must be a graduated rate estate 6

7 Pipeline Transaction - Mechanics Deemed disposition of shares on death, increasing adjusted cost base of shares to Estate Estate transfers shares to new holding corporation ( Newco ), taking back debt or high paid-up capital Newco shares up to the FMV of the shares on death. Wind-up company (or amalgamate Newco and company). Resulting company can repay debt or reduce paid-up capital Result: Double tax avoided, tax paid at capital gains rates. 7

8 Pipeline Transaction Selected Considerations Anti surplus stripping rule #1 (s. 84.1), applies where: Taxpayer (Estate) disposes of shares Taxpayer is resident in Canada and not a corporation Shares were capital property to taxpayer Shares are shares of a resident Canadian corporation (subject corporation) Shares are disposed of to another corporation (purchaser corporation) Taxpayer is non arm s length with purchaser corporation Immediately after disposition, subject corporation is connected with purchaser corporation (ss. 186(4)) Implications: Paid up capital of purchaser shares reduced to extent of soft ACB (i.e. look for capital gains exemption and V-Day value issues). Hard ACB can be converted to debt or paid-up capital. Taxpayer deemed to receive a deemed dividend for excess 8

9 Pipeline Transaction Selected Considerations Anti surplus stripping rule #2 (s. 84(2)) applies where: The corporation is resident in Canada The corporation is winding-up, discontinuing or reorganization its business A distribution or appropriation of the corporation s funds or property (in any manner whatever) The distribution or appropriation is to or for the benefit of the corporation s shareholders Implications: Amount of distribution/appropriation deemed to be a dividend 9

10 Pipeline Transaction Surplus Stripping Issues Does (should?) the specific rule in s supersede s. 84(2)? CRA position: both can apply to same transaction ( C STEP National Conference) Is Estate a creditor or a shareholder? What does on the winding up, discontinuance or reorganization mean? Fact specific. See E5 which suggested continuance of business for at least 1 year and distribution over a further period of time C6 where CRA indicates these conditions are not required but may be evidence that there is no discontinuance of business R3 (ruling withdrawn) Cash company CRA may apply 84(2) Surplus Stripping Jurisprudence: Most involve accommodation party transactions, not post-mortem planning No general scheme in the Act against surplus stripping Should there be specific post mortem rules? 10

11 The 88(1)(d) Bump Permits increase in adjusted cost base of certain property of corporation where there has been an arm s length acquisition of control Para. 88(1)(d.3) deems control to have been acquired by an estate from an arm s length person in a post mortem context May have limited application: Rules technical and complex Only certain capital property can be bumped Same mechanics as a Pipeline, so often used in combination. 11

12 The Case Study Harry owns preferred shares in an operating company (OpCo) ACB and PUC are nil FMV = $2M Harry is a widow and has three adult children: Ron, Lily and Phoebe. They currently own all issued common shares of OpCo in equal parts. He passed away on December 31, 2016 The children do not wish to carry on their father s business The corporation had the following tax attributes: GRIP of $500K CDA of $400K RDTOH of $25K *Assumption: Harry and his children are taxed at the highest marginal income tax rate Harry OpCo 1,000 Preferred Shares ACB = nil PUC = nil FMV = $2M 12

13 Scenario #1: No Tax Planning (if Opco has cash only) Harry s Terminal Tax Return Deemed disposition on death $2,000,000 Less adjusted cost base - Capital gain 2,000,000 Taxable capital gain 1,000,000 Personal tax rate 53.53% Harry s income tax payable $535,300 Harry s Estate OpCo 1,000 Preferred Shares ACB = $2M PUC = nil FMV = $2M 13

14 Scenario #1: No Tax Planning (cont.) On the wind-up of OpCo, the Estate will receive deemed dividend on which personal tax liabilities are created. Deemed dividend on distribution of assets Eligible dividend $500,000 Capital dividend 400,000 Non-eligible dividend 1,100,000 Total deemed dividend 2,000,000 Personal tax on eligible dividends (39.34%) 196,700 Personal tax on non-eligible dividends (45.30%) 498,300 Total personal tax payable 695,000 Less: corporate dividend refund (25,000) Net income tax liability $670,000 14

15 Scenario #1: No Tax Planning (cont.) Harry $535,300 Children $670,000 Total $1,205,300 Note: A capital loss of $2M would be created on the wind-up. Stop loss rules may apply to postpone the availability of the capital loss. 15

16 Scenario #2: Pipeline Transaction Harry s Terminal Tax Return Deemed disposition on death $2,000,000 Less adjusted cost base - Capital gain 2,000,000 Taxable capital gain 1,000,000 Personal tax rate 53.53% Total income tax payable $535,300 Note: OpCo s RDTOH and CDA balances may not be fully utilized in the pipeline transaction Promissory note of $2M Harry s Estate HoldCo OpCo 100 Common Shares 1,000 Preferred Shares ACB = $2M PUC = nil FMV = $2M 16

17 Scenario #3: S. 164(6) Loss Carryback Estate Tax Return Deemed dividend on redemption of shares Eligible dividend $500,000 Capital dividend 400,000 Non-eligible dividend 1,100,000 Proceeds of disposition $2,000,000 Less deemed dividend (2,000,000) Less adjusted cost base (2,000,000) Capital loss $2,000,000 Total deemed dividend 2,000,000 Personal tax on eligible dividends (39.34%) 196,700 Personal tax on non-eligible dividends (45.30%) 498,300 Total personal tax payable 695,000 Less: corporate dividend refund (25,000) Total Tax $670,000 Net income tax liability $670,000 17

18 Scenario #3: S. 164(6) Loss Carryback (cont.) Harry s Terminal Tax Return Deemed disposition on death $2,000,000 Less adjusted cost base - Capital gain 2,000,000 Less loss carryback (2,000,000) Taxable capital gain - Personal tax rate 53.53% Harry s income tax payable - Harry s Estate OpCo 18

19 Scenario #4: Hybrid Approach The hybrid approach consists of redeeming sufficient shares to use the CDA and RDTOH balances, and performing a pipeline with the remaining shares held by the Estate Estate Tax Return Deemed dividend on redemption of shares Eligible dividend (2.61 x RDTOH balance) $65,250 Capital dividend 400,000 Total deemed dividend 465,250 Personal tax on eligible dividends (39.34%) 25,670 Total personal tax payable 25,670 Less: corporate dividend refund (25,000) Net income tax liability $670 Proceeds of disposition $465,250 Less deemed dividend (465,250) Less adjusted cost base (465,250) Capital loss $465,250 Total Tax $456,243 19

20 Scenario #4: Hybrid Approach (cont.) Harry s Terminal Tax Return Deemed disposition on death $2,000,000 Less adjusted cost base - Capital gain 2,000,000 Less loss carryback* (297,875) Adjusted capital gain 1,702,125 Taxable capital gain 851,063 Personal tax rate 53.53% Harry s income tax payable $455,574 *Stop-loss rule applies to grind down capital losses available for loss carryback Promissory note of $1.5M Harry s Estate HoldCo OpCo 100 Common Shares 1,000 Preferred Shares ACB = $1.5M PUC = nil FMV = $1.5M 20

21 Summary of Scenarios Tax owing on Terminal T1 Tax owing by the corporation Tax owing by the Estate No Tax Planning Pipeline Transaction Loss Carryback Hybrid Approach $535,300 $535,300 - $410, , , Total Tax $1,205,300 $535,300 $670,000 $411,445 Available CDA - 400, Available GRIP - 500, ,750 Available RDTOH - 25,

22 Scenario #5: Asset Liquidation The asset liquidation approach consists on selling all of OpCo s assets to a newly incorporated corporation ( NewCo ) This transaction resembles a 88(1)(d) bump with less restriction on the type of assets on which it can be performed If the assets are sold within a year, the capital loss realized on the redemption of shares may be carried back to Harry s terminal return but may be subject to the stop-loss rules Harry s Estate OpCo 1,000 Preferred Shares ACB = $2M PUC = nil FMV = $2M 100 Common Shares NewCo 22

23 Scenario #5: Asset Liquidation (cont.) Old ECP Rules New ECP Rules With tax attributes Without tax attributes With tax attributes Without tax attributes Accrued gains on assets $2,000,000 $2,000,000 $2,000,000 $2,000,000 Taxable capital gain 1,000,000 1,000,000 Total business income 1,000,000 1,000,000 Corporate income tax payable $265,000 $265,000 $501,700 $501,700 Available cash for distribution 1,735,000 1,735,000 1,498,300 1,498,300 CDA balance 1,400,000 1,000,000 1,400,000 1,000,000 RDTOH balance 25, , ,700 GRIP balance 1,220, , ,000-23

24 Scenario #5: Asset Liquidation (cont.) Old ECP Rules New ECP Rules With tax attributes Without tax attributes With tax attributes Without tax attributes Deemed dividend on distribution of assets Eligible dividend $335,000 $720,000 $98,300 - Capital dividend 1,400,000 1,000,000 1,400,000 1,000,000 Non-eligible dividend - 15, ,300 Total deemed dividend $1,735,000 $1,735,000 $1,498,300 $1,498,300 Personal tax on eligible dividends 131, ,250 38,670 Personal tax on non-eligible dividends - 6, ,730 Less corporate dividend refund (25,000) - (37,680) (191,015) Net income tax liability $106,790 $290,045 $990 $34,715 Un-utilized RDTOH , ,685 24

25 Scenario #5: Asset Liquidation (cont.) Old ECP Rules New ECP Rules Tax owing on Terminal T1 Tax owing by the corporation Tax owing by the Estate With tax attributes Without tax attributes With tax attributes Without tax attributes $535,300 $535,300 $535,300 $535, , , , , , , ,715 Total Tax $907,090 $1,090,345 $1,037,990 $1,071,715 Available CDA Available GRIP 885, ,700 - Available RDTOH , ,685 25

26 Other Elements to Consider A hybrid approach, combining the pipeline transaction and loss carryback strategy, typically yields the lowest overall tax to the estate The CRA has accepted the use of the pipeline transactions for investment type corporations so long as the property distributed to the estate s beneficiaries is equal to the cost basis of the shares as a result of the deemed disposition on death (i.e. the fair market value on time of death) Time is of the essence when performing post-mortem tax planning 26