Corporate Tax Planning With Insurance (Dealing with Double Tax on Private Company Shares at Death) Richard Facia, Director Of Advanced Marketing A partner you can trust. 1
Post Mortem Estate Planning The Inside Scoop 2
Post Mortem Planning When Needed? Whenever tax is payable on the deemed disposition of private company shares at death and, Unlikely that the shares will be sold to a third-party Family business succession planning Investment holding companies Goals Minimize the tax burden arising at death Maximize distribution of deceased s assets to beneficiaries 3
Death & Taxes...in this world, nothing can be said to be certain, except death and taxes.. Potential for double tax if an individual dies owning shares of a private company Serious issue for private company shareholders and their families Adequate planning required whenever tax is payable on the deemed disposition of private company shares 4
Paul Preferred Shares The Scenario Opco Barbara Common Shares Paul owns preferred shares in Opco as a result of an estate freeze done a few years ago Redemption value (and FMV) = $5M Nominal ACB & PUC Paul s daughter Barbara owns the participating common shares FMV = $1.5M with nominal ACB & PUC Personal Tax Rates (Manitoba) 46.40% on income 39.15% on regular dividends 5
Concern about estate tax liability and have asked you for some help in reviewing their options 6
No Plan Deemed disposition at FMV of preferred shares at Paul s death Personal Tax in Paul s terminal return Tax @ 46.40% Taxable Gain @ 50% Capital Gain ACB $1,160,000 $2,500,000 $5,000,000 $0 FMV $5,000,000 7
No Paul $5m Preferred Shares Double Tax Issue Barbara $1.5m Common Shares Paul s estate now owns the preferred shares ACB & redemption value = $5M Nominal PUC Redemption of preferred shares to provide cash in the estate Pay estate tax Estate equalization Income to spouse Triggers taxable dividend 8
What Happens? On death, there are two dispositions 1. Deemed disposition by deceased = capital gains 2. Actual disposition by the estate = deemed dividend company winds up or, distributes its assets or, redeems its own shares 9
No Plan Double Tax $5,000 $4,000 $3,000 $5,000,000 $5,000,000 $2,000 $1,000 $0 $0 $1,957,500 Redemption Proceeds Paid-Up Capital Value Taxable Dividend Tax @ 39.15% 10
No Plan Double Tax $3,117,500 $1,160,000 $1,957,500 Estate Tax on deemed dispostion Dividend Tax on redemption Total Tax 11
How do we eliminate the double tax? Post Mortem Strategies Redemption & Loss Carry-Back Pipeline Strategy Include ACB Bump planning where there are nondepreciable capital assets Land, shares of other corporations, etc. 12
Redemption & Loss Carry-Back Opco redeems shares from estate within the estate s first taxation year Use loss carry-back under sub section 164(6) This section of the Act recognizes the potential for double taxation and provides a limited solution It allows the capital loss in the deceased s estate to be applied against the deceased s personal capital gain 13
Redemption & Loss Carry-Back Terminal Return of the Deceased Deemed Proceeds on death ACB of preferred shares Capital Gain $5,000,000 Nil $5,000,000 Estate of Deceased Total proceeds received $5,000,000 Less, deemed dividend ($5,000,000) Deemed proceeds ACB of Opco shares to Estate Capital Loss on redemption Nil ($5,000,000) ($5,000,000) 164 (6) Offset 14
Redemption & Loss Carry-Back 15
Pipeline Strategy Method of turning the ACB created on deemed disposition at death into a loan from corporation Repay loan tax-free 16
Pipeline Strategy Estate owns preferred shares Newco is incorporated and estate sells shares of Opco to Newco for Promissory Note = $5M Opco redeems shares from Newco for $5M using tax-free inter-corporate dividend Newco can use redemption proceeds to repay note owing to estate without incurring any further taxes Only tax is $1,160,000 capital gains tax on deemed disposition Newco Note Payable =$5M Estate FMV/ACB=$5M PUC=$0 Shares Opco Common Shares 17
Pipeline Strategy 18
Pipeline Strategy: Update Recent rulings, technical interpretations, and CRA comments have brought into question the use of pipeline planning CRA has indicated that subsection 84(2) may apply which would characterize the debt repayment as a deemed dividend paid by the corporation to the estate May negate benefits of this type of planning New Tax Court case [2012 TCC 123 ( MacDonald )] seems to endorse pipeline planning but is under appeal Stay Tuned 19
Use Life Insurance to Make It Better Opco purchases $5M insurance on Paul Death proceeds received by Opco taxfree Opco receives a credit to its CDA of $5M (assume ACB of policy is nil) 20
Two scenarios Solution: Solution: Redeem all of Paul s preferred shares Maximum CDA = lesser of 50% of gain in Paul s terminal return or loss in estate Stop-loss rules do not apply Redeem all of Paul s preferred shares Maximum CDA=100% of insurance proceeds Stop-loss rules apply 21
Stop/Loss Rules Technical amendment to ITA introduced in 1995 and implemented in 1998 Limits amount of losses that can be carried back under sub section 164(6) when a capital dividend paid or deemed to be paid 50% capital gain to deceased or 50% of capital loss to estate, whichever is less 22
Use Life Insurance To Make It Better Opco redeems shares from Paul s estate using $5M insurance proceeds 50% deemed gain or loss in estate ($2.5M), whichever is less, is tax-free CDA Balance of $2.5M is taxable dividend $5M Life Insurance on Paul Beneficiary Is Opco Opco Barbara Common Shares Preferred Shares Paul s Estate 23
Use Life Insurance To Make It Better Barbara Common Shares Paul s Estate Opco Preferred Shares Barbara has a $2.5M unused CDA credit $5M capital gain eliminated by $5M loss in estate [ss164(6)] $2.5M insurance proceeds paid tax-free through CDA and $2.5M as taxable dividends $978,750 She can remove up to $2.5M from Opco tax-free Tax saving of $978,750 Reduces value of Opco for capital gains tax purpose 24
Use Life Insurance To Make It Better Barbara Common Shares Opco $5M Life Insurance on Paul Beneficiary is Opco Opco redeems shares from Paul s estate using $5M insurance & CDA Stop/Loss Rules apply Stop-loss rules restrict loss in estate to $2.5M Paul s Preferred Shares Results in capital gain of $2.5M Paul s Estate 25
Use Life Insurance To Make It Better Barbara Common Shares Opco $5M Life Insurance on Paul Beneficiary is Opco Paul s Estate CDA Credit fully utilized for share redemption $5M Insurance proceeds paid tax-free through CDA Barbara has no unused CDA credit $2.5M Capital gain eliminated by $2.5M loss in estate [ss164 (6)] $2.5M Capital gain in deceased s terminal return $580,000 26
How to Beat the Stop/loss Rules Problem The Stop/Loss Rules prevent the full utilization of the loss carry-back under ss 164 (6) when shares are redeemed Solution Structure a spousal rollover and redeem the shares Shares Roll taxfree to spouse 27
Spousal Roll and Redeem Strategy Assume Paul has a surviving spouse, meet Jean... Upon Paul s death, preferred shares can be rolled over to Jean, tax-free No capital gain in Paul s terminal return Opco redeems shares from Jean 28
Use Life Insurance To Make It Better Spousal Roll& Redeem At death, Paul transfers his shares to Jean under the terms of his will PS Jean acquires his shares at his deemed ACB ($Nil) ACB & PUC to Jean = ($Nil) Shares Roll taxfree Barbara Common Shares Opco $5M Life Insurance on Paul Beneficiary is Opco 29
Use Life Insurance To Make It Better Barbara Common Shares Opco $5M Life Insurance on Paul Jean Beneficiary Receives is Opco $5M $500,00 Life Insurance on Paul Spousal Roll & Redeem Opco redeems shares from Jean using $5M insurance & CDA Preferred Shares Tax-Free 30
Use Life Insurance To Make It Better Barbara Common Shares Opco $5M Life Insurance on Paul Beneficiary is Opco $5M proceeds of disposition reduced by $5M deemed dividend $5M insurance proceeds paid taxfree through CDA CDA Credit fully utilized for share redemption Barbara has no unused unused CDA credit $0 31
Roll & Redeem Strategy Results No Tax Payable on Paul s death Stop/Loss rules do not apply Redemption is from an individual not the estate No gain at death & no loss carryback to deny 32
Summary No Planning (Double Tax) Value of preferred shares $5,000,000 Less: tax on capital gain $1,160,000 Less: dividend tax $1,957,500 Total Tax Payable $3,117,500 Net Funds to Estate $1,882,500 Tax as a % of corporate value 62.35% Remaining CDA Balance for Barbara $0 33
Summary No Planning (Double Tax) 164(6) Loss Carry- Back Value of preferred shares $5,000,000 $5,000,000 Less: tax on capital gain $1,160,000 $0 Less: dividend tax $1,957,500 $1,957,500 Total Tax Payable $3,117,500 $1,957,500 Net Funds to Estate $1,882,500 $3,042,500 Tax as a % of corporate value 62.35% 39.15% Remaining CDA Balance for Barbara $0 $0 34
Summary No Planning (Double Tax) 164(6) Loss Carry- Back Pipeline Strategy Value of preferred shares $5,000,000 $5,000,000 $5,000,000 Less: tax on capital gain $1,160,000 $0 $1,160,000 Less: dividend tax $1,957,500 $1,957,500 $0 Total Tax Payable $3,117,500 $1,957,500 $1,160,000 Net Funds to Estate $1,882,500 $3,042,500 $3,840,000 Tax as a % of corporate value 62.35% 39.15% 23.2% Remaining CDA Balance for Barbara $0 $0 $0 35
Summary No Planning (Double Tax) 164(6) Loss Carry- Back Pipeline Strategy 50% Solution With Insurance 100% Solution Roll & Redeem Value of preferred shares $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 Less: tax on capital gain $1,160,000 $0 $1,160,000 $0 $580,000 $0 Less: dividend tax $1,957,500 $1,957,500 $0 $978,750 $0 $0 Total Tax Payable $3,117,500 $1,957,500 $1,160,000 $978,750 $580,000 $0 Net Funds to Estate $1,882,500 $3,042,500 $3,840,000 $4,021,250 $4,420,000 $5,000,000 Tax as a % of corporate value 62.35% 39.15% 23.2% 19.58% 11.6% 0.0% Remaining CDA Balance for Barbara $0 $0 $0 $2,500,000 $0 $0 36
Benefits Of Life Insurance Creates tax-free cash to fund Estate tax liabilities Estate equalization Income to surviving spouse Manufacture tax-free Capital Dividends Reduce tax payable Increase estate value 37
Conclusion Creative use of life insurance together with good planning can reduce taxes and increase estate values 38
39
Contact Information Richard Facia, Director Of Advanced Marketing Industrial Alliance Insurance & Financial Services 1-800-268-4886, ext. 222 richard.facia@inalco.com 40