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A partner you can trust.

Corporate Tax Planning With Insurance

(Dealing with Double Tax on Private Company Shares at Death)

Richard Facia, Director Of Advanced Marketing

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The Inside Scoop

Post Mortem Estate Planning

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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

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• 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

Death & Taxes “....in this world, nothing can be said to be certain, except death and taxes..”

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The Scenario

Opco

Barbara Common Shares

Paul Preferred 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

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Concern about estate tax liability and have asked you for some help in reviewing their options

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No Plan

Deemed disposition at FMV of preferred shares at Paul’s death

Personal Tax in Paul’s terminal return

$5,000,000

$0 $5,000,000

$2,500,000

FMV

Taxable Gain @ 50%

Capital Gain

ACB

Tax @ 46.40% $1,160,000

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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

No Double Tax Issue Paul $5m Preferred Shares

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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

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No Plan Double Tax

$0

$1,000

$2,000

$3,000

$4,000

$5,000$5,000,000

$0

$5,000,000

$1,957,500

Redemption Proceeds Paid-Up

Capital Value Taxable Dividend Tax @

39.15%

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No Plan Double Tax

Estate Tax on deemed dispostion Dividend Tax on

redemption Total Tax

$1,160,000 $1,957,500

$3,117,500

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How do we eliminate the double tax?

Post Mortem Strategies Redemption & Loss Carry-Back

Pipeline Strategy Include ACB “Bump” planning where there are non-

depreciable capital assets Land, shares of other corporations, etc.

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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

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Redemption & Loss Carry-Back

Terminal Return of the Deceased

Deemed Proceeds on death

$5,000,000

ACB of preferred shares Nil

Capital Gain

Estate of Deceased Total proceeds received $5,000,000

Less, deemed dividend ($5,000,000)

Deemed proceeds Nil

ACB of Opco shares to Estate

($5,000,000)

Capital Loss on redemption

164 (6) Offset

$5,000,000

($5,000,000)

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Redemption & Loss Carry-Back

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Pipeline Strategy

Method of turning the ACB created on deemed disposition at death into a loan from corporation

Repay loan tax-free

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Estate

Opco

Common Shares

Newco

Note Payable =$5M

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

Pipeline Strategy

Shar

es

FMV/ACB=$5M PUC=$0

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Pipeline Strategy

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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

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Use Life Insurance to Make It Better

Opco receives a credit to its CDA of $5M (assume ACB of policy is nil)

Opco purchases $5M insurance on Paul

Death proceeds received by Opco tax-free

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Two scenarios

Solution: Redeem all of

Paul’s preferred shares

Maximum CDA=100% of insurance

proceeds

Stop-loss rules apply

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

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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

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Preferred Shares

$5M Life Insurance on Paul

Beneficiary Is Opco

Barbara Common Shares

Paul’s Estate

Opco

•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

Use Life Insurance To Make It Better

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Tax saving of $978,750

Reduces value of Opco for capital gains tax purpose

$5M capital gain eliminated by $5M loss in estate [ss164(6)]

$978,750

Paul’s Estate

Opco

$2.5M insurance proceeds paid tax-free through CDA and

$2.5M as taxable dividends

She can remove up to $2.5M from Opco tax-free

Barbara Common Shares

Use Life Insurance To Make It Better

Preferred Shares

Barbara has a $2.5M unused CDA credit

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Opco Barbara Common Shares

$5M Life Insurance on Paul

Beneficiary is Opco

Paul’s Estate Paul’s

Preferred Shares

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

Results in capital gain of $2.5M

Use Life Insurance To Make It Better

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Opco Barbara Common Shares

$5M Life Insurance on Paul

Beneficiary is Opco

Use Life Insurance To Make It Better

$5M Insurance proceeds paid tax-free through CDA

$2.5M Capital gain eliminated by $2.5M loss in estate [ss164 (6)]

$2.5M Capital gain in deceased’s terminal return

$580,000

Paul’s Estate CDA Credit fully utilized for share redemption

Barbara has no unused CDA credit

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Shares Roll tax-

free to spouse

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

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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

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Shares Roll tax-

free

Opco

Barbara Common Shares

$5M Life Insurance on Paul

Beneficiary is Opco

•At death, Paul transfers his shares to Jean under the terms of his will

•Jean acquires his shares at his deemed ACB ($Nil)

•ACB & PUC to Jean = ($Nil)

Spousal Roll& Redeem

PS

Use Life Insurance To Make It Better

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Jean Receives

$5M

$5M Life Insurance on Paul

Beneficiary is Opco

Barbara Common Shares

$500,00 Life Insurance on Paul

Preferred Shares

Tax-Free

Opco

Opco redeems shares from Jean using $5M insurance & CDA

Use Life Insurance To Make It Better

Spousal Roll & Redeem

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$5M Life Insurance on Paul

Beneficiary is Opco

Barbara Common Shares Opco

$5M insurance proceeds paid tax-free through CDA

$0

$5M proceeds of disposition reduced by $5M deemed dividend

Use Life Insurance To Make It Better

CDA Credit fully utilized for share redemption

Barbara has no unused unused CDA credit

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Roll & Redeem Strategy

• Stop/Loss rules do not

apply • Redemption

is from an individual not

the estate

• No gain at death & no loss carry-

back to deny

• No Tax Payable on Paul’s death

Results

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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

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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

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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

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Summary

No Planning (Double

Tax)

164(6) Loss

Carry-Back

Pipeline Strategy

With Insurance

50% Solution

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

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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

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Conclusion

Creative use of life insurance together with good planning can reduce taxes and

increase estate values

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Richard Facia, Director Of Advanced Marketing Industrial Alliance Insurance & Financial Services

1-800-268-4886, ext. 222

richard.facia@inalco.com

Contact Information