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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
Contact Information