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SUCCESSION PLANNING AND

THE FAMILY FARM

Presented by: Larry H. Frostiak, FCA, CFP, TEP Thursday, April 7, 2011

SPONSORED BY: SCOTIA PRIVATE CLIENT GROUP

SCOTIABANK, WINKLER

Frostiak & Leslie Chartered Accountants Inc.

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


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


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


The Two Certainties

 Death

 Taxes


Farm Succession Planning - Uncertainties

 Succession to next generation / sale to third party  Determination of successor / successors  Timing of succession


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


Tools of the Advisor  Will

 Trusts

 Life Insurance


Trusts  What is a Trust?

 Why is a Trust Useful?


Trust  A Trust is a relationship

 Settlor Trustees Beneficiaries

 Separation of Legal vs. Beneficial Ownership


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


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


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


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


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


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


Income Splitting – (continued 4)  Taxes Paid

Corporate $2,750

Personal 1,430

Total $4,180

Effective tax rate (on pre-tax income) 16.72%


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


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


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.


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


Succession Planning How accomplished? Example 1   Direct gift to a child/grandchild of:

Qualified farm property or

Shares of a qualified farm corporation

Parents

FARMCO

100%

BEFORE

Children

FARMCO

100%

AFTER


Parents

FARMCO

BEFORE AFTER

100%

Children

FARMCO

Common shares

Parents

Preferred shares

Example 2 – “conventional” estate freeze


Succession Planning Example 3 – “Downstream Freeze”

Parents

FARMCO

100%

Owns land equipment and operating assets

85(1) rollover of operating assets

Children FARMCO

Common shares

Parents

NEWCO

Pfd shares & debt

Retains Land, Equipment


Example 4 – Using a Trust / OPCO

Parents

FARMCO

100% FARMCO

100% common

Parents

Pfd shares

Sec 86(1) freeze in favour of a trust

Family Trust

Children / grandchildren


Example 5 – Using a Trust / HOLDCO

Parents

FARMCO

100% Common shares

85(1) rollover of operating assets

Family Trust

Children / Grandchildren

FARMCO

Parents

NEWCO

Pfd shares & debt

Retains Land, Equipment


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


Example 1 – Will Gift on Last to Die

Assets of Parents ($ 000’s)

Shares in FARMCO $1,000 Condo in Florida 300 RRSP 300 Non-registered investments 400

$2,000

 2 children (son active in farm/daughter not)

Solution?

Farm shares to son? All other assets to daughter? TAX IMPLICATIONS NOT EQUAL!


Example 2 – The “All-In” Solution (Estate freeze undertaken)

Parents

FARMCO

$1,000,000 in pref shares

Son

New common shares (nominal value)

Will leaves all assets 50/50 to son and daughter including the $1.0 million in freeze shares


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


Example 3 – Using Life Insurance (cont’d)

Parents Son Daughter

FARMCO

$1,000,000 in pref shares

New common shares

CDA/pref shares redeemed

Will Gift of Shares

$1.0 million of corporately owned last-to-die life insurance on parents

CDA in corp

Life insurance proceeds


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


BUSINESS “PARTNERS” Structuring Life Insurance

Assumptions:  X, Y both insured  OPCO owns policy and pays premiums  OPCO is the beneficiary

OPCO

X Y

50% 50%

Example 1


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


Example 2

Assumptions: !  X, Y both insured !  OPCO is the owner of the policy !  Xco and Yco respectively are designated as the

beneficiaries

OPCO

XCo YCo

X Y

50% 50%

50% 50%


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


Example 3

Assumptions: !  X, Y insured !  OPCO is the owner of the policy !  Shareholder Agreement in place !  Xco beneficiary on Y’s death !  Yco beneficiary on X’s death

OPCO

X Y

XCo YCo

Criss-Cross Structure

50% 50%


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)


Example 3 (cont’d)

Assumptions: !  Y dies !  Xco receives life insurance proceeds !  Shareholder Agreement in place

OPCO

X Y

XCo YCo

50% 50%



Tax Implications !  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

OPCO

X

Estate

XCo YCo

Scenario 1 (Xco buys OPCO shares)

Cash

100% CDA

Sells



Tax Implications !  Estate reports gain on sale of Yco shares !  Possible use of LCGE !  Double tax eliminated to Estate !  Xco gets “step-up” in ACB

OPCO

X

Estate

XCo YCo

Scenario 2 (Xco buys YCo shares)

100%

Cash

CDA 50% 50%


Questions? Thank-you!

 Larry H. Frostiak, FCA, CFP, TEP   204-487-5200   [email protected]

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