This is a good article about the basics of the general anti-avoidance rule.
I found an interesting discussion on Linkedin this morning. Monica J. Weissmann made this insightful comment about the article Accepting the Need for Change:
This is like “preventive maintenance” – take action BEFORE it is really needed , which is very correct and very hard to do … one can discuss and prove it, but when it’s time to act …this becomes a totally different story …especially when it will involve significant amounts of time and money …
I really like Monica’s “preventive maintenance” analogy. It reminds me of the old joke:
How many psychologists does it take to change a light-bulb? … only one … but the light-bulb has to want to change.
Businesses that continue to operate in spite of being insolvent or deeply dysfunctional are called “zombies”. As an outside consultant with 4, 6, or 10 hours to get to know the client’s story it is impossible to effect change in deeply troubled enterprises. The only way I have heard to breath life and growth back into a zombie is by a private equity firm who takes over, cleans house and rebuilds the business from the inside out.
A consultant’s role is much more limited. As the article in the link says:
Fortunately, for a great many businesses, a modest commitment to learning and change can reap substantial benefits in terms of performance and wealth creation.
This comment and the “preventive maintenance” comment are the keys to successful succession consulting. As an example the M&A world deals in “sale ready” or “near sale ready” businesses meaning that all of the lessons that succession consultants teach such as: “effective delegation” and “preparation for due diligence” have already been learned.
The key to success as a succession consultant is to look for well adjusted “learn ready” businesses.
Dysfunctional families need to be referred to mediators, social workers or psychologists who deal in those issues. If your business is well adjusted and learn ready, if you generate trust and work well with others, then you should be talking to a good succession consultant.
A trust is a highly effective creditor proofing strategy. A trust is creditor proofed from legal claims made against individuals. A trust is separate from the individual therefore claims made against the individual cannot be made against the trust.
Where a trust has family member beneficiaries it is called a family trust. A family trust can own a personal residence which can protect it against family law claims. A family trust can hold any type of asset including private company shares.
Purchasing growth shares
An effective strategy is to have a trust purchase small business growth shares after an estate freeze. Where growth shares are purchased by a trust there are six tax planning benefits:
- non-voting growth shares with nominal current FMV can be purchased by the trust after a freeze;
- small business shares are capital property so that if no dividends are paid then there is no annual taxation in the trust;
- dividends can be allocated to adult beneficiaries and retain the character of dividends on the return of the beneficiary;
- capital gains can be allocated to beneficiaries and retain the character of capital gains on the return of the beneficiary allowing the beneficiary to claim the capital gains exemption;
- if the trust owns ‘connected shares’ (>10% votes and value) then small business dividends paid to the trust can retain the character of dividends and be paid to a Holdco beneficiary on a tax free basis;
- small business shares can be rolled-out on a tax free basis to beneficiaries prior to the 21 year deemed disposition date.
A family trust is taxed at the highest tax rates on all income received, this means these trusts are not taxed at marginal rates. The annual taxation of an inter vivos trust can be managed in two ways:
- the trust can own capital property which does not generate annual income; and,
- trust income can be allocated to beneficiaries thus taking advantages of lower tax rates if available. Dividends can be allocated as dividends; and capital gains can be allocated as capital gains.
The second tax consequence of an inter vivos trust is that all property in the trust is deemed to be disposed of every 21 years. This means capital gain must be paid regardless of whether the asset is sold or not. CRA allows the trust property to roll-out to a capital beneficiary prior to the 21 year deemed disposition. Where a holding company is a capital beneficiary the growth shares can be rolled out to the holding company rather than children.
A roll-out will be denied if s. 75(2) has ever applied to the trust.
Income Tax Act s. 75(2)
Every trust must be designed carefully to avoid triggering s. 75(2). This section applies to property contributed to a trust by a settlor or a subsequent contributor.
A settlor is the person who settles the trust and contributes the initial property to the trust. After the trust is settled any family member can contribute to a trust. S. 75(2) is designed to catch any of these contributions. The term “contributor” includes the settlor and any other person who contributes property to a trust.
Where a contributor contributes property to a trust s. 75(2) applies two consequences:
- all income and loss with respect to that particular property, or substituted property, is attributed to the contributor. Once the contributor pays the tax CRA accepts that the trust no longer has to pay it; however the contributor has no right to demand that the trust repay the amounts the contributor has paid. Growth shares held over a long time can generate significant tax.
- the trust loses the right to roll property out of the trust on a tax free basis prior to the 21 year deemed disposition date.
Attribution no longer applies where: the contributed property is returned to the contributor; or, the contributor dies. The right to roll property out of the trust is forever lost if s. 75(2) applies at any time.
CRA says s. 75(2) is triggered where a contributor has the right:
- to receive the property back. The most common example is where the contributor is a capital beneficiary. It is not clear whether a contributor can be an income beneficiary.
- to direct to whom the property should go.
- to be the sole trustee, or demand a unanimous vote, or demand that no majority can be formed without the vote of the contributor.
Managing s. 75(2)
S. 75(2) does not apply where the trust enters into a bona fide loan arrangement on commercial terms; or, to fair market value purchase transactions.
The key to managing s. 75(2) is to ensure that none of the trustees or beneficiaries has made any contributions to the trust. This is done by ensuring the settlor is not a trustee or beneficiary; and, by ensuring that any property in the trust, other than the property contributed by the settlor, is either borrowed or purchased by the trust.
There two important steps to ensure that parents are not seen as ‘contributors’:
- the preference shares that the parents take back in exchange for their common shares must represent the fair market value of the business so that there truly is nominal value in the growth shares to be purchased by the trust;
- the trust has to get the money to buy the shares by way of a legitimate loan so that income will not be attributed back to a person who ‘contributes’ the money to buy the shares.
A lot of these business succession cases are factually based. This one makes a great read:
 The evidence before the court painted the picture of a family relationship. James and Lois helped their son, and Barry and Brenda reciprocated as one might expect. Families help each other, especially when they live close by. In this instance they were immediate neighbours and they also appear to have become friends as couples. On top of this, James and Barry shared an interest in automobile mechanics and the scrap yard. Each brought skills, interests, and resources to the table. But they did it as family and friends. In the early years of this close relationship, James probably contributed significantly because he had more time and resources. The two couples socialized back and forth, assisted and provided for each other as convenience and time permitted. When James
encountered poor health, Barry went out of his way to make his father feel wanted and included. He described bringing him to the garage to be part of what was happening there even though James was too feeble to contribute. After James passed away, Barry looked in regularly on his mother and tried to fill some of the void, including by helping with home maintenance and the provision of wood for burning.
 In my view, this relationship was a normal, healthy family one. It was based on mutual affection and respect. Families help each other. In this relationship I do not see anyone as having been taken advantage of in the many years of close association. The two couples enjoyed mutual generosity and affection in their relationship. They gave freely to each other and accepted mutual kindnesses. I do not see enrichment or deprivation entering the picture. It is not a situation like Petkuss (supra) where the nature of the relationship imported expectations of mutual obligation or dependency, i.e. spouse-like where a partner gave years of life and work without the security that a legally married spouse might reasonably expect and that public policy advocates.
The Judge concluded that the problem arose as a result of a disagreement over the business property:
 Having concluded that Barry probably called his mother in anger and claimed that the property was already his, I also conclude that Lois quite reasonably took it as a repudiation of her proposal that he purchase the property. Her fear and perception of
Barry’s hostility were also reasonable. She had to get on with the sale in order to repay Canada Life; so after taking legal advice she listed the property for sale.
 I find nothing unreasonable or treacherous in her doing so. Barry brought it on himself by his hostile assertion of ownership. Under those circumstances, Lois’ listing the property at a price recommended by the agent was quite reasonable.
Why has the boomer wealth transfer lasted as a news story for the last fifteen years or so? In November 2012 CIBC reported that the boomer transfer will be $3.8 trillion. Sure it’s a big number but what would it really get you? one Iraq war? the IRS budget for a year or so? twice as much as was lost in the 2008 market crash? The stack of dollar bills would be from here to the moon; but in terms of macro economics it is just one more of many big number events. So why is the topic of business succession in the media so often?
Business succession itself is not news. Business succession has been around since the first business owner passed it on and has applied to every business owner since. The news is the volume ($3.8 trillion) and number of transactions (hundreds of thousands) that will occur and actual real people involved. This is not some war far away or the hissing of phantom derivative dollars as the monetary system deflates. The challenge is whether there will be wealth preservation or wide spread destruction of value occurring in family businesses all across the nation.
The solution begins with understanding the term ‘business succession’. What does it mean? Business succession describes: a process; a market; a transaction; and a demographic. It is difficult to be precise, so it is helpful to know what business succession isn’t. Continue Reading
There is consensus in the planning world that planning driven by the perspective of only one discipline is a mistake The most cited culprit is tax planning. Holdcos, trusts, and freezes are not generic one size fits all plans; however, far too often advisors are swept away by the intrinsic coolness and efficiency of a tax plan and fail to examine the extrinsic family or client needs and whether the plan fits in this situation for this client.
A U.S. article entitled “Top 10 Estate ‘non-tax’ Planning Recommendations” is a type of warning signal to ensure that tax does not trump other important planning considerations.
As a tax guy I have to say that when I read the list I see it as 10 tax considerations; tax is integral and threaded through each. However I agree with the majority consensus that tax should not be the planning driver.
Tax is more like grammar. Good grammar is essential and is threaded through all we do. Bad grammar leads to misunderstanding and litigation – without a command of grammar a professional would not last in practice.
But here’s the point: Continue Reading
An accountant recently asked me the following question. I thought it was so well laid out that I asked permission to put it in a blog post. So here it is:
I have a client that is considering transferring an insurance policy from her personal name to a corporation of which she is a 100% shareholder. The details of the insurance policy are as follows:
- Death benefit/Face value $1,000,000
- Cash surrender value (CSV) $390
- Adjusted cost base (ACB) $53,769
- Fair market value (FMV) $207,331 (based on an actuarial valuation)
- Insured Father of shareholder
Here is my understanding of the tax implications on transfer from shareholder to corporation and on the eventual payment of the death benefit.
There are no tax implications to the shareholder on the transfer to the corporation under s.148(7) since the CSV is less than ACB. As such, the transferring shareholder has the ability to withdraw $207,331 from the corporation on a tax-free basis.
Also under s.148(7), the ACB of the policy acquired becomes its CSV of $390.
Assuming the insured dies the day after the insurance is transferred from shareholder to the corporation and the corporation has been named the beneficiary of the policy, the corporation will receive insurance proceeds of $1,000,000. This death benefit of $1,000,000 less the ACB of $53,769 flows to the capital dividend account (CDA) of the corporation to be paid to the shareholder.
Based on my analysis, my conclusions seem almost too good to be true. If the shareholder kept the policy in their personal name, they would receive $1.000,000 at the time the death benefit is paid. By transferring the policy to the corporation, the shareholder will receive the FMV of the policy of $207,331 on transfer plus the death benefit less ACB from the CDA of $999,610 (ie $1,000,000 – $390).
Please advise if my analysis is correct. Continue Reading
A very useful legacy project is to shoot a video passing on your world view and advice for life. This idea is discussed in Before Passing Along Valuables, Passing Along Values. These videos can be very elaborate multi media productions; however the budget is immaterial, its the story that counts.
The book 30 Lesson for Living is patterned on this idea, The author Karl Pillimer Ph.D. is a professor at Cornell who has conducted thousands of interviews with seniors or ‘experts’ as he calls them gathering and sorting the 30 lessons for living. The result is a fantastically readable, deeply meaningful book.
I started my career as a business start up lawyer; at the time I believed in corporations over people. It took the “30 Lesson for Living” to show me what is really meant when it is said that a corporation is a “legal fiction”. What I was missing is that a business doesn’t exist but for the people in it.
An author in a recent post wrote that one of her wealthy clients said that it was “stories, not sterling” that links generations together. Although 30 Lessons for Living is not a business book it was a very good exercise in filtering and prioritizing tax and legal training for the succession planner.
I now realize that a lot of what I am trying to do is to develop how those stories will be told in the future. I am re-framing my approach as a process of developing functional ongoing relationships between people and then creating legal fictions (legal and tax documentation) around those relationships.
That’s my story :)
Demographics is where the future comes from.
As Robert Kennedy said in a speech in Cape Town:
There is a Chinese curse which says ‘May he live in interesting times.’ Like it or not we live in interesting times. They are times of danger and uncertainty; but they are also more open to the creative energy of men than any other time in history.
The article Canada on track to outpace G7 over next 50 years: who is going to deliver the goods? is a very interesting take on another aspect of the ‘Boomer Bust’: labour shortages. The author rightly points out that Canadian business owners need to become familiar with the Temporary Foreign Worker Program.
image from tridentinternational.ca
The book “The Boomer Bust” makes the persuasive argument that U.S. demographics show that there will be a 6,000,000 fewer businesses in 20 years as the boomer bulge passes through retirement. The author interprets this as 1,000 businesses being listed for sale, every day, for 6,000 days.
Obviously there are other demographic factors but the point is simple – the unprepared will lose and it will be a lot more difficult to sell a business in the future.
But an outright sale is not the only method of succession. Public companies have had to struggle with the succession question in a very ‘public’ way for hundreds of years. Succession has been described as the single most important task of the board … Continue Reading