Estate Freeze

In 2015, CIBC conducted a poll to see how many Canadian business owners had a business transition plan. Almost half of them didn’t have one.

No business owner likes to think about handing over their business they’ve built from the ground up. But the fact of the matter is, you will have to do it eventually. Even more concerning, what if you were to become ill or incapacitated? Making a decision of this magnitude during trying times would not be ideal.

Your two main choices for passing on your business are:

  • Selling it

  • Transferring ownership to a successor of your choice (this can either be a family member or a non-family member such as a key employee)

When you die, all your capital property is deemed to have been sold immediately before your death. This includes your business. This means that capital gains taxes will be charged on whatever the fair market value (FMV) of your business is considered to be at the time of your death.

The higher the FMV of your business, the higher the capital gains taxes that will be charged. Your successors may not have the funds to pay these taxes which may force them to sell the business in order to fund the tax liability; thus, not to reaping the benefits of all your hard work as intended. 

The good news is that there’s a way to protect your business; an estate freeze.

What is an estate freeze?

For the business owner, an estate freeze can be an integral part of your estate planning strategy. The purpose of an estate freeze is to lock-in (freeze) the value of the business, freeing the successor from the tax liability that may arise should the business’ value increase.

This is how an estate freeze works:

  1. As a business owner, you can lock in or “freeze” the value of an asset as it stands today. Your successors will still have to pay taxes on your business when they inherit it – but not as much as if you hadn’t “frozen” your business and your company had increased in FMV.

  2. You continue to maintain control of your business. As well, you can receive income from your business while it is frozen.

  3. Your successor now benefits from the business’ future growth, but they won’t have to pay for any tax increases that occur before they inherit the business.

Freezing the value of your business can help you plan your tax spending properly. Selecting to “freeze” your business can help give you peace of mind that your successors won’t have to spend a considerable part of their inheritance on excessive taxes.

What happens when you freeze your estate?

  1.  When you execute an estate freeze, the first thing you need to do is exchange your common shares for preferred shares.  Your new preferred shares will have a fixed (a.k.a. “frozen”) value equal to the company’s present fair market value. Make sure you have everything in place to properly determine the fair market value before you exchange your shares. 

  2. Your company will then issue common shares, which your successors subscribe to for a nominal price (for example, 1 dollar). Note that your successors don’t own the stock yet – subscribing to the stocks means they will take ownership of the stocks at a future date.

As part of your estate freeze, you must have a shareholders’ agreement ready to bring in new shareholders. This agreement should list any terms and conditions related to the purchase, redemption, or transfer of your company’s common shares. 

1. You can choose to receive some retirement income from your preferred shares by cashing in a fixed amount gradually. This action will reduce your preferred shares’ total value, reducing income tax liability upon death. For example:

  • Your shares are worth $10,000,000, and you need $100,000 annually. You can then redeem $100,000 worth of shares.

  • If you live for 30 more after you freeze your estate, you will have withdrawn $3,000,000 of your shares. This reduces the value of your shares to $7,000,000. 

  • At your death, your tax liability is lower than it would have been had your shares remained at the original value of $10,000,000. 

2. You can opt to maintain voting control in your company. This can be complicated (so you should consult a licensed professional), but you can set up your estate freeze so that you still have voting control in your business with your preferred stock. 

How you can benefit from an estate freeze

  1. You get peace of mind. The most important benefit to a tax freeze is that you know, whoever your successors are, they will receive what they are entitled to and not have to deal with any unpredictable tax burdens. Since an estate freeze fixes the maximum amount of taxes to be paid, you can properly plan how much money to set aside for this tax liability. One option is to have a life insurance policy equal to the amount of the tax liability, with your successor as the beneficiary, so you know they will have enough money to pay for these taxes.

  2. You encourage participation in growing your business. Your chosen successors will be motivated to help the company grow, as they know they will benefit in the future.

  3. Further tax reductions. If your shares qualify for lifetime capital gains exemption, then an estate freeze also helps further reduce your successor’s tax liability.

Is an estate freeze the right strategy for you?

There are a few things you need to consider when deciding if an estate freeze is right for you or not. 

  1. Retirement funding. What kind of retirement savings, if any, do you have? If you have money put aside in RRSPs, TFSAs, or even have a pension from a previous job, then an estate freeze may be the right choice for you. If you were planning to sell your company and live off the proceeds in retirement, then it likely is not the right choice for you.

  2. Succession plans. Do you have someone in mind who would be a suitable successor? Just because you think your child, spouse, or best employee may want to take over your business doesn’t mean they do. Talk to anyone you are considering making a successor and see if they are both interested in and able to keep your business going. 

  3. Family relationships. Trying to figure out how to select a successor if you have several children may be challenging. It can cause a lot of strain amongst your children if they are all named successors if only some of them are actively interested in running the business. You may want to consider only making one child a successor and providing for your other children in different ways, such as making them a life insurance beneficiary. 

If you decide to pursue an estate freeze for your business, you are helping plan for your heirs’ future and cutting down on the amount of taxes that will eventually have to be paid.  That being said – an estate freeze can be complicated, and all the steps must be performed correctly. Be sure to consult an experienced professional be taking any steps to freeze your estate.

Easy Exit: Business Succession in a Nutshell

Getting into the world of business is a meticulous task, but so is getting out of it

Whether you’ve just hit the ground running on your business or if you’ve been at it for a long time, there is no better time to plan your exit strategy than now. Although the process may seem taxing, we’ve answered a few questions you may have about planning your business succession strategy. 

1. Who do I talk to about this? 

Deciding on how to go about the transition requires careful planning, and you need to consult no less than people who are well equipped to help you out. First, talk to your key advisors such as bankers and financial partners. You could also use some advice from your accountant and lawyers. If your company has an advisory board, better consult them as well. You may also hire a specialist or a consultant, depending on how you choose to go about your business succession plan. 

2. Who should I choose as a successor? 

There are several ways to go about this, and your decision will ultimately be your personal choice. You may pass on your business to a family member or to your top executives or managers. You may also choose to sell it to an outsider. Whichever path you choose, you can also decide on how much you want to be involved in the business after you pass it on. That is, if you want to be involved at all. 

3. When should I inform my successor about my plans? 

While a surprise inheritance may be heartwarming, it’s not the same with inheriting a business. Getting a successor ready—whether it’s a family member or someone from your company—requires careful planning and training. As soon as you’ve chosen a successor, better get started on getting them ready for the big shoes they’re about to fill. This includes helping them equip themselves with the necessary skills, knowledge, and qualifications necessary to run your business. 

4. How do I plan the transition itself? 

The transition will be twofold—transferring ownership and handing over the business itself. As far as transferring ownership is concerned, you need to consider legal and financial details. These include valuation, financing and taxation. You also need to consider if you wish to keep your current legal structure (corporation, sole prop, partnership, etc.) or if you (or your successor) would like to change it. You also need to plan how to prepare various stakeholders in the business for the transition. How will you prepare your customers, clients, and employees? What would be their level of involvement? Make sure that you put different strategies in place in order to ensure transparency and consistency in communicating changes in your business, especially something as drastic as succession. 

5. Now that I have a business succession plan ready, can I go back to business as usual? 

Not really. Your business and your customers’ needs may change over time. This means that you need to keep reviewing and adjusting your plan as your business also evolves. 

2021 Year-End Tax Tips for Business Owners

2021 Year-End Tax Tips for Business Owners

Now that we’re approaching the end of the year, it’s time to review your business finances. We’ve highlighted the most critical tax-planning tips you need to know as a business owner.

Salary and Dividend Mix

As a business owner, one essential part of tax planning is determining the right mix of salary and dividends for both yourself and your family members.

The following are the main options you can consider when determining how to distribute money from your business:

  1. Pay a salary to family members who work for your business and are in a lower tax bracket – This enables them to declare an income so that they can contribute to the Canada Pension Plan (CPP) and a Registered Retirement Savings Plan (RRSP). You must be able to prove the family members have provided services in line with the amount of compensation provided.

  2. Pay dividends to family members who are shareholders in your company – The amount of dividends someone can receive without paying income tax on them will vary depending on the province or territory they live in.

  3. Distribute money from your business via income sprinkling – This is shifting income from a high-tax rate individual to a low-rate tax individual. However, this strategy can cause issues due to Tax On Split Income (TOSI) rules. A tax professional can help you determine the best way to “income sprinkle” so none of your family members are subject to TOSI.

  4. Keep money in the corporation if neither you nor your family members need cash – Taxes can be deferred if your corporation retains income and the corporation’s tax rate is lower than your personal tax rate.

No matter what strategy you take to distribute money from your business, keep in mind the following:

  • Your marginal tax rate as the owner-manager.

  • The corporation’s tax rate.

  • Health and payroll taxes.

  • How much RRSP contribution room do you have.

  • What you’ll have to pay in CPP contributions.

  • Other deductions and credits you’ll be eligible for (e.g., charitable donations or childcare or medical expenses).

Compensation

An important part of year-end tax planning is determining appropriate ways to handle compensation. The following are the main things to consider:

  1. Can you benefit from a shareholder loan? A shareholder loan is an agreement to borrow funds from your corporation for a specific purpose. The interest from the loan may be deductible if the proceeds of the shareholder loan were used to produce income from business or property.

  2. Do you need to repay a shareholder loan to avoid paying personal income tax on the amount you borrowed?

  3. Is setting up an employee profit-sharing plan a better way to disburse business profits than simply paying out a bonus?

  4. Keep in mind that when an employee cashes out a stock option, only one party (the employee OR the employer) can claim a tax deduction on the cashed-out stock option.

  5. Think about setting up a Retirement Compensation Arrangement (RCA) to help fund you or your employee’s retirement.

Passive Investments

One of the most common tax advantages available to Canadian-Controlled Private Corporations (CCPC) is the Small Business Deduction (SBD).

For qualifying businesses, the SBD reduces your corporate tax rate. Keep in mind that the SBD will be reduced by five dollars for every dollar of passive investment income over $50,000 your CCPC earned the previous year.

The best way to avoid losing any of the SBD is to make sure that the passive investment income within your associated corporation group does not exceed $50,000.

These are some of the ways you can make sure you preserve your access to the SBD:

  1. Defer the sale of portfolio investments as necessary.

  2. Adjust your investment mix to be more tax efficient. For example, you could choose to hold more equity investments than fixed-income investments. Only 50% of the gains realized on shares sold is taxable, but investment income earned on bonds is fully taxable.

  3. Invest excess funds in an exempt life insurance policy. Any investment income earned on an exempt life insurance policy is not included in your passive investment income total.

  4. Set up an individual pension plan (IPP). An IPP is like a defined benefit pension plan and is not subject to the passive investment income rules.

Depreciable Assets

Another tactic you should consider for year-end tax planning is to hasten your purchase of any depreciable assets. A depreciable asset is a type of capital property that you can claim the Capital Cost Allowance (CCA) on.

These are two of the best ways to make the most of tax planning with depreciable assets:

  1. Make use of the Accelerated Investment Incentive. With this incentive, some depreciable assets are eligible for an enhanced first-year allowance.

  2. Purchase equipment such as zero-emissions vehicles and clean energy equipment eligible for a 100 percent tax write-off.

Donations

Another essential part of tax planning is to make all of your donations before year-end. This applies to both charitable donations and political contributions.

For charitable donations, you need to consider the best way to make your donations and the different tax advantages of each type of donation. For example, you can:

  • Donate securities.

  • Give a direct cash gift to a registered charity.

  • Use a donor-advised fund account at a public foundation. A donor-advised fund is like a charitable investment account.

  • Set up a private foundation to solely represent your interests.

We can help walk you through the tax implications of each of these types of charitable donations.

Make the Most of Covid-19 Relief Programs

While some COVID-19 relief programs, such as the Canada Emergency Wage Subsidy (CEWS) and Canada Emergency Rent Subsidy (CERS) have ended, others are still available. See if your business can benefit from any of the following relief programs:

  1. Canada Recovery Hiring Program (CRHP). This program will continue to run until May 2022. If your business is eligible and continues to experience a decline in revenues as compared to pre-pandemic levels. In that case, the CRHP will provide support to assist in hiring new staff or increasing the wages of your existing staff.

  2. Tourism and Hospitality Recovery Program. This new program provides wage and rent support to eligible businesses such as hotels and restaurants with an average monthly revenue reduction of at least 40% over the first 13 qualifying periods for the CEWS and a current month revenue loss of at least 40%.

  3. Hardest Hit Business Recovery Program. This provides rent and wage support of up to 50% for eligible entities. Eligible entities must meet two conditions – an average monthly revenue reduction of at least 50% over the first 13 qualifying periods for the CEWS and a current month revenue loss of at least 50%.

  4. General support in the event of a public health lockdown. If there is a public health lockdown and your business loses sufficient revenue, your business would be eligible for support at the same subsidy rates as the Tourism and Hospitality Recovery Program.

  5. Know what’s included as taxable income. If you received assistance from the government assistance programs, including the CEWS, CERS, and CRHP, this assistance is taxable as income.

Get year-end tax planning help from someone you can trust!

We’re here to help you with your year-end tax planning. Book some time with us today to learn how you can benefit from these tax tips and strategies.

Succession Planning for Business Owners

Succession Planning for Business Owners

Business owners deal with a unique set of challenges. One of these challenges includes succession planning. A succession plan is the process of the transfer of ownership, management and interest of a business. When should a business owner have a succession plan? A succession plan is required through the survival, growth and maturity stage of a business. All business owners, partners and shareholders should have a plan in place during these business stages.

We created this infographic checklist to be used as a guideline highlighting main points to be addressed when starting to succession plan.

Needs:

  • Determine your objectives- what do you want? For you, your family and your business. (Business’ financial needs)

  • What are your shares of the business worth? (Business value)

  • What are your personal financial needs- ongoing income needs, need for capital (ex. pay off debts, capital gains, equitable estate etc.)

There are 2 sets of events that can trigger a succession plan: controllable and uncontrollable.

Controllable events

Sale: Who do you sell the business to?

  • Family member

  • Manager/Employees

  • Outside Party

  • There are advantages and disadvantages for each- it’s important to examine all channels.

Retirement: When do you want to retire?

  • What are the financial and psychological needs of the business owner?

  • Is there enough? Is there a need for capital to provide for retirement income, redeem or freeze shares?

  • Does this fit into personal/retirement plan? Check tax, timing, corporate structures, finances and family dynamics. (if applicable)

Uncontrollable Events

Divorce: A disgruntled spouse can obtain a significant interest in the business.

  • What portion of business shares are held by the spouse?

  • Will the divorced spouse consider selling their shares?

  • What if the divorced spouse continues to hold interest in the business without understanding or contributing to the business?

  • If you have other partners/shareholders- would they consider working with your divorced spouse?

Illness/Disability: If you were disabled or critically ill, would your business survive?

  • Determine your ongoing income needs for you, your spouse and family. Is there enough? If there is a shortfall, is there an insurance or savings program in place to make up for the shortfall amount?

  • Will the ownership interest be retained, liquidated or sold?

  • How will the business be affected? Does the business need capital to continue operating or hire a consultant or executive? Will debts be recalled? Does the business have a savings or insurance program in place to address this?

Death: In the case of your premature death, what would happen to your business?

  • Determine your ongoing income needs for your dependents. Is there enough? If there is a shortfall, is there an insurance or savings program in place to make up for the shortfall amount?

  • Will the ownership interest be retained, liquidated or sold by your estate? Does your will address this? Is your will consistent with your wishes? What about taxes?

  • How will the business be affected? Does the business need capital to continue operating or hire a consultant or executive? Will debts be recalled? How will this affect your employees? Does the business have a savings or insurance program in place to address this?

Execution: It’s good to go through this with but you need to get a succession plan done.  Besides having a succession plan, make sure you have an estate plan and buy-sell/shareholders’ agreement.

Because a succession plan is complex, we suggest that a business owner has a professional team to help. The team should include:

  • Financial Planner/Advisor (CFP)

  • Succession Planning Specialist

  • Insurance Specialist

  • Lawyer

  • Accountant/Tax Specialist

  • Chartered Life Underwriter (CLU)

Next steps…

  • Contact us about helping you get your succession planning in order so you can gain peace of mind that your business is taken care of.

Insurance Planning for Business Owners

For business owners, making sure your business is financially protected can be overwhelming. Business owners face a unique set of challenges when it comes to managing risk. Insurance can play an important role when it comes to reducing the financial impact on your business in the case of uncontrollable events such as disability, critical illness or loss of a key shareholder or employee.

This infographic addresses the importance of corporate insurance.

The 4 areas of  insurance a business owner should take care of are:

  • Health

  • Disability

  • Critical Illness

  • Life

Health: We are fortunate in Canada, where the healthcare system pays for basic healthcare services for Canadian citizens and permanent residents. However, not everything healthcare related is covered, in reality, 30% of our health costs* are paid for out of pocket or through private insurance such as prescription medication, dental, prescription glasses, physiotherapy, etc.

For business owners, offering employee health benefits make smart business sense because health benefits can form part of a compensation package and can help retain key employees and attract new talent.

For business owners that are looking to provide alternative health plans in a cost effective manner, you may want to consider a health spending account.

Disability: Most people spend money on protecting their home and car, but many overlook protecting their greatest asset: their ability to earn income. Unfortunately one in three people on average will be disabled for 90 days or more at least once before the age of 65.

Consider the financial impact this would have on your business if you, a key employee or shareholder were to suffer from an injury or illness. Disability insurance can provide a monthly income to help keep your business running.

Business overhead expense insurance can provide monthly reimbursement of expenses during total disability such as rent for commercial space, utilities, employee salaries and benefits, equipment leasing costs, accounting fees, insurance premiums for property and liability, etc.

Key person disability insurance can be used to provide monthly funds for the key employee while they’re disabled and protect the business from lost revenue while your business finds and trains an appropriate replacement.

Buy sell disability insurance can provide you with a lump sum payment if your business partner were to become totally disabled. These funds can be used to purchase the shares of the disabled partner, fund a buy sell agreement and reassure creditors and suppliers.

Critical Illness: For a lot of us, the idea of experiencing a critical illness such as a heart attack, stroke or cancer can seem unlikely, but almost 3 in 4 (73%) working Canadians know someone who experience a serious illness. Sadly, this can have serious consequences on you, your family and business, with Critical Illness insurance, it provides a lump sum payment so you can focus on your recovery.

Key person critical illness insurance can be used to provide funds to the company so it can supplement income during time away, cover debt repayment, salary for key employees or fixed overhead expenses.

Buy sell critical illness insurance can provide you with a lump sum payment if your business partner or shareholder were to suffer from a critical illness. These funds can be used to purchase the shares of the partner, fund a buy sell agreement and reassure creditors and suppliers.

Life: For a business owner, not only do your employees depend on you for financial support but your loved ones do too. Life insurance is important because it can protect your business and also be another form of investment for excess company funds.

Key person life insurance can be used to provide a lump sum payment to the company on death of the insured so it can keep the business going until you an appropriate replacement is found. It can also be used to retain loyal employees by supplying a retirement fund inside the insurance policy.

Buy sell life insurance can provide you with a lump sum payment if your business partner or shareholder were to pass away. These funds can be used to purchase the shares of the deceased partner, fund a buy sell agreement and reassure creditors and suppliers.

Loan coverage life insurance can help cover off any outstanding business loans and debts.

Reduce taxes & diversify your portfolio, often life insurance is viewed only as protection, however with permanent life insurance, there is an option to deposit excess company funds not needed for operations to provide for tax-free growth (within government limits)  to diversify your portfolio and reduce taxes on passive investments.

Talk to us about helping making sure you and your business are protected.

Government of Canada to allow up to $400 for home office expenses

For the 2020 tax year, the Government of Canada introduced a temporary flat rate method to allow Canadians working from home this year due to Covid-19 to claim expenses of up to $400. Taxpayers will still be able to claim under the existing rules if they choose using the detailed method.

Eligibility

From the canada.ca website:

Each employee working from home who meets the eligibility criteria can use the temporary flat rate method to calculate their deduction for home office expenses.

To use this method to claim the home office expenses you paid, you must meet all of the following conditions:

  • You worked from home in 2020 due to the COVID-19 pandemic

  • You worked more than 50% of the time from home for a period of at least four consecutive weeks in 2020

  • You are only claiming home office expenses and are not claiming any other employment expenses

  • Your employer did not reimburse you for all of your home office expensesWhat if your employer has reimbursed you for some of your home office expenses

You need to meet all of the above conditions to be eligible to use the Temporary flat rate method.

New eligible expenses

For the detailed method, the CRA has expanded the list of eligible expenses that can be claimed as work-space-in-the-home expenses to include reasonable home internet access fees. A comprehensive list of eligible home office expenses has also been created.

Business Owners: 2020 Tax Planning Tips for the End of the Year

It’s a great time to review your business finances now that we are nearing year-end. Your business may be affected by recent tax changes or new measures to help with financial losses due to COVID-19. Figuring out the tax ramifications of these new measures can be complicated, so please don’t hesitate to consult your accountant and us to determine how this may affect your business finances.

We’re assuming that your corporate year-end is December 31. If it’s not, then this information will be useful when your business year-end comes up.

Below, we have listed some of the critical areas to consider and provide you with some helpful guidelines to make sure that you cover all the essentials. We have divided our tax planning tips into four sections:

  • Year-end tax checklist

  • Remuneration

  • Business tax

  • Estate

Business Year-End Tax Checklist

Remuneration

  • Salary/dividend mix

  • Accruing your salary/bonus

  • Stock option plan

  • Tax-free amounts

  • Paying family members

  • COVID-19 wage subsidy measures for employers

Business Tax

  • Claiming the small business deduction

  • Shareholder loans

  • Passive investment income including eligible and ineligible dividends

  • Corporate reorganization

Estate

  • Will review

  • Succession plan

  • Lifetime capital gains exemption

Remuneration

What is your salary and dividend mix?

Individuals who own incorporated businesses can elect to receive their income as either salary or as dividends. Your choice will depend on your situation. Consider the following factors:

  • Your current and future cash flow needs

  • Your personal income level

  • The corporation’s income level

  • Tax on income splitting (TOSI) rules. When TOSI rules apply, be aware that dividends are taxed at the highest marginal tax rate.

  • Passive investment income rules

Also consider the difference between salary and dividends:

Salary

  • Can be used for RRSP contribution

  • Reduces corporate tax bill

  • Subject to payroll tax

  • Subject to CPP contribution

  • Subject to EI contribution

Dividend

  • Does not provide RRSP contribution

  • Does not reduce a corporate tax bill

  • No tax withholdings

  • No CPP contribution

  • No EI Insurance contribution

  • Depending on the province¹, receive up to $50,000 of eligible dividends at a low tax rate provided you have no other sources of income

¹The amount and tax rate will vary based on province/territory you live in.

It’s worth considering ensuring that you receive a salary high enough to take full advantage of the maximum RRSP annual contribution that you can make. For 2020, salaries of $154,611 will provide the maximum RRSP room of $27,830 for 2021.

Is it worth accruing your salary or bonus this year?

You could consider accruing your salary or bonus in the current year but delaying payment of it until the following year. If your company’s year-end is December 31, your corporation will benefit from a deduction for the year 2020. The source deductions are not required to be remitted until actual salary or bonus payment in 2021.

Stock Option Plan

If your compensation includes stock options, check if you will be affected by the stock option rules that went into effect on January 1, 2020. These new rules cap the amount of specific employee stock options eligible for the stock option deduction at $200,000 as of January 1, 2020. These rules will not affect you if a Canadian controlled private corporation grants your stock options.

Tax-Free Amounts

If you own your corporation, pay yourself tax-free amounts if you can. Here are some ways to do so:

  • Pay yourself rent if the company occupies space in your home.

  • Pay yourself capital dividends if your company has a balance in its capital dividend account.

  • Return “paid-up capital” that you have invested in your company

Do you employ members of your family?

Employing and paying a salary to family members who work for your incorporated business is worth considering. You could receive a tax deduction against the salary you pay them, providing that the salary is “reasonable” with the work done. In 2020, the individual can earn up to $13,229 (increased for 2020 from $12,298) and pay no federal tax. This also provides the individual with RRSP contribution room, CPP and allows for child-care deductions. Bear in mind there are additional costs incurred when employing someone, such as payroll taxes and contributions to CPP.

COVID-19 wage subsidy measures for employers

To deal with the financial hardships introduced by COVID-19, the federal government introduced two wage subsidy measures:

  • The Canada Emergency Wage Subsidy (CEWS) program. With this, you can receive a subsidy of up to 85% of eligible remuneration that you paid between March 15 and December 19, 2020, if you had a decrease in revenue over this period. You must submit your application for the CEWS no later than January 31, 2021.

  • The Temporary Wage Subsidy (TWS) program. With this program, which reduces the amount of payroll deductions you needed to remit to the CRA, you can qualify for a subsidy equal to 10% of any remuneration that you paid between March 18, 2020, and June 19, 2020. You can claim up to a maximum of $1,375 per employee and $25,000 in total.

You can apply for both programs if you are eligible. If you qualify for the TWS but did not reduce your payroll remittances, you can still apply. The CRA will then either pay the subsidy amount to you or transfer it over to your next year’s remittance.

Business Tax

Claiming the Small Business Deduction

Are you able to claim a small business deduction? The federal small business tax rate decreased to 9% in 2019. It did not increase in 2020, nor is it expected to increase in 2021. From a provincial level, there will be changes in the following provinces:

Therefore, a small business deduction in 2020 is worth more than in 2021 for these provinces.

Should you repay any shareholder loans?

Borrowing funds from your corporation at a low or zero interest rate means that you are considered to have received a taxable benefit at the CRA’s 1% prescribed interest rate, less actual interest that you pay during the year or thirty days after the end of the year. You need to include the loan in your income tax return unless it is repaid within one year after the end of your corporation’s taxation year.

For example, if your company has a December 31 year-end and loaned you funds on November 1, 2020, you must repay the loan by December 31, 2021; otherwise, you will need to include the loan as taxable income on your 2020 personal tax return.

Passive investment income

If your corporation has a December year-end, then 2020 will be the second taxation year that the current passive investment income rules may apply to your company.

New measures were introduced in the 2018 federal budget relating to private businesses, which earn passive investment income in a corporation that also operates an active business.

There are two key parts to this:

  • Limiting access to dividend refunds. Essentially, a private company will be required to pay ineligible dividends to receive dividend refunds on some taxes. In the past, these could have been refunded when an eligible dividend was paid.

  • Limiting the small business deduction. This means that, for impacted companies, the small business deduction will be reduced at a rate of $5 for every $1 of investment income over $50,000. It is eliminated if investment income exceeds $150,000. Ontario and New Brunswick are not following these federal rules. Therefore, the provincial small business deduction is still available for income up to $500,000 annually.

Suppose your corporation earns both active business and passive investment income. In that case, you should contact your accountant and us directly to determine if there are any planning opportunities to minimize the new passive investment income rules’ impact. For example, you can consider a “buy and hold” strategy to help defer capital gains.

Think about when to pay dividends and dividend type

When choosing to pay dividends in 2020 or 2021, you should consider the following:

  • Difference between the yearly tax rate

  • Impact of tax on split income

  • Impact of passive investment income rules

Except for two provinces, Quebec and Alberta, the combined top marginal tax rates will not change from 2020 to 2021 at a provincial level. Therefore, it will not make a difference for most locations if you choose to pay in 2020 or 2021.

In Quebec and Alberta, as there will be increases in the combined marginal tax rate, you will have potential tax savings available if you choose to pay dividends in 2020 rather than 2021.

When deciding to pay a dividend, you will need to decide whether to pay out eligible or ineligible dividends. Consider the following:

  • Dividend refund claim limits: Eligible refundable dividend tax on hand (ERDTOH) vs Ineligible Refundable dividend tax on hand (NRDTOH)

  • Personal marginal tax rate of eligible vs. ineligible dividends (see chart below)

Given the passive investment income rules, typically, it makes sense to pay eligible dividends to deplete the ERDTOH balance before paying ineligible dividends. (Please note that ineligible dividends can also trigger a refund from the ERDTOH account.)

Eligible dividends are taxed at a lower personal tax rate than ineligible dividends (based on top combined marginal tax rate). However, keep in mind that when ineligible dividends are paid out, they are subject to the small business deduction; therefore, the dividend gross-up is 15% while eligible dividends are subject to the general corporate tax rate, a dividend gross-up is 38%. It’s important to talk to a professional to determine what makes the most sense when selecting the type of dividend to pay out of your corporation.

Corporate Reorganization

It might be time to revisit your corporate structure, given recent changes to private corporation rules on income splitting and passive investment income to provide more control on dividend income distribution.

Before you issue dividends to other shareholders in your private company (this includes your spouse, children, or other relatives), review the TOSI rules’ impact with us or your tax and legal advisors.

Another reason to reassess your structure is to segregate investment assets from your operating company for asset protection. You don’t want to trigger TOSI, so make sure you structure this properly. If you are considering succession planning, this is the time to evaluate your corporate structure as well.

Another aspect of corporate reorganization can be loss consolidation – where you consolidate losses from within related corporate groups.

Estate

Ensure your will is up to date

If your estate plan includes an intention for your family members to inherit your business using a trust, ensure that this plan is still tax-effective; income tax changes from January 1, 2016 eliminated the taxation at graduated rates in testamentary trusts and now taxes these trusts at the top marginal personal income tax rate. Review your will to ensure that any private company shares that you intend to leave won’t be affected by the most recent TOSI rules.

Succession plan

Consider a succession plan to ensure your business is transferred to your children, key employees or outside party in a tax-efficient manner.

Lifetime Capital Gains Exemption

If you sell your qualified small business corporation shares, you can qualify for the lifetime capital gains exemption (In 2020, the exemption is $883,384), where the gain is entirely exempt from tax. The exemption is a cumulative lifetime exemption; therefore, you don’t have to claim the entire amount at once.

The issues we discussed above can be complicated. Contact your accountant and us if you have any questions. We can help.

The Difference between Segregated Funds and Mutual Funds

Segregated Funds and Mutual Funds often have many of the same benefits however there are key differences you should consider:  

  • Both are managed by investment professionals. 

  • You can generally redeem your investments and get your current market value at any time. 

  • You can use them in your RRSP, RRIF, RESP, RDSP, TFSA or non-registered account. 

There are key differences including:

  • Guarantees

  • Contract

  • Fees

  • Resets

  • Creditor Protection

  • Probate

Contract:

  • Segregated Funds: Policy owner, Annuitant and Life Insurance company

  • Mutual Funds: Account holder, Mutual fund and Investment Company

Fees

  • Segregated Funds: Management Expense Ratio & Insurance Fee (Typically higher)

  • Mutual Funds: Management Expense Ratio

Why is this important?  

Since Segregated funds are offered by life insurance companies, they are individual insurance contracts. Which means….

  • Maturity Guarantees

  • Death Benefit Guarantees

  • Maturity and death benefit resets

  • Potential Creditor Protection (depends on the setup)

  • Ability to Bypass Probate

Mutual Funds do not have these features with the exception of possible creditor protection of RRSP, RRIF dependant on provincial legislation.

What are these features?

Maturity and Death Benefit Guarantees mean the insurance company must guarantee at least 75% of the premium paid into the contract for at least 15 years upon maturity or your death. 

Resets means you have the ability to reset the maturity and death benefit guarantee at a higher market value of the investment.

Potential Creditor Protection is available when you name a beneficiary within the family class, there are certain restrictions associated with this. 

Bypass Probate: since you name a beneficiary to receive the proceeds on your death, the proceeds are paid directly to your beneficiary which means it bypasses your estate and can avoid probate fees. 

We can help you decide what makes sense for your financial situation. 

Importance of a Buy-Sell Agreement

Starting a new business venture can be both exciting and nerve-racking at the same time. The hopes and dreams of success, financial freedom and being your own boss are accompanied by many uncertainties and risks. To add to some of the anxiety, comes the facts: about half of all new businesses will not be around within the next 5, and only about one third will survive 10+ years. The situation often becomes more complex when there are multiple owners and the future success of a business is at risk if proper planning is not done. The unexpected ‘exit’ of a partner due to death, disability, illness, retirement or just simply that ‘it’s not working out’ can create a very difficult situation for the remaining business owner(s) and the business itself. Many businesses operate under a ‘handshake’ sort of agreement, but those rarely are upheld when the situation starts to get challenging. In order to protect against all of these pitfalls, it is always advised to have the right structure in place to address any potential challenges that may arise. This is done through incorporating a Buy-Sell Agreement between the owners.

What is a Buy‐Sell Agreement?

A buy-sell agreement is a legally binding contract designed to establish a set of rules or actions for the remaining business owner(s) to carry on the business, in the event one of them is no longer involved in the business – this can be due to death, illness, injury, retirement or a simple desire to ‘get out’. In other words, this document dictates how the remaining owner(s) will interact with each other and how the business will operate when certain situations occur. This agreement creates certainty and a ‘game plan’ in case one or more of the partners are no longer able or willing to commit to the business.

Types of Buy‐Sell Agreements

Buy-sell agreements are generally structured as a cross purchase agreement, promissory note agreement, or a share redemption agreement.With a cross-purchase agreement, each shareholder within the agreement agrees to purchase a specified percentage of the shares owned by the departing shareholder, and if it’s due to death, the deceased shareholder’s estate is obligated to sell the shares to the remaining shareholder(s). A shareholder will generally purchase insurance on the life of the other shareholder(s) and on death, will use the proceeds from the insurance to buy out the remaining shares from the deceased shareholder’s estate.With a promissory note agreement, corporate owned life insurance is placed on the life of each shareholder, with the corporation named as the payor and beneficiary. In the event that a shareholder dies, the surviving shareholder(s) purchases the deceased’s shares from their estate using a promissory note. Once the remaining shareholder(s) owns the deceased shareholder’s shares, the company collects the death benefit on the insurance policy with the excess amount above the adjusted cost basis of the policy in the capital dividend account. The company then provides the surviving shareholder(s) a capital dividend which provides the remaining shareholder(s) the necessary funds to pay off the promissory note.Under the share redemption arrangement corporate owned life insurance is placed on the life of each shareholder with the corporation named as the payor and beneficiary. In the event that a shareholder dies, the company collects the insurance proceeds and places the excess amount above the adjusted cost basis of the policy in the capital dividend account. The company uses the proceeds in the capital dividend account to redeem the shares held by the deceased shareholder’s estate. Once that is done, the remaining shareholder(s) takes over the ownership of those purchased shares.Each structure has their advantages and disadvantages and should be reviewed with a legal professional, tax professional as well as a knowledgeable Financial Advisor.

Why the business needs a buy‐sell agreement

A buy-sell agreement is a crucial component of a business that should be incorporated to protect the shareholders as well as the business itself. It is designed to ensure important things are taken care of if someone leaves the business for whatever reason, so that the business can continue to grow and run successfully. A buy-sell agreement offers several key benefits to your business:

  • It maintains the continuity of your business by ensuring members get to decide what happens to the business before any problems arise.

  • It protects company ownership by laying out a succession plan for departing members. This keeps remaining shareholders from being burdened by untested and unproven successors (like the widow or children of the departing co-owner).

  • It minimizes dispute between remaining co-owners and the family of the departing owner by having a strategy in place ahead of time to govern business operations.

  • It alleviates co-owner stress and uncertainty by specifically identifying which events would trigger a buyout.

  • It protects business assets and liquidity by providing a financial (and tax) plan for each of the different triggers addressed in the agreement.

  • It protects the interest of, not just the business entity itself, but also that of the business owners to ensure members (and their families, in the event of death or disability) are handled with respect, courtesy and the utmost fairness.

What to include in the buy‐sell agreement

Since a buy-sell agreement is a legally binding document, it generally should be drafted with a knowledgeable and experienced Legal Professional. Most agreements are started through a generic template, but then are customized for the needs of each business/partner and can be a fairly thorough and comprehensive document. There are several different components of a buy-sell agreement and several different aspects need to be addressed, such as the valuation of the company, ownership interests, buy-out clauses, and terms of payment. The agreement should generally be drafted at the very start of the business, so as to avoid any issues or misunderstandings later on. The agreement will also address certain ‘triggering events’, which are listed below.

Disagreement

Conflict between owners of a business in regards to the direction or management of the business can sometimes occur, and can even push the most successful business off-course. In a situation where no agreement or mediation can be reached, it may make sense to allow for one or more of the partners to be bought out. This would allow the business to continue moving forward and is often referred to as a ‘shot-gun clause’. Sometimes a situation where one owner offers to buy-out the other would also offer to be bought-out for the same value, thus ensuring fair treatment and value of the shares.

Divorce

An owner who is in the midst of a divorce may be bought-out by other partners, to protect the company ownership. A divorce settlement will generally depend on the partner’s share of the business. It’s not uncommon for a family law judge to order a business owner to split his or her interest in a company with the former spouse. To protect the business from this event, a clause should require the shares held by the former spouse of a partner to be acquired by the company or one of the other owners.

Retirement

The value of the business comprises a significant component for the retirement of many business owners. Allowing the remaining partners to reclaim the interest in the business keeps the business intact and provides the retiring partner with a market to liquidate their ownership, thus providing the retiring partner with a cash infusion to enjoy their retirement. There may also be some distinction in the agreement between early retirement and regular retirement and how the shares of the departing owner are to be valued.

Bankruptcy

Borrowing money to expand or grow the company, or to purchase equipment or goods, is common for many companies. However, lending institutions often require personal guarantees from the owners/shareholders of the business. Having one or more owners that are not able to provide this guarantee can lead to higher fees and impact the overall financial well-being and growth of the business. Therefore, a provision should be considered to allow the other shareholders the opportunity to acquire shares of the defaulting shareholder(s).

Disability

An owner who has become disabled and unable to perform their duties can impact the overall well-being of the business. The agreement should address several situations and questions, such as whether the partner will continue to receive a salary, and for how long, or whether they will continue in the day-to-day management of the company.The buy-sell agreement also needs to clearly define what is considered a disability and should include a timeline for which the disabled partner would be given the opportunity to return. Often the business will purchase disability buy-sell insurance and link the definitions to the plan. This has the added benefit of providing an independent third party to determine when the criteria for the buy-out are satisfied.

Death

The death of a partner is an unfortunate and difficult situation for both the family and business partners alike. To deal with the stress of continuing the business, establishing the rules of business continuity upon death provides peace of mind to both the surviving partners and the family of the deceased. The surviving partners benefit from the assurance of not having to deal with an unwanted partner and the family is assured that they will be treated fairly.Generally, all partners/co-owners will be covered by a ‘key person’ life insurance policy, which can be paid by either the company or the other partners, where the death benefit would be used to buy out the deceased owner’s shares (as mentioned above).

Funding the buy‐sell agreement

Without sufficient resources to fund a potential buy-out, the agreement itself can fall apart. The partners need to decide where the money will come from to complete the buy-out – whether it will be the responsibility of individual owners or from the company itself. While not all events can be protected, two can: the death and disability of a shareholder. By using an insurance policy, funds can be made available at the time they are needed, thus minimizing potential liquidity issues, protecting the business and the impacted shareholders, as well as the family of the deceased shareholder. Using insurance provides the protection needed at a fraction of the cost to the alternatives and can provide immediate capital and significant tax benefits.

Working as a partnership between 2 or more individuals is never an easy task, and the situation only gets more complicated when one or more of them exits the business. Protecting not only the business, but your personal interests, as well as your family’s future are very important objectives for any business owner, and should not be overlooked. Although no business can be certain of success, there are strategies and structures that can help protect the business from failure in the future. Working with a knowledgeable and experienced Financial Advisor, Legal Professional and Tax Professional, you can be assured that you can have the proper Buy-Sell Agreement in place so that all parties involved benefit.

Accessing Corporate Earnings

One of the financial planning issues that business owners face is how to access their corporate earnings in a tax efficient way.

There are 5 standard methods:

  • Salary

  • Dividend

  • Shareholder Loans

  • Transfer Personal Assets

  • Income Splitting

There are also unique ways utilizing life insurance and critical illness insurance to access your retained earnings. Please contact us to learn how we can get more money in your pocket than in the government’s.