tax|mentor
practical tax updates
Business Succession
Family, Employee, Arm’s Length or Wind-up
Key Tax Planning Issues for
Business Transition
Presented by:
William H. Cooper, CPA, CGA, LLB
and
Moon Mah, CPA, CGA, LLB
of Boughton Law Corporation
a member of Meritas Law Firms Worldwide
@2014
©2010
Business Succession
- Transition
Table of Contents
• The Will
• Planning Considerations
• New Wills, Estates and Succession
Act (“WESA”)
• Intestate Succession: Pre and Post
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WESA
Multiple Wills
Succession Plan: Family Transition
Use of Trusts in Planning
Family Law Act
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Who, when, what…
Trust Interest Problem
Timing Changes
Agreements
• Tax/Legal Transition Issues
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Identifying Transition Options
Business Wind-up Transition
Family Business Transition
Employee Transition
Arm’s Length Sale Transition
Wills
Business Split Up
AETs and JSTs
CGE and CGE Qualified Shares
Holdco Spin Off
Estate Freeze
Wasting Freeze
Other – SHA’s and Misc Tax Issues
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The Will
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Is it current?
Do a family tree
Identify who has specific talents, needs or issues
Does the Will work, given the present
circumstances?
Update and/or consider additional options
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Planning Considerations
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Is the family situation stable?
Is the spouse provided for?
Who are the potential heirs? Do any of them
have issues? (bad marriage, spending habits,
addictions)
Does the Will deal with the business?
Can multiple Wills help?
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New Wills Estates And Succession Act (“WESA”)
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Came into effect March 31, 2014
Changes to Wills drafting - terminology
No change to Wills Variation
Potential for more litigation: courts able to “fix”
errors in the formalities
Very little that impacts existing Wills BUT major
changes if there is no Will
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Intestate Succession: Pre WESA
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No children: all to spouse
Spouse and one child: $65,000 to spouse, rest split
equally
Spouse and more children: $65,000 to spouse,
1/3 of balance to spouse, rest to kids
Spouse gets a life interest in the “spousal home”
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Intestate Succession: WESA
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No children: all to spouse
Spouse is entitled to $300,000 if all kids are shared
with the deceased
Spouse gets only $150,000 if the deceased’s kids are
from another relationship
Spouse and kids share all the rest 50/50
No life interest in the “spousal home” but spouse has
the right to buy it from the estate; may put the
preferential entitlement toward that purchase
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Multiple Wills
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Separate “probatable” and “non-probatable” assets
Deal with assets in different jurisdictions
Appoint different executors for business assets and
personal assets
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Succession Plan: Family Transition
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Is one child more active in the business?
How to compensate others?
Are the kids in on the planning?
Do any have special talents?
Do any have unreasonable expectations?
How to take advantage of strengths/talents
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Use of Trusts in Planning
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Trusts - avoid problems, such as:
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Wills Variation (only applies to estate)
Matrimonial Disputes
Unreasonable demands of shareholders
Dissipation of assets through legal battles, hard feelings
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Benefits of Inter Vivos Trusts
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Testamentary vs. Inter Vivos
“in a Will” vs. “during life”
Inter Vivos Trusts are private documents
Assets in a Trust do not form part of the deceased’s
estate
No need for probate (or probate fees)
Cannot be attacked under Wills Variation
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Use of Inter Vivos Trusts
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Often part of a corporate planning strategy
Family Trusts (with an estate freeze)
Joint Spousal or Alter Ego Trusts (for those 65 and
older)
Roll-Overs allow capital gains deferral
Consider Family Law Act issue (discretionary trusts)
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Family Law Act - Who is Affected
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Legally Married: from the date of marriage
Living together for 2 yrs+
(note, can be immediate if the parties have a child
together, except under Parts 5 and 6)
Inclusion is automatic
May “opt out” by agreement
Agreements can be made to deal with future
events, without binding now
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FLA - When does Separation Occur?
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Under the old act, needed a triggering event
Now, it’s communication by one spouse to the
other, even if they continue to live in the same
house
Or action by one spouse demonstrating an
intention to separate
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FLA - Part 5 – Property Division
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Equal entitlement and responsibility
S. 81 …
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spouses are both entitled to family property and
responsible for family debt, regardless of their respective
use or contribution, and
on separation, each spouse has a right to an undivided
half interest in all family property as a tenant in common,
and is equally responsible for family debt
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FLA -What is Family Property?
s. 84: family property includes everything, unless
specifically excluded (s.85):
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that is owned by at least one spouse, or
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in which at least one spouse has a beneficial
interest; and
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after separation, …… if derived from family
property
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FLA -What is Family Property?
(cont…)
Includes everything:
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Acquired during the relationship
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Disposed of during the relationship but a spouse
retains authority (eg Family Trust settled by a
spouse)
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Held by a spouse at separation; and
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The increase in value of Excluded Property that
occurred during the relationship
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FLA - What is Excluded Property?
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Property acquired before the relationship
Gifts, inheritances
Certain settlements and damage awards
Any of the above held in trust for a spouse
Property held in a Discretionary Trust, if:
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Spouse did not contribute to the trust,
Spouse is a beneficiary of the trust, and
Someone other than the Spouse settled the trust
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FLA - What is EXCLUDED?
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It is clear that property in a discretionary trust
previously was Excluded Property, if:
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A spouse did not contribute to it,
A spouse is a beneficiary, and
The trust was settled by a person other than the spouse
A beneficial interest in a trust is also Excluded
Property if owned before the relationship started
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FLA - Trust Interest Problem
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In either case, the increase in value of Excluded
Property during the relationship is Family Property
Problem fixed? Now only the discretionary interest
in the Trust is Excluded Property – not the increase
in value of property in the trust
Problem fixed – Bill 14 Justice Statues Amending
Act – OIC 23/5/14
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FLA – Timing Changes
Important dates will change
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Presumptive Equal Division:
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At “end of the relationship”
Valuation of Family Property by agreement or at date of a
hearing
Increased value since date of marriage or start of
cohabitation
NOTE: for non-married spouses the date is retroactive to
the date they started cohabiting, not the 2 year
anniversary that actually brings them under the Act
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Family Law Agreements
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Useful to create certainty
Should be a pre-requisite to share ownership
Build into the family trust: no beneficial interest
unless an agreement is in place
Family Law Act creates an issue that can be
mitigated by an Agreement
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Identifying Transition Options
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The Business Wind-up Transition
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unsaleable and no family successor
The Family Transition
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viable business with qualified family successor
The Employee Buy-Out
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strong business - financeable - involved employees
The Arm’s Length Sale
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viable stand alone business
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Business Wind-up Transition
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Operating businesses phase out due to
obsolescence or loss of market share - issue is loss
of “active status”
Dying business with significant business real
estate?
Candidate to crystallize Capital Gains Exemption
(“CGE”) while business still active?
By crystallizing- in effect purchasing a lifetime life
insurance policy
Project tax liability on death and the estate’s ability
to pay – consider life insurance and use of CDA
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Family Business Transition
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Next generation up to the task of managing
business?
Identifying a Suitable Family Successor – consider:
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stability of marriages - competition between siblings family member with interest and ability to run business
Competing siblings – consider business split up
while under parents’ control – avoid s.55 post
death of survivor
Spin-off of redundant or investment/cash assets to
investment/holding company
Separate passive retirement assets
Consider estate freeze and multiplication of CGE
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Employee Transition
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Limited market – good if no logical arm’s length buyer
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e.g. construction businesses not saleable except to insiders
Start early in developing key employees
Long term planning required to effect this option –
consider ESOPs and SARs – “golden hand cuffs” – tie
in with bonus program – arm’s length minority
shareholdings bad - be careful - s.7 options do not
yield CGE!
Get key employees under contract and incentivized
with bonuses and equity participation
Be careful creating minority share position - need SHA
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Arm’s Length Sale Transition
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Typically only available for mature businesses where
the business “runs itself”
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If not then arm’s length sale unlikely – or value depressed
Are key arrangements legally documented
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key employees under contract?
if employees are writing software code have they assigned
the copyright to the company?
leases in place to protect operating facilities, etc.
Does business run itself without regular contact with
owner-manager?
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Few private businesses ever make it to this level – many
clients have unrealistic view of business’ value!
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Tax / Legal Transition Issues
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If a family member has been identified as the likely
successor, do principals’ Wills permit the transfer
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successor family owners often have little interest in working
for the benefit of siblings - consider alternatives to balance
estate
financial advisors need to be family councillors – this stage
requires some difficult decision making by the principal
If two or more potential sibling successors - consider
split of Opco into separate operating entities
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must be done well before death of surviving parent to avoid
taxable spin off – s.55
Consider spin off of investments to siblings not involved in
business to balance Opco transition to a single child
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Tax / Legal Transition Issues
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Is there significant family discord – with possible
challenge of Will? – consider Alter Ego / Joint
Spousal Trust option in place of a will at age 65
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not just to avoid Estate Duties
avoid Wills Variation claims - implement the Will NOW
avoids public disclosure of holdings under Will probate filing
separate businesses operations and/or investment activities
into separate entities - so kids don’t have to deal with each
other
if achieved during lifetime of principals this avoids family
discord and s. 55 butterfly problems on a non-pro rata
distribution which would arise when parents are gone
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Tax / Legal Transition Issues
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CGE and qualified shares - most successful Opcos don’t qualify
for CGE – now $800,000 per “individual” indexed
CGE was designed to encourage creation of new businesses
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most successful Opcos don’t qualify due to passive investment of
excess cash flow taxed at low SBD rate
Plan well in advance - ensure company meets 24 month - 50%
- and time of sale - 10% active business asset tests
Options to insure access to CGE include (discussed below):
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Purify and crystallization
Holdco spinoff of non-essential business assets
Estate Freeze with Family Trust and Holdco Beneficiary
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Tax / Legal Transition Issues
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Crystallize CGE by triggering disposition:
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internal S.85 – swap common shares for prefs and elect into
a taxable gain – claim CGE – better that Holdco roll
roll common shares to Holdco and elect a gain – bad choice
– CGE ACB trapped – many crystallizations in early 90’s
flawed
Watch out for Minimum Tax, ABIL and CNIL balances
May need to pay a “cleansing” bonus or dividend first
A dying business with significant operating real
estate holdings should crystallize to cover value of
RE prior to loss of qualified small business
corporation share status
Avoid need for separate holding/investment company
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Tax / Legal Transition Issues
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Holdco spin out - alternatively get Opco set up with
Holdco to permit tax deferred removal of
investments assets and excess cash flow
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should be considered where there are no substantial
outstanding creditor claims
isolates investment assets from liability issues inherent in
business operations
requires “freeze” of share capital of Opco
Holdco spin out lets kids run business during parents
lifetime with no risk to parent/principals “pension
assets”
Restricts Opco to value of active business –
facilitates sale
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Tax / Legal Transition Issues
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Estate Freeze /Family Trust Option
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If value of Opco exceeds available CGEs (say $1.6 mil for
husband and wife), issue new common shares post freeze
to Family (inter vivos) Trust
Same benefits a Holdco spin off but shifts value of Opco to
next generation - only use if parents have sufficient assets
to live on
Reduces tax on death of surviving parent - gives estate and
next generation more flexibility and financial options
Permits multiplication of CGE on growth shares
21 year deferral of capital gains recognition - works
best with a SHA in place where there are multiple
kids as shareholders
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Tax / Legal Transition Issues
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Consider wasting freeze of Prefs arising on
Crystallization or Holdco Spin off Freeze
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if parents have more assets to live on than they need – stop
paying wages or dividends and use those funds to
repurchase the freeze shares – “kill two birds with one
stone” - eliminate the gain inherent in freeze prefs while
distributing owner compensation
if it is timed right there may be no taxable capital gain on
the death of the surviving parent
Minimal current tax impact for an investment company
earning income subject to RDTOH
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Tax / Legal Transition Issues
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Existing Family Trust?
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make sure Opco onside the QSBC Share test
review for 21 year deadline and determine timing and strategy for
Trust wind up – consider tax deferred roll out of Trust assets to
beneficiaries
roll out of assets or roll down to Holdco and roll out shares?
make sure beneficiaries have not moved to US or ceased to be
resident
Make sure as to status of Trustees – alive? – still resident in
Canada?
Consider impact of new BC FLA when establishing the
Family Trust as it may create an interest in Trust’s assets
(shares of family company) in the departing spouse of a
child who is a named beneficiary of a discretionary Family
Trust
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Tax / Legal Transition Issues
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Family Shareholders Agreement an essential if more
than one child to retain ownership of family
operating company
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parents should consider implementing a Family
Shareholders’ Agreement (SHA) - a road map on how to
run the family business in terms of profit sharing and share
ownership
have a family meeting to discuss parents’ wishes - include
kids but don’t plan on any unanimous agreement
implement SHA at the time of the estate freeze and settling
of a Family Trust
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Tax / Legal Transition Issues
Other Miscellaneous Issues
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Consider S. 84.1 which can convert capital gain to deemed
taxable dividend
Consider application of “designated person” attribution
rules (s.74.4) when effecting an estate freeze and the
creation of an investment Holdco – double tax potential
Consider Part IV tax and Part VI.1 tax on any Holdco spin
off and cross-redemption of shares leading to intercorporate dividends made non-taxable by the s. 112(1)
deduction
Consider s.55 which turns tax free inter-corporate
dividends into taxable capital gains
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tax|mentor
practical tax updates
Thank - you
Business Succession - Family, Employee, Arm’s Length
or Wind-up - Key Tax Planning Issues for Business
Transition
@2014
©2010