POST-MORTEM AND SHAREHOLDER AGREEMENT CONSIDERATIONS IN LIGHT OF THE ELIGIBLE
DIVIDEND REGIME
FAIZAL VALLI, CA1
Introduction The purpose of this paper is to demonstrate the complexities of allocating the general rate income pool
(“GRIP”)2 among shareholders within the context of a shareholder agreement, particularly on the death of
a shareholder. This paper will briefly review the eligible dividend3 regime, and the effect of the GRIP on
common post-mortem planning strategies. This paper will also outline potential methods to allocate the
GRIP balance among shareholders of a Canadian-controlled private corporation (“CCPC”).4 Finally, a
comprehensive case is utilized to illustrate a tax efficient post-mortem strategy in a non-arm’s length
situation.
Eligible Dividends
Tax integration has long been a policy objective of the Canadian income tax system. Corporate income is
subject to corporate taxes. Such corporate after-tax income is then available for distribution to the
corporation’s shareholders by way of a dividend, which is then subject to personal income taxes, resulting
in two levels of taxation. The tax policy seeks to achieve integration such that income earned in a
corporation and paid to its shareholder(s) provides roughly the same after-tax result as income earned
directly by an individual. However, tax integration has generally only been achieved for active business
income5 earned by CCPC’s up to the available small business deduction,6 but has not been achieved for
such income earned by large private corporations, or public corporations.7
In recent years, investors turned to more tax efficient structures, namely income trusts8 and publicly
traded partnerships,9 to earn greater after-tax income, as compared to after-tax income earned from public
corporations. The main attraction to these structures was that the income was distributed directly to
individual unitholders, without the imposition of taxes at the entity level, thus providing better
integration.
In an effort to improve tax integration, the Department of Finance (“Finance”) issued a press release on
November 23, 2005 titled Minister of Finance Acts on Income Trust Issue, in which Finance introduced
the concept of eligible dividends, or generally, corporate dividends paid from after-tax income subject to
the general corporate tax rate.10 Accordingly, the recipient of an eligible dividend would be entitled to an
enhanced gross-up11 and dividend tax credit,12 whereas the existing gross-up and dividend tax credit
would remain the same for non-eligible dividends, or corporate dividends paid from after-tax income
benefiting from the small business deduction. As a result, the eligible dividend regime generally results
in better tax integration for large corporations or public corporations, since the taxation of eligible
dividends reflects the fact that dividends are paid from income subject to the higher general corporate tax
rate.
F. Valli, Page 1
Eligible dividends are taxable dividends received by a person resident in Canada and designated as such.13
Eligible dividends may be paid by a CCPC to the extent that such CCPC has an amount in its GRIP.14 A
CCPC’s GRIP is comprised of income that has been subject to the general corporate tax rate. A taxpayer
receiving an eligible dividend must gross-up income by 45% of the dividend (for 2009). However, the
taxpayer is entitled to a dividend tax credit of 11/18 (for 2009).15 This gross-up and dividend tax credit
compares favorably to 25% gross-up and 2/3 dividend tax credit available for non-eligible dividends.
The eligible dividend regime has changed the tax planning framework for Canadian owner-managed
corporations. As an example where owner-managers would typically bonus down corporate income to
the small business limit,16 it may now be more tax efficient to pay higher corporate taxes in order to
increase a corporation’s GRIP balance, and pay eligible dividends.17 Furthermore, eligible dividends play
an important role in post-mortem planning, especially in the context of the various share redemption
strategies discussed below.
The Incidence of Double Taxation on Death
The potential double tax issue in post-mortem planning for shareholders of CCPC’s has been the subject
of many past papers.18 Accordingly, this paper will briefly outline the double tax issue, and then describe
some mitigating strategies. The examples below focus on situations where a CCPC has two related19 or
arm’s length20 shareholders, and one shareholder dies. In addition, the shareholder agreement of such
CCPC requires a redemption or repurchase of the deceased shareholder’s shares. It is assumed that the
CCPC has sufficient funds available to redeem or repurchase the deceased shareholder’s shares, whether
through a corporate-owned life insurance policy, cash reserves, or the sale of the CCPC’s property.
In order to illustrate the incidence of double tax on death, assume that Mr. Apple owns 100 Class A
voting common shares of Opco, a CCPC, with an adjusted cost base (“ACB”) and paid-up capital
(“PUC”) of $Nil, and a fair market value (“FMV”) of $1,000,000. Mr. Apple is resident in Alberta, and is
subject to the highest marginal personal tax rate.
On Mr. Apple’s death, there is a deemed disposition of his Opco shares at their FMV immediately before
death, which results in a capital gain reported on Mr. Apple’s terminal tax return of $1,000,000.21 The
shares are then deemed to be acquired by Mr. Apple’s estate at an ACB equal to their FMV.22 When the
shares acquired by Mr. Apple’s estate are subsequently repurchased by Opco, there is a deemed dividend
on the repurchase23 equal to the FMV of $1,000,000. At the same time, the repurchase constitutes a
disposition24 of the shares for which the proceeds are $Nil.25 This results in a capital loss of $1,000,000 to
the estate. Therefore, tax is imposed twice: first on the deemed disposition prior to Mr. Apple’s death,
and then on the repurchase dividend. Furthermore, Mr. Apple’s estate is left with a capital loss of
$1,000,000 which may potentially be useless.
In order to eliminate such double tax, the executor of Mr. Apple’s estate26 may elect under subsection
164(6) of the Act to carry back the capital loss realized in the estate to Mr. Apple’s terminal tax return,
within the estate’s first taxation year. Accordingly, the $1,000,000 capital loss realized will offset the
F. Valli, Page 2
$1,000,000 capital gain in Mr. Apple’s terminal return, resulting in tax imposed only on the deemed
dividend to the estate.27
Pre-1995 Tax Elimination on Death
Prior to 1995, a common way to eliminate tax on death was through the use of a corporate-owned life
insurance policy to redeem/repurchase the shares of the deceased shareholder (the “Pre-1995 Life
Insurance Strategy”). Using the example above, assume that Mr. Orange, a non-arm’s length individual,
owns 100 Class B voting common shares of Opco (representing 50% of the issued and outstanding voting
common shares of Opco) with an ACB and PUC of $Nil, and a FMV of $1,000,000. Accordingly, Opco
has a FMV of $2,000,000. Mr. Orange is also resident in Alberta, and is subject to the highest marginal
personal tax rate. Finally, Opco owns life insurance policies on the lives of both Mr. Apple and Mr.
Orange for $1,000,000 each.
Prior to 1995, on Mr. Apple’s death Opco would receive life insurance proceeds of $1,000,000, and such
amount would be credited to Opco’s capital dividend account (“CDA”).28 A capital gain of $1,000,000
would be reported on Mr. Apple’s terminal tax return for the deemed disposition of his Opco shares, and
Mr. Apple’s estate would be deemed to have acquired the Opco shares with an ACB of $1,000,000.
Subsequently, Opco would repurchase the shares acquired by Mr. Apple’s estate, giving rise to a deemed
dividend which Opco would elect to be a capital dividend,29 resulting in no tax payable by the estate. In
addition, the deemed dividend on repurchase would constitute a disposition of the Opco shares and the
estate would report a capital loss of $1,000,000. The estate’s executor would then elect to carry back
such loss pursuant to subsection 164(6) to offset Mr. Apple’s capital gain realized on death. As a result,
the tax payable by Mr. Apple and the estate would be eliminated.30 Table 1 illustrates the Pre-1995 Life
Insurance Strategy.31
F. Valli, Page 3
Table 1
Pre-1995 Life
Ins. Strategy
Terminal return:
Capital gain
Tax thereon (using current Alberta tax rate)
$
$
1,000,000
195,000
Estate first return:
Deemed dividend - intended to be a capital dividend
Tax thereon
$
$
1,000,000
-
Proceeds for capital gains purposes
ACB to the estate
Capital loss available for 164(6) election
$ Nil
$ (1,000,000)
$ 1,000,000
Amended terminal return:
Net capital gain as originally filed
Capital loss applied under 164(6) election
Amended capital gain
$ 1,000,000
$ (1,000,000)
$
-
Total taxes:
Terminal return, as filed
Recovery on 164(6) election
Tax on capital dividend
Total taxes:
$
$
$
$
195,000
(195,000)
-
Effective April 26, 1995, Finance expanded the stop-loss rules in subsection 112(3).32 Specifically,
subsection 112(3.2) was amended to limit the capital loss to a trust, including a testamentary trust, on the
disposition of shares, to the extent that such trust had received non-taxable dividends on such shares. As
a result, a portion of the capital gain realized in Mr. Apple’s terminal return could now be taxable to the
extent that Mr. Apple’s estate received a non-taxable (i.e. capital) dividend.
Finance also added subsection 40(3.6), the affiliate stop-loss rules, in 1995. Subsection 40(3.6) generally
states that where a taxpayer disposes of shares of a corporation, and such taxpayer is affiliated33 with the
corporation immediately after the disposition, the taxpayer’s loss is deemed to be $Nil, and the loss
amount is added to ACB of any shares retained by the taxpayer.
However, subsection 40(3.61) was recently added as an exception to the affiliate stop-loss rule in postmortem situations. Specifically, subsection 40(3.61) states that subsection 40(3.6) does not apply where
the executor of a deceased taxpayer’s estate elects under subsection 164(6). It is important to note that
subsection 40(3.6) may still apply to losses of trusts such as spousal or alter ego trusts.
F. Valli, Page 4
Impact of Subsection 112(3.2) Amendment
Table 2 shows the impact of the 1995 amendment to the stop-loss rules in subsection 112(3.2) (the “1995
amendment”), where Mr. Apple’s estate receives a $1,000,000 capital dividend. As illustrated, the capital
gain in Mr. Apple’s terminal tax return is no longer fully eliminated. Rather, $500,000 of the capital gain
is taxable.
Table 2
Impact: 112(3.2)
Amendment
Terminal return:
Capital gain
Tax thereon (using current Alberta tax rate)
$
$
1,000,000
195,000
Estate first return:
Deemed dividend - intended to be a capital dividend
Tax thereon
$
$
1,000,000
-
Proceeds for capital gains purposes
ACB to the estate
Capital loss before stop-loss rules
$
$
$ Nil
(1,000,000)
1,000,000
Reduction in loss available for 164(6) election - Lesser of:
(i) capital dividend received of $1,000,000 and
(ii) loss otherwise determined of $1,000,000 minus taxable
dividend received on the shares by the estate,
in this case $Nil on the $1,000,000
Minus
50% of the lesser of:
(i) the loss otherwise determined of $1,000,000 and
(ii) captial gain on deemed disposition on death of $1,000,000
Capital loss available for 164(6) election
$
$
(500,000)
500,000
Amended terminal return:
Capital gain as originally filed
Capital loss applied under 164(6) election
Amended capital gain
$
$
$
1,000,000
(500,000)
500,000
Total taxes:
Terminal return, as filed
Recovery on 164(6) election $500,000 @ 19.5%
Tax on capital dividend
Total tax
$
$
$
$
195,000
(97,500)
97,500
F. Valli, Page 5
Grandfathering Provisions
It is important to note that the 1995 amendment to the stop-loss rules does not apply in the following two
circumstances.
Pre-Existing Agreements
A disposition of shares (by an estate, for example) made pursuant to an agreement in writing in place
before April 27, 1995 (a “grandfathered agreement”) is not subject to the 1995 amendment. The CRA has
taken a strict position in stating that a grandfathered agreement will lose its grandfathered status if it is
modified or altered in any way. Grandfathered status may be lost even if changes to a shareholder’s
agreement are made that do not affect the buyout or redemption/repurchase of a deceased shareholder’s
shares. The CRA has provided several technical interpretations as to whether specific circumstances will
cause a shareholder’s agreement to lose its grandfathered status. In addition, several previous papers have
discussed grandfathered agreements.34
Pre-Existing Insurance
Where a corporation redeems/repurchases a deceased individual’s shares using life insurance proceeds,
such redemption/repurchase is not subject to the 1995 amendment where the following conditions apply:
1. the corporation, or a partnership of which a corporation was a member, was a beneficiary of a life
insurance policy that insured the life of the individual or the individual’s spouse, and such policy
was in place on April 26, 1995;
2. the shares being redeemed/repurchased were owned on April 26, 1995 by the individual (other
than a trust), or by a particular trust under which the individual (other than a trust) was a
beneficiary;
3. it was reasonable to conclude on April 26, 1995 that a main purpose of the life insurance policy
was to fund, directly or indirectly, in whole or in part, a redemption, acquisition or cancellation of
the share by the corporation that issued the share; and
4. the disposition is made by the individual or the individual’s spouse or common-law partner, or the
estate of the individual or the individual’s spouse or common-law partner within the estate’s first
taxation year.35
As a result, shares which meet the above grandfathering circumstances (“grandfathered shares”) may be
disposed of using the Pre-1995 Life Insurance Strategy discussed previously, resulting in the elimination
of taxes on death.
The 50% Solution
Alternatively, Opco can employ the 50% Solution, whereby on the repurchase of the Opco shares for
$1,000,000, only 50% of the deemed dividend to Mr. Apple’s estate, or $500,000, is elected to be a
capital dividend. The remaining $500,000 is deemed to be a taxable dividend to Mr. Apple’s estate.
F. Valli, Page 6
Where Opco has sufficient GRIP and designates such deemed dividend to be an eligible dividend
pursuant to subsection 89(14), the estate will pay less tax.
As a rule of thumb, a capital dividend may be paid to the estate of up to 50% of the capital gain on Mr.
Apple’s terminal return. If the capital dividend is in excess of 50% of such capital gain, the excess
amount will grind down36 the capital loss available for carryback under subsection 164(6). Table 3 shows
the total taxes where the 50% Solution is used.
Table 3
Terminal return:
Capital gain
Tax thereon
Estate first return:
Deemed dividend - 50% intended to be a capital dividend
Deemed dividend - 50% as a taxable dividend
Eligible
Dividend
Non-Eligible
Dividend
$ 1,000,000
$
195,000
$ 1,000,000
$
195,000
$
500,000
$
500,000
$ 1,000,000
$
500,000
$
500,000
$ 1,000,000
Proceeds for capital gains purposes
ACB to the estate
Capital loss before stop-loss rules
$ Nil
$ Nil
$ (1,000,000) $ (1,000,000)
$ 1,000,000 $ 1,000,000
Reduction in loss available for 164(6) election - Lesser of:
(i) capital dividend received of $1,000,000 and
(ii) loss otherwise determined of $1,000,000 minus taxable
dividend received on the shares by the estate,
in this case $Nil on the $500,000
Minus
50% of the lesser of:
(i) the loss otherwise determined of $1,000,000 and
(ii) capital gain on deemed disposition on death of $1,000,000
Capital loss available for 164(6) election
$ Nil
$ Nil
$ 1,000,000 $ 1,000,000
Amended terminal return:
Capital gain as originally filed
Capital loss under 164(6) election
Amended capital gain
$ 1,000,000 $ 1,000,000
$ (1,000,000) $ (1,000,000)
$
$
-
Total taxes:
Terminal return, as filed
Recovery on 164(6)
Tax on deemed dividend 14.55% / 27.71%
Total tax
$
$
$
$
F. Valli, Page 7
195,000
(195,000)
72,750
72,750
$
$
$
$
195,000
(195,000)
138,550
138,550
As illustrated above, the 50% Solution, combined with eligible dividends, may reduce overall tax, as
compared to the result in Table 2 where 100% of the deemed dividend is elected to be a capital dividend.
In addition, the 50% Solution preserves 50% of the CDA.
A practical issue arises where Opco intends to declare a total dividend of $1,000,000, of which $500,000
is intended to be a capital dividend. This is because subsection 83(2) requires the full amount of the
dividend to be elected as a capital dividend. In this situation, Opco can first increase the PUC of the
shares to be redeemed/repurchased by $500,000, which will result in a deemed dividend equal to the PUC
increase.37 Such deemed dividend may then be elected to be a capital dividend. Opco can then
repurchase the estate’s shares for $1,000,000, resulting in a deemed dividend to the estate of $500,000.
Redemption without Life Insurance Policy
Table 4 shows the total taxes where Opco does not have a corporate-owned life insurance policy to fund
the redemption/repurchase of Mr. Apple’s shares. As a result, Mr. Apple’s estate has a deemed taxable
dividend of $1,000,000 assuming Opco does not have a positive CDA balance. In this situation, it is
assumed that Opco has sufficient funds on hand available to redeem Mr. Apple’s shares. However, if
Opco needs to liquidate assets to fund the redemption/repurchase, the corporate tax on such liquidation
should also be considered.
Table 4
Eligible
Dividend
Non-Eligible
Dividend
Terminal return:
Capital gain
Tax thereon
$ 1,000,000
$ 195,000
$ 1,000,000
$
195,000
Estate first return:
Deemed dividend
Tax on deemed dividend 14.55% / 27.71%
$ 1,000,000
$ 145,500
$ 1,000,000
$
277,100
Proceeds for capital gains purposes
ACB to the estate
Capital loss available for 164(6) election
$ Nil
$ Nil
$ (1,000,000) $ (1,000,000)
$ 1,000,000 $ 1,000,000
Amended terminal return:
Capital gain as originally filed
capital loss under 164(6)
Amended capital gain
$ 1,000,000 $ 1,000,000
$ (1,000,000) $ (1,000,000)
$
$
-
Total taxes:
Terminal retun, as filed
Recovery on 164(6) election
Tax on deemed dividend 14.55% / 27.71%
Total taxes:
$
$
$
$
195,000
(195,000)
145,500
145,500
$
$
$
$
195,000
(195,000)
277,100
277,100
F. Valli, Page 8
As Table 4 illustrates, the difference in total taxes is significant where Mr. Apple’s estate receives an
eligible dividend rather than a non-eligible dividend. As such, it is evident that the executor of Mr.
Apple’s estate will want to maximize the amount of eligible dividends received so as to reduce the overall
tax burden, or consider other alternatives if GRIP is not available.
The Pipeline Strategy
Another strategy to minimize double tax is commonly known as the Pipeline Strategy. As discussed
previously, Mr. Apple is subject to the deemed disposition of his Opco shares immediately before death,
and Mr. Apple’s estate is deemed to acquire the Opco shares with an ACB equal to their FMV. Assume
that Opco receives life insurance proceeds of $1,000,000 upon Mr. Apple’s death. The Pipeline strategy
then begins with Mr. Apple’s estate incorporating a holding company, Holdco, and disposing of the Opco
shares to Holdco for their FMV of $1,000,000, in exchange for a promissory note of $1,000,000. Such
disposition results in a capital gain of $Nil to the estate. Opco then repurchases the shares owned by
Holdco,38 and elects to pay Holdco a capital dividend on such repurchase using Opco’s life insurance
proceeds of $1,000,000. Accordingly, Holdco then uses the $1,000,000 proceeds to repay its promissory
note to Mr. Apple’s estate. As a result of the Pipeline Strategy, tax is only imposed on the capital gain
reported on Mr. Apple’s terminal tax return. Table 5 illustrates the total taxes using the Pipeline Strategy.
F. Valli, Page 9
Table 5
Eligible
Dividend
Non-Eligible
Dividend
Terminal return:
Capital gain
Tax thereon
$
$
Estate first return:
Proceeds on sale of Opco shares to Holdco
ACB of Opco shares
Capital gain - Estate
$ 1,000,000 $ 1,000,000
$ (1,000,000) $ (1,000,000)
$
$
-
Holdco return - repurchase of Opco shares:
Deemed dividend - intended to be a capital dividend
Tax thereon
$
$
Holdco return - capital loss on repurchase of Opco shares:
Proceeds for capital gains purposes
ACB to Holdco
Capital loss available before stop-loss rules
$ Nil
$ Nil
$ (1,000,000) $ (1,000,000)
$ 1,000,000 $ 1,000,000
Reduction in loss pursuant to paragraph 112(3)(b)
$ (1,000,000) $ (1,000,000)
Capital loss available for 164(6) election
$
Total taxes:
Terminal return, as filed
Capital gain - Estate
Taxable dividend - Holdco
Total tax
$
$
$
$
1,000,000
195,000
1,000,000
-
-
195,000
195,000
$
$
$
$
$
$
$
$
$
1,000,000
195,000
1,000,000
-
-
195,000
195,000
Section 84.1 is an anti-avoidance provision that should be reviewed when considering the Pipeline
Strategy. The purpose of subsection 84.1 is twofold: to prevent the extraction of PUC, and to prevent
capital gains stripping on the transfer of shares to a corporation. Specifically, subsection 84.1(1) applies
where a taxpayer (other than a corporation) disposes of shares of a Canadian corporation (the “subject
corporation”) to another non-arm’s length39 corporation (the “purchaser corporation”), and immediately
after the disposition, the subject corporation would be connected40 with the purchaser corporation. In the
Pipeline Strategy example above, subsection 84.1(1) will apply since Mr. Apple’s estate is disposing of
the Opco shares (the subject corporation) to Holdco (the purchaser corporation), a non-arm’s length
corporation, and immediately after the disposition Opco will be connected with Holdco.
As such, paragraph 84.1(1)(b) deems Mr. Apple’s estate to have received a dividend to the extent that the
proceeds of disposition are in excess of the estate’s ACB of the Opco shares. The estate’s ACB is
reduced for V-day value,41 and to the extent the capital gains deduction (“CGD”)42 has been previously
claimed on the Holdco shares.43 In the above example, it is assumed that the ACB of the Opco shares is
not reduced with regards to V-day value and the CGD. Accordingly, Mr. Apple’s estate will not be
F. Valli, Page 10
subject to a deemed dividend under paragraph 84.1(1)(b) since the proceeds on the sale of Opco shares of
$1,000,000 is equal to the estate’s ACB of the Opco shares. Note that care should be exercised when
contemplating the use of the Pipeline Strategy, especially where the deceased shareholder has previously
claimed the CGD.
Summary
Table 6 provides a summary of the total taxes in Tables 1 to 5.
Table 6
Pre-1995 Life Ins. Strategy
Subsection 112(3.2) Impact
50% Solution
Redemption without Life Ins.
Pipeline Strategy
Total Tax Total Tax
Eligible Non-Eligible
Total Tax Dividends Dividends
$
$
$
97,500
72,750
138,550
145,500
277,100
195,000
195,000
Based on the above strategies, it is evident that the total taxes can vary depending on whether Mr. Apple’s
estate receives eligible or non-eligible dividends, with the exception of the Pipeline Strategy.
Eligible Dividend Rates – Looking Ahead
The eligible and non-eligible dividend tax rates for the Prairie Provinces from 2009 to 2012 are shown in
Table 7, assuming individuals are in the highest marginal tax brackets in the respective Provinces.
Table 7
Eligible Dividends
Alberta
2009
14.55%
2010
16.11%
2011
18.62%
2012
20.85%
Manitoba
Saskatchewan
23.83%
20.35%
25.09%
21.64%
26.74%
23.36%
28.12%
24.18%
Non-Eligible Dividends
Alberta
2009
27.71%
2010
27.71%
2011
27.71%
2012
27.71%
Manitoba
Saskatchewan
38.21%
30.83%
38.21%
30.83%
39.14%
30.83%
39.14%
30.83%
Capital Gains - 2009 to 2012
19.50%
23.20%
22.00%
F. Valli, Page 11
The eligible dividend rate in Alberta will increase to 20.85% from 2012 onward, which will be higher
than the capital gains rate of 19.5%. Accordingly, the Pipeline Strategy may be more tax-efficient from
2012 onwards. However, eligible dividend considerations may continue to be important where the
Pipeline Strategy is not available, or in provinces where eligible dividend rates are lower than capital
gains rates.
Shareholder Agreement Considerations
As the importance of receiving eligible dividends in the preceding post-mortem planning scenarios has
been established, this section focuses on the potential methods of allocating the GRIP balance among
related and arm’s length shareholders within a shareholder agreement. In the absence of planning or
forethought with respect to such allocation, the chance for litigation exists. This section discusses
additional issues that should be considered regarding GRIP allocation. Finally, two examples are
provided for possible use when drafting a shareholder agreement to contemplate the allocation of GRIP.
GRIP Allocation Methods: No Prior Freeze
Where the shareholders of a CCPC have not previously carried out an estate freeze, there are a number of
different methods that may be utilized to allocate GRIP, which are best described using an example.
Accordingly, assume that Mr. Apple and Mr. Orange each own 100 Class A and B voting common shares
of Opco, respectively. The ACB and PUC of Mr. Apple’s and Mr. Orange’s shares is $Nil, and the FMV
attributable to each shareholder is $1,000,000. There are no other issued and outstanding shares of Opco.
Mr. Apple and Mr. Orange wish to amend Opco’s shareholder agreement to contemplate the allocation of
Opco’s GRIP balance on the death of one of the shareholders.
Allocation: Percentage of Voting Shares
The shareholder agreement may contemplate allocating Opco’s GRIP balance according to the percentage
of voting (or equity) shares owned by each shareholder. The advantage of this method is its simplicity.
The disadvantage is that it does not account for how long Mr. Apple and Mr. Orange have each been
shareholders of Opco. For example, suppose that Mr. Apple has been the sole shareholder of Opco since
its incorporation in 2000, whereas Mr. Orange became a shareholder in 2006. If Mr. Apple dies in 2009,
the allocation of the GRIP balance by percentage of voting shares may not seem equitable if the opening
GRIP balance generated by Opco from 2001 to 2005 is greater than the 2006 to 2008 GRIP additions,
when Mr. Orange was a shareholder.44 Another disadvantage is that this method does not contemplate
allocation of GRIP to non-voting shares.
Adjustment for Years of Shareholdings
The shareholder agreement may contemplate allocating Opco’s GRIP balance according to the percentage
of voting shares held, adjusted for the number of years each individual has been a shareholder. In the
F. Valli, Page 12
above example, Mr. Apple’s shares should be entitled to 100% of the opening GRIP balance generated
from 2001 to 2005, and 50% of the GRIP additions from 2006 to 2008.
Adjustment for Prior Eligible Dividends Received
The shareholder agreement may also contemplate eligible dividends already designated to each
shareholder prior to the allocation determination time, being the time of death of one of the shareholders.
For example, suppose that Opco has no prior GRIP balance and generated its first GRIP addition of
$100,000 in 2008. In addition, suppose that only Mr. Apple received an eligible dividend of $50,000 in
2008 on his Class A common shares, and subsequently died in 2009. In this case, it would seem
inequitable to allocate 50% of the remaining GRIP balance of $50,000 to Mr. Apple’s shares since he
already benefitted from the $50,000 eligible dividend in 2008. Rather, the remaining GRIP balance of
$50,000 might be allocated entirely to Mr. Orange.
GRIP Allocation Methods: Prior Freeze or Freeze Contemplated
Suppose Mr. Apple is currently the only shareholder of Opco, and he is contemplating carrying out an
estate freeze and introducing his son Barry as a new common shareholder. In this situation, Mr. Apple
has complete control over amending the shareholder agreement, and he may choose to have all of the
GRIP balance attributed to his common or preferred shares on death. Opco may then issue a separate
class of common shares to Barry subsequent to the estate freeze.
Allocation: FMV of Shares Held
Alternatively, a more equitable method may be to allocate the GRIP balance according to the FMV of all
shares owned by each shareholder. This method may also apply in arm’s length situations and where Mr.
Apple has already carried out an estate freeze. Again, the shareholder agreement may also account for the
number of years each individual has been a shareholder, and prior eligible dividends received by each
shareholder.
Additional GRIP Allocation Considerations
The following considerations may also apply when determining GRIP allocation.
Ability to Negotiate GRIP Balance
The shareholder’s agreement may provide additional flexibility if shareholders can negotiate the
allocation of the GRIP balance. For example, suppose Opco has a GRIP balance of $100,000, of which
$50,000 is otherwise allocable to each of Mr. Apple and Mr. Orange. In this situation, the shareholder
agreement may allow the executor of Mr. Apple’s estate to negotiate with Mr. Orange to receive an
additional GRIP allocation. If, for example, Mr. Apple’s estate accepts lower redemption/repurchase
proceeds in exchange, then subsection 69(1) should be reviewed.
F. Valli, Page 13
Application to RDTOH and CDA
The shareholder agreement may also contemplate the allocation of a corporation’s refundable dividend
tax on hand (“RDTOH”)45 and CDA balances. This may also provide additional flexibility where the
deceased shareholder’s estate can negotiate with the surviving shareholder to obtain the most tax-efficient
outcome. It is arguable whether the RDTOH balance is a tax pool that should be allocable to
shareholders, or whether such tax pool should belong to the corporation, since it represents a pre-payment
of tax by the corporation. However, if shareholders decide to provide for the allocation of the RDTOH
balance, they should address how the RDTOH entitlement will be distributed to Mr. Apple’s estate.46
Non-Resident Shareholders
Pursuant to subsection 89(1), only a Canadian resident can receive an eligible dividend. As such, a nonresident shareholder cannot take advantage of the lower eligible dividend tax rate. However, suppose for
example that a non-resident of Canada and a Canadian resident each own 50% of the same class of shares
of a CCPC, and the CCPC intends to pay an eligible dividend of $100,000 to its shareholders. In this
situation, the non-resident shareholder will receive an ordinary taxable dividend, rather than an eligible
dividend. In addition, the CRA has stated that such $50,000 dividend designated as an eligible dividend
to the non-resident shareholder will not reduce the GRIP balance.47
Amendments to Grandfathered Shareholder Agreements
As previously discussed, grandfathered shares may still be disposed using the Pre-1995 Life Insurance
Strategy to eliminate tax the death of a shareholder. However, the benefits of amending a grandfathered
shareholder agreement to allocate GRIP should be weighed against the cost of losing grandfathering
status.
“Wasting Estate Freeze” Implications
Where a shareholder owns fixed-value preferred shares, such shareholder may consider having the
preferred shares redeemed using the available GRIP balance, in order to take advantage of relatively low
eligible dividend rates between 2009 and 2011. Accordingly, such shareholder’s GRIP entitlement might
also be adjusted to account for eligible dividends received during such shareholders’ lifetime.
Application upon Departure of a Shareholder
The shareholder agreement may contemplate the allocation of GRIP (and/or CDA and RDTOH) upon a
shareholder’s departure from the corporation, rather than just upon death. This may apply where the
corporation repurchases/redeems the shares of the departing shareholder, rather than circumstances where
the departing shareholder sells his or her shares to another party. Where the corporation has three
shareholders, for example, and the departing shareholder cannot utilize his or her GRIP allocation, the
shareholder agreement may contemplate how GRIP is allocated between the remaining two shareholders
upon the third shareholder’s departure.
F. Valli, Page 14
Examples for Drafting Shareholder Agreement
As should be evident so far, an important consideration when drafting a shareholder agreement is to
provide maximum flexibility to the shareholders. In addition, the shareholder agreement may allow for
the most tax-efficient outcome to the deceased shareholder and the estate, or the most equitable outcome
to the deceased and surviving shareholders. At the April 21, 2009 presentation to the Calgary branch of
STEP Canada, Chris Ireland and Kevin Wark provided the following example for possible inclusion in a
shareholder agreement.
The executor shall obtain professional advice as to the most tax-efficient manner of disposing the
shares…income tax benefits available to the deceased shareholder and the estate, including capital
losses, the capital gains exemption, the refundable dividend tax on hand, the capital dividend
account and the general rate income pool shall be maximized…and the surviving shareholders
shall co-operate in structuring a buyout that meets the tax planning objectives of the deceased and
the estate.”
The following is another example for possible inclusion in a shareholder agreement, which contemplates
an equitable allocation of GRIP and CDA. Again, suppose Mr. Apple and Mr. Orange each own 50 Class
A and B common shares of Opco, respectively, and are each entitled to 50% of the FMV of Opco. Opco
was incorporated in 2001 and has a taxation year that ends on December 31st. In addition, Mr. Apple was
the sole shareholder of Opco from 2001 to 2005.
On death or exit of a shareholder, the corporation’s GRIP, used as the basis for eligible dividends,
and the corporation’s CDA balances (the “tax balances”), unless otherwise provided herein, shall
be allocated to the deceased or departing shareholder in the following order:
1.
Subject to the adjustment under paragraph 3 below, where the corporation has only common
shares issued and outstanding, the tax balances shall be allocated in proportion to the
percentage of common shares owned by each shareholder at the determination time [i.e. the
determination time being the time of death or departure]; or
2.
Subject to the adjustment under paragraph 3, where the corporation has issued and
outstanding common shares and fixed value preferred shares, the tax balances shall be
allocated in proportion to the fair market value of all of the issued and outstanding shares
owned by each shareholder at the determination time.
3.
The above allocations shall be adjusted to take into account the years of shareholdings of, and
eligible dividends and capital dividends received by, each shareholder, as follows:
a.
for the years from 2001 to 2005, 100% of the tax balances generated in those years shall
be allocated to Mr. Apple;
b.
for the years after 2005, the tax balances generated in those years shall be allocated in
accordance with paragraph 1 or 2 above, as applicable;
F. Valli, Page 15
c.
the total entitlement to eligible dividends and capital dividends for each shareholder,
from the commencement of his/her shareholding up to the determination time (the “total
entitlement”), shall be determined;
d.
the total of eligible dividends and capital dividends received by each shareholder, from
the commencement of his/her shareholding up to the determination time (the “total
received”), shall be determined; and
e.
the total entitlement shall be reduced by the total received.
The shareholders hereby acknowledge that it is their intent to allocate the tax balances in an
equitable manner.
The purpose of this shareholder agreement example is to ensure that each shareholder receives the
proportionate amount of GRIP and CDA created in the corporation based on the proportionate FMV of
shares (or common shares) owned by each shareholder. Such proportionate amount is adjusted for each
prior year of ownership, as well as prior GRIP and CDA allocated to the shareholders. Where a
corporation receives proceeds from a life insurance policy on the death of a shareholder, the allocation of
the resulting CDA may be made to the deceased shareholder’s shares, if so desired, pursuant to an
additional provision within the above example, or as a separate share redemption provision within the
shareholder agreement.
As a continuation of the above example, Table 8 outlines the share ownership in Opco since
incorporation, Opco’s GRIP additions, and eligible dividends received by the shareholders.
Table 8
Percentage Ownership
Year
Mr. Apple Mr. Orange
2001-2005
100%
0%
2006
50%
50%
2007
50%
50%
2008
50%
50%
2009
50%
50%
GRIP
Addition
$ 500,000
$ 500,000
$ 500,000
$ 500,000
$ 1,000,000
$ 3,000,000
Eligible Div. Received
Mr. Apple Mr. Orange
$
$
$ 250,000 $
$ 375,000 $ 375,000
$ 250,000 $ 250,000
$
$
$ 875,000 $ 625,000
Suppose that Mr. Apple died on May 1, 2009. Accordingly, the allocation of GRIP to Mr. Apple’s shares
will be as follows.
F. Valli, Page 16
Table 9
Year
2001-2005
2006
2007
2008
2009
GRIP Entitlement
Mr. Apple Mr. Orange
$ 500,000 $
$ 250,000 $ 250,000
$ 250,000 $ 250,000
$ 250,000 $ 250,000
$ 500,000 $ 500,000
$1,750,000 $1,250,000
Previous
Eligible Div.
Received
$ (875,000) $ (625,000)
GRIP
Entitlement
$ 875,000
$ 625,000
As illustrated in Table 9, the GRIP entitlement is determined for each of Opco’s taxation years based on
the FMV of shares owned in each such year. The GRIP entitlement is then adjusted for previous eligible
dividends received.
Comprehensive Case
The following comprehensive case is used to illustrate a tax-efficient post-mortem strategy in a non-arm’s
length situation.
Mr. Apple is a resident of Alberta for income tax purposes, and is not a resident or citizen of any other
country. Mr. Apple is married to Mrs. Apple, and has two children from a prior marriage. Mr. Apple is
the sole shareholder of Holdco, a CCPC, and owns 100 Class A common shares with a FMV of
$50,000,000, and an ACB and PUC of $Nil. The FMV of the common shares of Holdco is derived from
Holdco’s ownership of 100 common shares of Opco. Holdco is the sole shareholder of Opco, a CCPC
which carries on business in Canada. The FMV of the common shares of Opco is $50,000,000 and the
ACB and PUC of the Opco shares held by Holdco are $Nil. The Holdco shares are not subject to the
grandfathering provisions pursuant to subsection 112(3.2). Finally, Holdco has a CDA balance of
$8,000,000, and Opco has a GRIP balance of $20,000,000.
Mr. Apple died on May 1, 2009. Holdco’s shareholder agreement requires the repurchase of Mr. Apple’s
shares on death. In addition, Mr. Apple’s will has allocated 50 Class A common shares of Holdco to his
wife, and the remaining 50 Class A common shares to his two children. The executor of Mr. Apple’s
estate would like to minimize the overall tax burden to Mr. Apple.
F. Valli, Page 17
Tax-Efficient Solution
In the present case, the most tax efficient solution is to utilize subsection 70(6) to transfer 50 Class A
common shares to Mr. Apple’s spouse,48 and to pay a capital dividend and an eligible dividend to Mr.
Apple’s estate on Holdco’s repurchase of the remaining 50 shares. The eligible dividend should be
designated in the 2009 calendar year to take advantage of lower eligible dividend tax rates.
Implication of Common Shares Acquired by Estate
On Mr. Apple’s death, there will be a deemed disposition of the common shares of Holdco at their FMV
of $50,000,000. 50 common shares will be transferred to Mrs. Apple on a tax-deferred basis pursuant to
subsection 70(6), and will be deemed to have been acquired by the estate for their ACB of $Nil. The
remaining 50 common shares will be deemed to have been acquired by the estate with an ACB of
$25,000,000 and PUC of $Nil. As a result, the capital gain on Mr. Apple’s terminal return will be
$25,000,000 (rather than $50,000,000).
Subsection 47(1) should be reviewed with respect to the estate’s acquisition of the 100 Class A common
shares. Where subsection 47(1) applies, a taxpayer must average the cost of identical properties acquired
after 1971. Whether a given property is identical to another is a question of fact which must be
determined on a case by case basis. However, shares of a corporation of the same class will likely be
identical property for the purposes of subsection 47(1).49 Pursuant to the preamble of subsection 47(1), such provision applies where a taxpayer who owns one
property, or two or more identical properties, subsequently acquires one or more other properties, each of
which is identical to each such previously acquired property. In the present situation, the estate will
acquire all 100 common shares of Opco at the same time, notwithstanding that the 50 common shares
eventually transferred to Mrs. Apple will have a different ACB than the 50 common shares that will be
transferred to the children. As such, subsection 47(1) should not apply since there is no previously owned
identical property in the estate.
The CRA has commented favourably on the above issue in Document No. 2004-0083161E5.50 In that
case, the taxpayer owned 100 common shares of a family farm corporation. The taxpayer died and under
his will, the shares were divided between his two children. The shares were distributed from the estate to
the children two years after the death of the taxpayer. One child was resident in Canada while the other
was a non-resident. The shares transferred to the child resident in Canada benefited from the rollover
provision at subsection 70(9.2), thus incurring no income tax on the taxpayer’s death and resulting in
shares with low ACB. However, the shares transferred to the non-resident child were subject to the
deemed disposition under subsection 70(5) resulting in capital gains to the deceased taxpayer and a high
ACB on such shares. The taxpayer queried the CRA as to whether subsection 47(1) would apply to
average the ACB of the two children’s shares when they were held in the estate. The CRA responded by
F. Valli, Page 18
stating that subsection 47(1) would not apply, as the estate acquired the shares at the same moment (i.e.
the taxpayer’s death). In a similar situation,51 the CRA confirms that subsection 47(1) does not apply in a case when an estate
holds identical shares which have differing ACB’s due to the application of subsection 70(5) to a portion
of the shares and the application of subsection 70(6) to the remainder of the shares. Accordingly,
subsection 47(1) should not apply to the 100 Class A common shares acquired by Mr. Apple’s estate.
Tax-Efficient Solution – Steps
The following steps should be undertaken to administer Mr. Apple’s estate and minimize overall taxes on
Mr. Apple’s death.
Step 1: GRIP Dividend to Holdco
In order to shift the appropriate GRIP balance to Holdco, Opco will pay a $17,000,000 dividend on the
100 common shares owned by Holdco. The dividend will be designated as an eligible dividend in
accordance with subsection 89(14), and will be deductible by Holdco pursuant to subsection 112(1).
Step 2: Exchange 50 Class A Common Shares
For Holdco to be able to declare a capital dividend and eligible dividend only on the 50 Class A common
shares being transferred to the children, such shares will have to be exchanged for a separate class of
common shares, such as Class B common shares. Such exchange would occur on a tax-deferred basis
pursuant to subsection 51(1).
Step 3: Increase PUC of Class B Common Shares
Next, Holdco will increase the PUC of the 50 Class B common shares by $8,000,000, resulting in a
deemed dividend to the estate of $8,000,000.52 Holdco will elect to pay such dividend from its CDA,
resulting in a tax-free capital dividend to the estate. The 50 Class B common shares will then have a PUC
of $8,000,000.
Step 4: Repurchase of Class B Common Shares
Within the first taxation year of Mr. Apple’s estate, Holdco will repurchase the 50 Class B common
shares from the estate for cancellation at their FMV of $25,000,000. Since the PUC of such shares is
$8,000,000 further to Step 3, there will be a deemed dividend in the amount of $17,000,000,53 which
Holdco will designate as an eligible dividend, in accordance with subsection 89(14). In satisfaction of the
repurchase, Holdco will issue a promissory note to the estate for $25,000,000.
The repurchase of the 50 Class B common shares will trigger a deemed disposition of such shares by the
estate.54 At the time of disposition, the ACB of the 50 Class B common shares will be $33,000,000,55 and
F. Valli, Page 19
the proceeds of disposition of such shares will be $8,000,000.56 Therefore, the capital loss on the deemed
disposition of such shares will be $25,000,000.57
Step 5: Carryback of Estate’s Capital Loss
The executor of Mr. Apple’s estate will then elect under subsection 164(6), within the estate’s first
taxation year, to have the $25,000,000 capital loss realized in the estate to be reported in Mr. Apple’s
terminal income tax return. Such capital loss is not reduced by subsection 112(3.2) in accordance with
the calculation in Table 10.
TABLE 10 - CALCULATION OF SUBSECTION 112(3.2) GRIND:
STATUTORY
REFERENCES AND
NOTES
112(3.2)(a)
The amount (if
any) by which
the lesser of:
(a) Capital dividends received by
the estate on the shares;
(b) The loss otherwise determined
incurred by the estate from the
disposition of the shares minus
taxable dividends received by
the trust on the share
Exceeds one
half of the lesser
of:
(c) The loss otherwise determined
incurred by the estate from the
disposition of the shares during
the estate’s first taxation year (d) the individual’s capital gain on
death from the disposition of
the shares
Plus:
Plus:
112(3.2)(a)(i)
$25,000,000
112(3.2)(a)(ii)(A)
($17,000,000)
$8,000,000
$12,500,000
112(3.2)(iii)(A)
(50% of $25,000,000)
12,500,000
112(3.2)(iii)(B)
(50% of $25,000,000)
(e) taxable dividends received on
the shares and designated under
104(19) or (20) by the trust in
respect of a beneficiary that
was a corporation, partnership
or trust
(f) a life insurance capital dividend
received on the shares and
designated under 104(19) or
(20) by the trust in respect of a
beneficiary
that
was
a
corporation, partnership or trust
F. Valli, Page 20
$ 8,000,000
N/A
112(3.2)(b)(i)
N/A
112(3.2)(b)(ii)
112(3.2) Grind:
N/A
In this case the lesser of
amounts (a) and (b) does
not exceed one half of the
lesser of amounts (c) and
(d), therefore the grind
amount is nil.
Summary
Table 11 shows the total tax on Mr. Apple’s death using subsection 70(6) and subsection 164(6),
compared to the tax-efficient solution. It is apparent that with optimal tax planning by the executor of Mr.
Apple’s estate, there is a significant tax savings. Even if there is no GRIP available in the tax-efficient
solution, the total tax is $4,710,700.58
Table 11
Loss Carryback Suggested
Non-Eligible
Case Solution
Dividend
Eligible Dividend
Terminal return:
Capital gain
Tax thereon
$
$
25,000,000 $
4,875,000 $
25,000,000
4,875,000
Estate first return:
Deemed dividend
Intended to be a capital dividend
Eligible dividend
Tax thereon 14.55% / 27.71%
$
$
$
$
25,000,000
6,927,500
$
$
$
$
25,000,000
8,000,000
17,000,000
2,473,500
Proceeds for capital gains purposes
ACB to the estate
Capital loss available for 164(6) election
$
$
$ Nil $
25,000,000 $
25,000,000 $
8,000,000
33,000,000
25,000,000
Amended terminal return:
Net capital gain as originally filed
Capital loss applied under 164(6) election
Amended capital gain
$
$
$
25,000,000 $
(25,000,000) $
$
25,000,000
(25,000,000)
-
Total taxes:
Terminal return, as filed
Recovery on 164(6) election
Tax on deemed dividend
Total taxes:
$
$
$
$
4,875,000
(4,875,000)
6,927,500
6,927,500
$
$
$
$
4,875,000
(4,875,000)
2,473,500
2,473,500
F. Valli, Page 21
Conclusion In addition to improving tax integration, the eligible dividend regime has drawn focus to the importance
of shareholder GRIP allocation in post-mortem planning, since the benefits of receiving eligible dividends
are evident. As discussed in this paper, there are a number of issues to consider with respect to the
allocation of GRIP between shareholders. Finally, in contemplating the allocation of GRIP and other tax
balances, shareholder agreements should be flexible.
1
The author wishes to acknowledge the following individuals for their significant contributions to the writing and
research of this paper: Kim G C Moody, CA, TEP, Roberto Domagas, CA and Nicolas F. Baass, LL.B, LL.M (Tax)
of Moodys LLP Tax Advisors, as well as Adam Hoffman, LL.B and Jadranka Sahacic of Shea Nerland Calnan LLP
Barristers & Solicitors. All errors, however, remain those of the author.
2
GRIP is defined in subsection 89(1) of the Income Tax Act, RSC 1985, c. 1 (5th Supp.), as amended (herein
referred to as “the Act”), and is calculated pursuant to the provisions in section 89. 3
Eligible dividend is defined in subsection 89(1).
4
Canadian-controlled private corporation is defined in subsection 125(7).
5
Active business income includes income earned from an “active business carried on by a corporation,” defined in
subsection 125(7).
6
The small business deduction is defined in subsection 125(7) of the Act, and the small business deduction rate is
defined in subsection 125(1.1).
7
Public corporation is defined in subsection 89(1).
8
Also known as SIFT trust, which is defined in subsections 122.1(1) and (2).
9
Also referred to as SIFT partnership, which is defined in subsections 197(1) and (8).
10
Corporate tax is computed in accordance with Part I, Division E, Subdivision b of the Act (sections 123 to 125.5).
11
A taxable dividend received is grossed-up pursuant to paragraph 82(1)(b).
12
A dividend tax credit may be claimed by individuals pursuant to section 121.
13
A corporation must designate a dividend as an eligible dividend pursuant to subsection 89(14). In addition, a nonresident may not receive eligible dividends. Regarding the designation of an eligible dividend to a non-resident, see
footnote 47.
14
In contrast, a Canadian corporation other than a CCPC may not pay eligible dividends to the extent that such
corporation has a balance in its low rate income pool (“LRIP”). LRIP is defined in subsection 89(1), and will not be
the focus of this paper.
15
The eligible divided gross-up and dividend tax credit will decrease after 2009 pursuant to paragraph 82(1)(b) and
section 121, respectively.
16
The small business limit is defined in subsection 125(2).
17
Alternatively, owner-managers may choose to obtain a deferral within the corporation if there is no immediate
need to receive dividends.
18
See Joel Cuperfain “Got Me Those “Low Capital Gain, High Dividend Tax, Stop-Loss Rules, Estate-Planning”
Blues” in “Personal Tax Planning,” (2001), vol. 49, no. 3 Canadian Tax Journal, 764-794, Marco Faccone, CA and
Leanne Gehlen, CA, “Post-Mortem Estate Planning: Selected Canadian and US Tax Issues Relating to the
Implementation of Post-Mortem Strategies,” 2006 British Columbia Tax Conference, (Vancouver: Canadian Tax
Foundation, 2006), 12:1-34, and David Christian, ”Post-Mortem Tax Planning,” Report of Proceedings of FiftyNinth Tax Conference, 2007 Tax Conference (Toronto: Canadian Tax Foundation, 2008), 37:1-27.
19
Related persons are defined in subsection 251(2).
20
Arm’s length is defined in subsection 251(1).
21
Pursuant to paragraph 70(5)(a).
22
Pursuant to paragraph 70(5)(b).
F. Valli, Page 22
23
Pursuant to subsection 84(3).
See subsection 84(9).
25
See paragraph (j) of the definition of proceeds of disposition under section 54.
26
Or the executrix, as the case may be (herein referred to as the “executor”).
27
With respect to the timing of the subsection 164(6) loss carry back, Mr. Apple’s terminal tax return will first
report and pay tax on the capital gain. When the deemed disposition subsequently occurs within the estate’s first
taxation year, the executor will elect in prescribed form pursuant to Regulation 1000 of the Act. The executor will
then file an amended terminal tax return in respect of Mr. Apple to offset the capital gain previously reported, and to
recover the tax previously paid.
28
Pursuant to paragraph (d) of the definition of CDA in subsection 89(1).
29
In prescribed form and in accordance with subsection 83(2).
30
Note that the tax burden of the capital gain was not eliminated altogether. Rather, it simply shifted to Mr. Orange,
the remaining shareholder. As a result, even though the Pre-1995 Life Insurance Strategy was favourable to Mr.
Apple’s estate, it may not have been as favourable to Mr. Orange.
31
The format for the calculations in Tables 1 to 5 is credited to the following author: Margaret A. Riggin, CA,
“Post-Mortem Planning Under the New Dividend Regime,” 2007 Ontario Tax Conference, (Toronto: Canadian Tax
Foundation, 2007), 10:1-24.
32
See the Department of Finance Draft Amendments to the Income Tax Act, the Income Tax Application Rules, the
Canada Pension Plan, the Children’s Special Allowances Act, the Customs Act, the Old Age Security Act, the
Unemployment Insurance Act and a Related Act, April 26, 1995.
33
Subsection 251.1(1) provides a definition for “affiliated persons”
34
See for example, Glenn Stephens, “The Canada Revenue Agency Looks at the Grandfathering Rules”, XII(2)
Insurance Planning (Federated Press) 767-71 (2006), and Kevin Wark, “Stop-Loss Grandfathering Revisited”,
XII(3) Insurance Planning (Federated Press) 783-84 (2006).
35
For a detailed discussion of the grandfathering provisions, see T.R. Burpee, “The New Stop-Loss Rules:
Grandfathered Shares” in “Personal Tax Planning,” (1998), vol. 46, no. 3 Canadian Tax Journal, 678-695.
36
pursuant to subsection 112(3.2) 37
Pursuant to subsection 84(1). Note that the shareholders should have separate classes of shares so that only the
desired class of shares is subject to the PUC increase.
38
Section 55 should be reviewed with regards to the dividend to Holdco on the repurchase of Opco shares.
Specifically, if subsection 55(2) applies, such dividend to Holdco will be recharacterized as deemed proceeds of
disposition of the Opco shares. In the present situation, the exception in subsection 55(3) should apply to such
dividend. A potential sale of Opco to unrelated parties may put such dividend offside under section 55.
39
Supra, footnote 20.
40
Subsection 186(4) provides the definition of “connected,” which is slightly modified in subsection 84.1(1).
41
V-day, or Valuation Day, is defined in section 24 of the Income Tax Application Rules.
42
Capital gains deduction is defined in subsection 110.6(1).
43
See paragraph 84.1(2)(a) and (a.1).
44
Recall that subsection 89(7) generally provides an addition to a CCPC’s opening GRIP balance based on such
CCPC’s high-rate taxable income less dividends paid from 2001 to 2005.
45
Refundable dividend tax on hand is defined in subsection 129(3).
46
For example, suppose Mr. Apple’s estate is entitled to $100,000 on the repurchase of its shares, and $50,000 of
Opco’s $100,000 RDTOH balance. In addition, suppose that Opco only has sufficient cash on hand to fund the
repurchase the shares of Mr. Apple’s estate. On such repurchase, Opco will receive a RDTOH refund of $33,000.
Opco may then distribute the refund to Mr. Apple’s estate as a dividend, in satisfaction of Mr. Apple’s RDTOH
entitlement. This will result in a RDTOH refund of $11,000. This cycle may continue indefinitely until Mr. Apple’s
RDTOH entitlement is fully satisfied. A more efficient approach may be for Opco to satisfy the $50,000 RDTOH
entitlement by way of a promissory note to Mr. Apple’s estate.
47
See CRA Document No. 2008-0284951C6 – Eligible Dividend and Non Residents, October 10, 2008.
24
F. Valli, Page 23
48
Note that on Mr. Apple’s death subsection 70(6) allows Mr. Apple’s shares to transfer to Mrs. Apple on a taxdeferred basis. In this case, the Spousal Rollover and Redeem Strategy may be utilized. See Glenn Stephens, “The
‘Spousal Rollover and Redeem’ Strategy”, XI(2) Insurance Planning 694-96 (2005). In addition, pursuant to
subsection 70(6), the 50 Class A common shares must vest indefeasibly in Mrs. Apple, or a trust for the benefit of
Mrs. Apple, within 36 months after the death of Mr. Apple.
49
Where subsection 47(1) applies, the taxpayer is deemed to have disposed of all previously owned identical
property for proceeds equal to the ACB pursuant to paragraph 47(1)(a), and to have reacquired such property for an
ACB equal to the average cost of all identical properties.
50
CRA Document No. 2004-0083161E5 – Adjusted Cost Base of Shares Under Administration of an Estate,
September 17, 2004.
51
CRA Document No. 2000-0015655 – Adjusted Cost Base of Shares Redeemed by Estate, May 24, 2001.
52
Pursuant to subsection 84(1).
53
Pursuant to subsection 84(3).
54
Supra, footnote 24 and 25.
55
Recall that the estate was originally deemed to have acquired the 50 Class A common shares (later exchanged for
Class B common shares) at an ACB of $25,000,000, since such shares were disposed by Mr. Apple at their FMV of
$25,000,000 on death. In addition, pursuant to paragraph 53(1)(b) the increase in the PUC of the class B common
shares of $8,000,000 will also increase the ACB of the class B common shares by an equivalent amount. As a
result, the ACB of the 50 Class B common shares is $33,000,000.
56
Pursuant to paragraph (j) of the definition of proceeds of disposition at section 54, the proceeds of disposition of
the shares will be the FMV of such shares, reduced by the amount of the deemed dividend under subsection 84(3).
The FMV of such shares is $25,000,000 and the deemed dividend under subsection 84(3) is $17,000,000 resulting in
proceeds of disposition of $8,000,000.
57
As discussed previously, subsection 47(1) can be problematic if applicable. If subsection 47(1) applied in this
situation, the ACB of the 100 Class A common shares acquired by the estate would be $25,000,000, of which
$12,500,000 of the ACB would transfer to the 50 new Class B common shares. On the deemed disposition of such
Class B common shares pursuant to Step 4, the ACB would increase to $20,500,000, further to footnote 56. This
would result in a capital loss on such deemed disposition of $12,500,000 rather than $25,000,000. Accordingly,
only half of Mr. Apple’s capital gain of $25,000,000 would be sheltered by the 164(6) election, rather than the full
capital gain.
58
This represents the $17,000,000 deemed dividend to the estate taxed at the non-eligible tax rate of 27.71% in
2009.
AUTHOR INFORMATION
Of Moodys LLP Tax Advisors, Calgary. BBA (Honours) (2004) Simon Fraser University; CA (2005)
Institute of Chartered Accountants of B.C.
F. Valli, Page 24