As most files that come across our desks are multifaceted, in writing this article we chose to lay out a common scenario involving a family business and provide a strategic process to address related corporate tax, real estate, and succession planning issues.
Shaun Moishe MacDonald is 58 years old and is happily married with 4 children, two of whom work in the family business. Shaun makes widgets and exports them internationally. The business is tremendously successful, located in its own 100,000 square foot building in Vaughan with no mortgage. When Shaun started the business 35 years ago, his lawyer convinced him to incorporate and set up MacDonald Widgets Inc. (“MWI”).
MWI has only common shares as authorized capital. From inception, Shaun has continued to own the 100 issued and outstanding common shares that were issued from treasury. Shaun is the only officer and director.
The company has a value of $20,000,000 (recent appraisal) in addition to $5,000,000 cash in the bank. Shaun had a recent health scare and although he’s now fine, he is worried about paying the least amount of tax, providing for a fair and equitable succession plan, and fulfilling his charitable purposes.
Shaun’s accountant, Freddy, knows that he needs assistance to deal with Shaun’s complex issues, but worries he could possibly lose his client. He contacts his favorite tax accountant, Wally, an advisor he has previously worked with and trusts, and Wally proceeds to bring his team of experts to work with them both. The importance of a knowledgeable team possessing the expertise to not only provide a holistic solution, but one that takes into account the various needs of the individual client cannot be overstated. The team must at a minimum, consider tax minimization, succession planning, execution and have the practical ability to be able to show the client and the referring practitioner how to operate and understand any structure created.
One of the most important considerations is whether the business is continuing in the family, or whether Shaun would consider a sale to a third-party. Although this process is beyond the scope of this article, it is assumed that Shaun is confident in his children and plans to transition the business to the two children working in the business and yet provide equal distribution between all of them. Shaun’s concern is to avoid dissention on his death and ensure fairness.
There are several steps here for consideration:
Step 1: Understanding your Clients’ Facts and Circumstances
A. Dissect the business and consider its components:
a. Real Estate – Separate the real property from operating companies. Wally will have to look at options to separate the business from the real estate, as further discussed below.
b. Redundant Assets – Businesses should constantly monitor the level of redundant assets for creditor proofing and potential asset distribution purposes. MWI has $5,000,000 potentially exposed to creditors. Wally will consider ways to purify the business from all redundant assets, review financial statements and analyze potential steps to distribute same at the lowest marginal tax rate.
You are encouraged to always look at your client’s personal facts such as personal wealth outside the corporation, holding companies, life insurance, health status, quality of life, etc.
Step 2: Consider Assets from an Estate Planning Perspective
Once Wally has dissected the business and looked at the components, he will begin to address estate planning wishes.
A. Real Estate – Separation of the real estate will be key as it will provide Shaun with a rental income stream that he can use to fund his retirement. Consideration should be given as to how the real estate will be leased back to the business and how it will remain in the family.
B. Redundant Assets – This cash can be handled so that Shaun can remove it from MWI, invest it and supplement his retirement with that income. Consideration should also be given to how the cash will be depleted and how it will remain in the family wealth.
C. Transitioning the Business – Shaun will need to consider whether the business will be purchased by his children, gifted to some of the children and compensate the others equally, or sell out and distribute cash when and how he wants during his lifetime.
Step 3: Tax Planning Strategies
Like most business owners, Shaun’s top tax wish list will probably include:
A. Using the Life-time Capital Gains Exemption (“LCGE”). The LCGE is a deduction that allows shareholders of a Qualified Small Business Corporation (“QSBC”) to deduct up to $883,384 (in 2021) of the gain realized on the sale of QSBC shares, essentially resulting in no income tax on that amount, and since June of this year this can apply to small business intergenerational transfer. Qualifying for the LCGE is no simple task. Businesses must be purified and meet the eligibility requirements.
B. Reducing Probate on Death. The Province of Ontario levies probate tax on the value of a deceased’s estate. Probate can generally be managed by implementing secondary corporate wills for high-net-worth individuals. This should be undertaken concurrently with the estate planning to ensure all Wills are updated and dully executed by an estate lawyer.
C. Reducing Tax on Death. Typically, in the year of death, taxpayers have a “deemed disposition” which essentially means you are deemed to have sold your assets at fair market value at the time of death. When taxpayers are survived by a spouse, the deceased’s assets generally go to the surviving spouse tax-free. In such scenario, deemed disposition will occur on the surviving spouses’ death. There are multiple planning strategies for business owners to implement tax planning strategies which allow them to minimize the value of their holdings and utilize structures such as family trusts or insurance to pass wealth to future generations or to assist in charitable giving.
D. Creating Family Trusts. Trusts allow for fixed or discretionary distribution and can be used to move dividends to corporate beneficiaries on a tax-free basis in certain circumstances. Often the trust can almost be controlled post-mortem by the individual setting it up or through his will.
E. Finding the most tax efficient way to take out cash from the company. Considerations might include the use of capital gain strips, insurance structures, freezes and redemption, etc.
Step 4: Implementing the Plan
This is where Wally really demonstrates his value. Purifying MWI of its real estate and redundant assets is a big undertaking. Separating those assets can be done in one of many ways. For instance, MWI can roll its business assets on a tax-deferred basis into a new subsidiary (“Newco”) in return for shares in Newco. This is probably the simplest way at immediately separating the business from the redundant cash and real estate.
This strategy may not be ideal for Shaun as it will complicate his LCGE qualification and potentially delay certain succession plans. This scenario may be suitable for business owners who aren’t looking to sell or pass their businesses to future generations in the near term as it will give time for tax planning to vest.
Breaking up companies near to or as part of a sale event can attract taxation prematurely. Clients must be diligent in seeking timely advice to avoid falling into this trap.
Another option is for Wally to consider implementing an estate freeze as part of a roll-down of the widget business into Newco by freezing the value of shares given to MWI which effectively stops the growth that was attributing to Shaun and enables the opportunity to introduce a new common shareholder (perhaps a trust) that will accumulate the future growth of the widget business. Shaun should consult his lawyer and accountant surrounding the viability of establishing a trust for his family. This also allows for creditor proofing through intercorporate dividend with loans back to the operating company secured by registration under the Personal Property Security Act (in Ontario).
The trust can be discretionary, and Shaun can also use dual wills to offset values and equalize the children’s shares. There also is the ability to utilize insurance to offset taxes and facilitate charitable giving if that is one of Shaun’s priorities.
By incorporating these elements, Shaun’s team of advisors can be nimble and proactive in creating a bespoke strategy for Shaun’s current circumstances, enabling corporate planning now and on an ongoing basis and planning for his future estate.
About the Authors
Razik Sarsam is a Partner with MNP’s Tax Services group in Mississauga and helps owner-managed private businesses and public companies minimize taxes and achieve their business goals. His areas of specialization include tax planning and minimization, structuring, corporate reorganizations, family succession, estate planning and merger, acquisition and divesture transactions. In international tax, Razik helps companies expand their business operations into Canada, acquire entities, incorporate subsidiaries and handle cross-border tax matters.
MNP is a leading national accounting, tax and business consulting firm in Canada.
Jayson Schwarz LLM, is the senior managing partner of Schwarz Law Partners LLP. He practices in the areas of corporate/commercial transactions, business structure, real estate law, tax, succession and corporate planning fields.
Schwarz Law Partners LLP is a full-service boutique law firm, offering sound and practical professional advice in the areas of Real Estate, Business Law, Corporate, Securities and Commercial matters. Our firm tagline “Guiding Your Growth” has been followed with vigour for over 40 years. Schwarz Law Partners LLP services clients of all sizes, from small family businesses to Banks, Trusts, Credit Unions and international corporations.