COVID-19: Effective tax planning strategies for you and your business
As a Canadian business owner, you have at your disposal a variety of tax planning strategies to help you manage the impact of the global pandemic on your business and stakeholder wealth.
The Tax group at Fuller Landau highlights six effective strategies that, depending on your personal and business circumstances, could help minimize the tax burden and manage income flow for you, other stakeholders, and your business.
Maximizing the Benefit of Your Capital Dividend Account (CDA)
Your corporation’s CDA is a great way for individual shareholders to receive tax-free funds from the corporation. You can maximize the benefit of your corporation’s CDA account as follows:
- Realize capital gains first
- Payout CDA either by a cash dividend or interest-free promissory note(s)
- Realize capital losses to offset realized capital gains
Note that capital dividends can be used to redeem fixed value preferred shares, if such have been previously put in place, which allows for tax-free liquidity and reduced tax upon death.
Putting Estate Freezes in Place
You can also freeze the value of your interest in the corporation with the intention that some or all the future growth of the shareholder’s interest will accrue to the benefit of other shareholders which may include a family trust.
Having an estate freeze in place can reduce tax upon death and allows for additional family members to utilize their capital gains exemption in the event of the sale of the corporation.
The best time to put an estate freeze in place is when the value of your corporation is low but is expected to increase in the future. In addition, if an estate freeze was put in place previously and the value of the corporation has decreased, it may be beneficial to reverse the original freeze and put a new freeze into place based on the decreased value of the corporation.
Planning to minimize taxes upon death is always best done sooner than later. Individual shareholders of a corporation should also consider having dual wills and the appropriate insurance policies in place.
Loss Utilization Planning
During downturns in the economy, loss utilization planning can be an effective tool to reduce the tax burden. Non-capital losses, both corporate and personal, can be carried back three years and carried forward 20 years. Capital losses can be carried back three years and forward indefinitely.
The concept of loss utilization is to allow a profitable member of a corporate group (“Profitco”) to utilize the losses of another member of a corporate group that is in a loss position (“Lossco”). This could include the wind-up/amalgamation of Lossco and Profitco or the transfer of assets to Profitco and various intercompany transactions.
You can also purposely trigger losses on assets that have reduced in value and are unlikely to increase again to offset realized gains. An election under subsection 50(1) of the Income Tax Act may become available to you to trigger a deemed disposition of shares or bad debt for nil proceeds if they have become worthless. This election gives the taxpayer the ability to claim a capital loss (or allowable business investment loss, which is available to individual taxpayers).
The Prescribed Rate Loan Strategy
A prescribed rate loan is a tax planning strategy which allows taxpayers to effectively transfer income from higher-income earners to lower-income family members, reducing total income taxes for the family. This type of planning is also not subject to the tax on split income (TOSI). The strategy is especially effective when the CRA prescribed interest rate is low, and the stock market decline is anticipated to reverse.
The CRA 2020 Q3 quarterly prescribed interest rate decreased from 2% to 1%, making it a good time to implement the prescribed rate loan strategy through a loan to either a spouse or family trust. The prescribed interest rate at the time the loan is established will remain in effect for the duration of the loan regardless of any future interest rate increases.
Generally, setting up a prescribed rate loan requires personally held cash. However, in a downturn or declining stock market, it could be an opportunity for the individual in the higher tax bracket who owns a reduced portfolio value to do a loan “in-kind” when their capital gain on the transaction may be lower.
Earn Capital Gains instead of Dividends
A shareholder may be able to arrange to extract funds from a corporation while receiving the benefit of preferential capital gain tax rates as opposed to dividend tax rates. Currently, in Ontario’s top tax bracket, capital gains are taxed at the rate of 26.76%, while eligible dividends are taxed at 39.34%, and other than eligible dividends are taxed at 47.74%. This means that extracting $1,000,000 from the corporation via this strategy would provide a minimum tax savings of approximately $125,000, less the transaction costs.
This strategy can be accomplished in several different ways, depending on circumstances. Corporations with significant retained earnings, large cash accumulations, redundant assets, or assets with significant unrealized capital gains would be some of the primary targets for implementing this planning.
Structured Buy-Sell of Flow-Through Shares
This is an investment in flow-through shares of a public company where an arm’s length third party immediately purchases the shares from the investor. Buy-sell transactions take place within a short time of each other, minimizing cash-flow requirements needed to make an investment. Such structured transactions provide clients with the full benefits of investing in flow-through shares, while eliminating any market risk associated with such investments.
Structured buy-sell transactions can be done both on a corporate and personal level and could help reduce taxes associated with sudden increases in income as well as building up tax pools for use against future tax liabilities. In addition, corporate-level transactions could help address high shareholder debit balances and help avoid TOSI (in certain specific circumstances). Transactions at the personal level are also well suited for high income earners with significant ordinary income (wages, interest, trust income).
Structured buy-sell transactions can also be used as part of a donation strategy whereby the flow-through shares acquired are first donated to a registered charity and then sold to the arm’s length third party. This can significantly reduce the after-tax cost of donating.
The Fuller Landau Tax group is ready to assist with any of your tax planning strategy needs or questions.
About the Authors
Pavlo Fedorchuk, CPA, CA, CMA, CBV, is the Director of Tax Services at Fuller Landau. He can be reached at 416-645-6576 or pfedorchuk@fullerllp.com.
Nadia Pulla, CPA, CA, is a Senior Manager in our Tax group. She can be reached at 416-645-6543 or npulla@fullerllp.com.
Jennifer So, CPA, CGA, is a Manager in our Tax group. She can be reached at 416-645-6549 or jso@fullerllp.com.