Selected Tax Advisory Issues for SMPs

FVTTG DiscussionNovember 5, 2015Erin Swint, CPA, CA

Bryan Hubbell, CPA, CGABen Tokarek, CPA, CA, TEP

LIMITATIONS & RESTRICTIONS

This is a general discussion only.

Each situation is fact specific.

Please talk to your tax advisor before proceeding.

LIMITATIONS & RESTRICTIONS

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without the appropriate advice after a thorough examination of the particular situation.

Any advice herein is based on the facts provided to us and on current tax law including judicial and administrative interpretation. Tax law is subject to continual change, at times on a retroactive basis and may result in incremental taxes, interest, or penalties. Should the facts provided to us be incorrect or incomplete or should the law or its interpretation change, our advice may be inappropriate. We are not responsible for updating our advice for changes in law or interpretation after the date hereof.

Tax Advisory-Selected Issues1

1-The Bigger Picture

2-Accounting Journal Entry

3-Estates & Trusts

4-New Section 55

Tax Advisory-The Bigger Picture1

ObjectivesPlanningLawsEthicsAdvice

TAX

Dynamic Mix

Tax Advisory – the Bigger Picture1. Family

a. Objectives – employment, succession, sale, estates, life style,

retirement,

b. Planning – family dynamics, research tools,

c. Laws – FLA, WESA, other,

d. Ethics – work ethics, integrity, religion, standards, reputation

e. Advise – communication, family meetings, patriarch/matriarch,

format(email-fax-phone-in person).

2. Businessa. Objectives – expansion, contraction, succession, sale, other,

b. Planning – business dynamics, research tools, accounting, valuations,

c. Laws – corporate, commercial, partnership, employees,

shareholders, real estate, other,

d. Ethics – professional, trade, franchise, buying group, associations,

social standards,

e. Advise – business knowledge limitations.

Tax Advisory – the Bigger Picture

1. Financiala. Objectives – short/medium/long term perspectives, retirement,

b. Planning – knowing financial limitations and constraints, research

tools, accounting, brokers,

c. Laws – commercial, finance, contracts, customers, suppliers,

borrowers, lenders,

d. Ethics – lenders’ expectations, trust, integrity, other,

e. Advise – communication format.

2. Taxa. Objectives – compliance, savings, deferral, aggressive

b. Planning – research/reference tools, referrals,

c. Laws – statute, cases, CRA (folio-IT-IC-TI-Admin), policy,

d. Ethics – professional, social-personal standards/repugnancy, GAAR,

civil penalties,

e. Advise – communication format (standards of practice).

Accounting-Journal Entry2

1. Hickman Motors Ltd. v. The Queen, 97 DTC 5363 (S.C.C.) -accounting entries only report on transaction; the actual facts establish the nature and true substance of the transaction.

2. CRA Audit Manual 13.9.22 – Claiming Expenses – Verify that journal entries are supported by the appropriate documents.

3. Per CRA 9823175 - We agree that a journal entry recording a credit in a shareholder loan account does not, in and by itself, constitute the payment of the salary or dividend nor make the transaction legally effective. However, other evidence, such as the appropriate documentation in the minutes of a directors' meeting and the T-4 or T-5 reporting of the relevant amount would demonstrate that a payment has occurred.

1. Purify SBC using AJE – No – per CRA 2011-0415161E52. Consider - Is the AJE a backdating issue?

1. Per CRA 2010-0381961E5 ("backdating" or altering documents and records is clearly not permitted under any provision of the Act)

3. AJE establishing a payable (liability)?4. AJE as payment of a liability?

Accounting-Journal Entry2

AJE as Payable (Liability)3

1. Ordinary dividends – No1. Corporation law/directors’ resolutions2. Per CRA 2013-0515761E5

2. Capital dividends – No1. Corporation law/directors’ resolutions2. Per CRA 2007-0229311I7

3. Bonus/Wages – Maybe? (subject to Fillion below)1. Was liability established before year end? Per CRA 2006-

0168751R3, 2005-0157341R32. But then see CRA admin policy (?) IC 01-1 example 5,

4. Business expenses – No (mostly?)1. Fillion et al. v. The Queen, 2004 DTC 6579 (FCA) – interpreted

as - not enough to make an accounting entry backed by a vague invoice …. must be established that the evidence was real, fully supported and justified

AJE as Payment4

1. Ordinary dividends – No - per CRA 2013-0515761E5

2. Capital dividends – No - per CRA 2007-0229311I7

3. Bonus/Wages – Yes (Maybe?)- per 2012-0452531E5; but does not consider a promissory note (unless an absolute payment?) as a valid payment? Also see IT-109R2 #15(b) and per CRA 2004-0060641E5 and 9218597

4. Business expenses – No (mostly?)

1. Fillion et al. v. The Queen, 2004 DTC 6293 (FCA) - not enough to make an accounting entry backed by a vague invoice …. must be established that the evidence was real, fully supported and justified

2. Settled by net DR/CR – Is it a payment? or S80 forgiveness of debt?

Trusts and Estates

2016 – continental shift in estate planning

1. 2013 federal budget1. Announced intention to eliminate graduated tax rates for

testamentary trusts and grandfathered inter-vivos trusts

2. Effective January 1, 2016

3. Two new categories of testamentary trusts• Graduated rate estate

• Qualified disability trust

4. Restriction on 104(13.1) and (13.2) designations

2. Legislation introduced August 29, 20141. Bill C-43 received Royal Assent December 17, 2014

Trusts and Estates

Graduated rate estate - ITA 248(1)

1. Estate that arose on and as a consequence of the individual’s death,

2. GRE status for up to 36 months from date of death,

3. Must be a testamentary trust,

4. Estate designates itself as a GRE in T3 return for its first taxation year that ends after 2015, and

5. No other estate designates itself as the GRE of the individual

Trusts and Estates

Testamentary

Trust

Estate

Non-

Estate

Assets

Bequest of

Residue

DeceasedTypical Scenario

Examples include: - RRSP/RRIF’s- Life Insurance- Jointly held property- Life interest trusts

Trusts and Estates

1. Benefits of being a GRE– Graduated tax rates for up to 36 months from the date of

death– No tax instalment requirements– Can have off calendar year end– Flexibility to use donation credits on date of death return

or estate T3 return– Ability to use 164(6) loss carry back planning to eliminate

double tax on private company shares

2. Loss of GRE status at end of 36 month period– Deemed year end– Mandatory December 31 year end

Trusts and Estates

1. Top rate taxation after 2015 for testamentary trusts created before January 1, 2013

2. Multiple will planning?

– CRA comments at STEP Canada 2015 Annual Conference

– Practical issues in BC

Trusts and Estates

Qualified disability trust – ITA 122(3)

– Testamentary trust

– Resident in Canada

– Annual joint election with one or more beneficiaries who are eligible for the disability tax credit to be a QDT

– Only one QDT per eligible beneficiary

Trusts and Estates

1. Life Interest trusts

– Spousal trust

– Alter ego or joint partner trust

2. Useful for

– Possible income splitting with spousal trusts

– Avoid probate

– Avoid wills variation

Trusts and Estates

1. Death of beneficiary – old rules– Deemed disposition on death of beneficiary or last to die in joint

partner trust– Tax payable by trust

2. Death of beneficiary – new rules– Deemed year end on death of beneficiary or last to die in joint

partner trust– Gains from deemed disposition reported on date of death

return of individual beneficiary– Tax payable by estate– 160(2) and 160(1.4) joint and several liability of trust and estate– Can trust voluntarily pay tax on behalf of estate?

Trusts and Estates

Summary

– January 1, 2016 is fast approaching

– Traditional estate plans may not be tax-effective

– Review existing wills and estate plans

– Is GRE status required?

– Consider planning options to eliminate double tax on private company shares

– Funding payment of tax on assets in life interest trusts

– Planning for tax rate changes

Section 55:

2015 Proposed Changes

S. 55(2) converts otherwise tax free div. to Capital

Gains or Proceeds on Disposition

Budget 2015

April 21, 2015 – Federal Budget

Major changes proposed to Section 55

Other proposed amendments related to Section 55

Amendments to cost of stock dividends (Section 52)

Amendments to cost base additions for safe income (Section 53)

Amendments to proceeds of disposition (Section 54)

Budget 2015

July 31, 2015 - Proposed amendments to Income Tax Act (ITA)

Effective for all dividends received after April 20, 2015

55(3)(a) Related party exemption has been narrowed

Redemption , acquisition, and cancellation

No longer available for cash dividends

Big Picture

2 New Purpose Tests

Significant reduction in the FMV of any share

Significant increase in the cost of property for the dividend recipient

Other safe harbours have been narrowed:

SIOH – available to the extent the shares have a capital gain

Dividends subject to Part IV tax provided inter-corporately refunded as

part of the series, and refund does not go to individual shareholders

Assumptions

2015 BC Tax Conference paper

“When Intercorporate Dividends are not Tax-Free, Including Changes

to Subsection 55(2) in the Federal Budget”

Paper argues that proposed section 55 will not:

Revoke integration

Will continue to be seen as an anti-avoidance provision

Purpose of dividend will take on renewed importance

Examples

Example #1

“Normal” inter-corporate dividends – normally wouldn’t think

twice unless a sale of assets or shares was looming

Now may need to consider safe income on hand

Opco

Holdco

Dividend

Examples

Example #2

Dividend sprinkling shares held by Holdco

Entire dividend may be a capital gain (Section 55(2.5))

Subject to share rights and restrictions SIOH may not accrue on

shares held by Holdco

Opco

Holdco

Dividend

Examples

Opco

Holdco

Stock Dividend

Example #3

Stock dividend freeze of Opco

FMV of stock dividend may be a capital gain

(Proposed Section 55(2.2) to 55(2.4))

For portion not attributable to SIOH

Examples

Example #4

Opco pays dividend to trust which allocates it to its corporate

beneficiary – Holdco

Now may need to consider safe income on hand

In 2014-0538061C6 SIOH carries through the trust

Opco

Holdco

FT

Dividend

Dividend

Options

Option #1 – Freeze and redeem

Holdco freezes its interest in Opco for pref. shares

Via s. 85, s86 or s51 of the ITA

Presumes all other criteria for s. 55(3)(a) exists

Opco redeems pref. shares

Opco

Holdco Holdco

Opco

Common Pref

Holdco

Opco

CommonRedemption of pref

Step 1 Step 2

Options

Option #1 – Freeze and redeem

Pro

55(3)(a) exemption is available – redemption

No SIOH calculation

Don’t have to rely on not meeting the purpose tests

Cons

Valuation of company in order to freeze value

Expensive to implement

GAAR?

Options

Option #2 – Stock dividend to individual then roll &

redeem

Stock dividend freeze of individual’s shares in Opco

Individual rolls stock dividend shares of Opco to Holdco in

exchange for pref shares of Holdco

Opco redeems stock dividend shares held by Holdco

Presumes all other criteria for s. 55(3)(a) exists

Options

Option #2 – Stock dividend to individual then roll &

redeem

Opco

Holdco

Step 1

Holdco

Opco

Holdco

Opco

Holdco

Opco

Step 2

Step 3

Common & PrefCommon

Common & Pref

Common

Pref

Common Common

Common

Pref

Common

Redemption of pref

Options

Option #2 – Stock dividend to individual then roll and

redeem

Pro

55(3)(a) exemption is available

No SIOH calculation

Don’t have to rely on not meeting the purpose tests on the inter-corporate

redemption

Options

Option #2 – Stock dividend to individual then roll and

redeem

Cons

Conferral of a benefit if stock div on one common s/h and not all common

shareholders s. 15(1.1)

If unplanned for potential litigation?

Valuation of company in order to freeze value

Expensive to implement

GAAR?

Examples

Option 3 – Safe income on hand dividend

Opco

Holdco

Dividend

Options

Option #3 – Pay a safe income dividend

Pro

55(2) will not apply

Don’t have to rely on not meeting the purpose tests

GAAR shouldn’t apply

Cons

Calculate safe income – could be costly & time consuming

Proposed rules suggest there must be a gain on the share

Safe Income on HandSome points to consider:• Safe Income – kind of like R/E on tax basis• Safe Income – must be on hand• Calculated at a determination time• Calculated for each individual shareholder• Shared amongst multiple classes of shares

– Dependant on SR&R of shares issued

• Aggregate amongst any corporation– Significant interest and/or contribute to the gain

• Prev use of CGE may reduce available SIOH

Summary: Can be very complex calculation

Options

Option #4 – Document purpose for dividend

Purification, Securitize loans, Access RDTOH

Among others

Placer Dome 96 DTC 6562 (FCA) – 3 basic propositions for

purpose

Onus on taxpayer to establish the inapplicability of s. 55(2)

Mere denial none of the purposes was to effect a reduction of capital gain is

not enough (need to explain why none of the purposes was a significant

reduction)

Not necessary to additional evidence which shows or tends to show

testimony is true.

Options

Option #4 – Document purpose for dividend

Pros

Argument provided that dividend does not meet purpose tests in 55(2.1)

No SIOH calculation

Cons

Subjective evidence

Could be expensive to defend

Supporting cases:

VIH Logging 2005 DTC 5095 (FCA)

CPL Holdings 95 DTC 5253 (FCTD)

Meager Creek Holdings ltd. 98 DTC 2073 (TCC)

Lobbying for change

Submission by CPA/CBA on May 27, 2015

Submission by STEP Canada on September 30, 2015

And other practitioners

Summary

When paying an inter-corp. div. proceed with caution

Use extreme caution on inter-corporate stock dividends

SIOH can be a very complicated calculation

Purposefully ignoring SIOH might be GAARable 2012-0433261E5

If relying on purpose test document, document, doc…

why none of the purposes is to affect a significant reduction of a

capital gain

Get help if outside of your comfort zone – don’t be a stat.

THANK YOU!

Thank you for attending today!

We stand on the shoulders of all who have come

before.

Thank you for participating and contributing to the

conversation.

QUESTIONS?

Erin Swint, CPA, CA

Phone: 604-853-2030

Fax: 604-853-7297

Email: erin@squireandcompany.ca

Bryan Hubbell, CPA, CGA

Phone: 604-557-5759

Fax: 604-850-7399

Email: bryan@manningelliott.com