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Tax and Family Business Succession Planning – What’s New

By: David Louis, J.D., C.A., Tax Partner
Minden Gross LLP, a member of MERITAS Law Firms Worldwide.

(*This release is based on an article published in Tax Notes # 557, June 2009, CCH Canadian Limited)

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We are currently working on the third edition of Tax and Family Business Succession Planning, for fall publication by CCH Canadian Limited.  This publication seems to have caught a wave of popularity: family business succession planning and tax planning for wealthy families continue to be hot topics.[1] 

Given that the new edition follows the second edition fairly closely, one might ask what has happened in the last couple of years to merit another edition.  Actually, a lot. 

In general, recent reductions in corporate tax rates, along with the eligible dividend rules, have resulted in a greater bias to retain profits at the corporate level rather than distributing them as salaries/bonuses, thus militating in favour of freezes[2].  In the last few years, this trend has continued.  Changes stemming from the November 2007 federal announcements will result in decreasing corporate tax rates, until federal rates reach a mere 15% in 2012[3].  This year’s Ontario Budget also removed barriers to retaining income at the corporate level[4].  In that province, the general corporate business rate in 2014 will be less than 53% of the applicable rate where income is bonused out. 
 

Hardly a Week Goes By . . .

It is hard to remember a week that has gone by without a new development pertaining to the book.  In the week before publication of this article, there were at least four relevant developments that I have come across (so far!).  The Federal Court of Appeal released its decision on Copthorne[5]; to no-one’s surprise, the Court (which usually sides in favour of the CRA) upheld the lower court’s verdict that the paid-up-capital inflation plan in question contravened GAAR.  But the Court also strengthened the series-of-transactions anti-avoidance concept which is key to many planning manoeuvres, by pouring cold water on the notion that there must be a “strong nexus” between the series of transactions itself and transactions in contemplation of the series, instead looking to a “motivating factor” test.  An article by Richard Wise in the latest issue of Canadian Tax Highlights speaks to the value of an interest in a discretionary trust[6].  Another article in the same issue[7] indicates that the 2009 federal Budget provisions to remedy the result in La Survivance[8] (which, for example, could play havoc with the capital gains exemption on a share sale to a public company or non-resident) has deficiencies when CCPC status of a target corporation is to be claimed on a “sign-and-close” transaction[9].  Propep Inc. v. The Queen[10], a civil law case, seems to support a narrow interpretation of “beneficiary” e.g., for the purposes of the look-through association rules in subsection 256(1.2)[11]. 

Going a further back in time, in the Frye case[12], the Ontario Court of Appeal held that a specific bequest of shares “trumped” restrictions on ownership in a shareholders’ agreement.  Some other recent developments we will mention include CRA restrictions pertaining to stock dividend freezes[13], technical interpretations pertaining to assets used in an active business for the purposes of the capital gains exemption, and developments in respect of distributions from trusts to non-resident beneficiaries.

APFF Stuff

Some of the most interesting new developments come from the Association de Planification Fiscal et Financière (APFF) Round Tables.  In the APFF 2007 Round Table, there were a series of questions on the effect of freeze structures involving family trusts on the tax consequences of various situations pertaining to an operating business.  The questions focused on the deductibility of bonuses, the tax treatment of a bad loan from freezor to a frozen corporation, the deductibility of interest on freezor’s borrowings to make an interest-free loan to a frozen corporation, etc.[14]  Another question, from the 2008 APFF Round Table, elaborates on an earlier technical interpretation[15] specifying that, for the purposes of the association rules, trustees are considered to own shares held by a trust.[16]  Other recent APFF questions give an update on the CRA’s views in respect of the attributes of estate freeze preferred shares[17], and canvass the advisability of adding restrictions on the assignability of interests in certain trusts.[18]

If you read this newsletter regularly, you will know that, in recent months, the “control premium” issue has surfaced – that is, whether there is a premium attributable to voting control in isolation (e.g., as would be the case for so-called “thin-voting” shares)[19].  Originally, this seemed to be a local (west coast) issue; but more recent CRA statements - that a willing buyer will pay “some amount” for a control premium position[20] - has put practitioners on notice that, in theory at least, this is a Canada-wide issue.  At time of writing, the reaction of practitioners in dealing with this issue is still unfolding; and based on discussions with leading valuators, we think that the premium in a freeze structure – that is, where freezor has access to only limited dividends – is modest, notwithstanding the CRA’s apparent position[21].

While this issue is now well known, what might not be is that some of the methodology that might be used to counter a control premium gives rise to other technical issues.  In particular, when shares pass in and out of an estate, there is presumably an acquisition of control, with the loss-streaming rules etc., being potentially applicable.  Happily, though, there are certain “saving rules” in subsection 256(7) that usually alleviate the acquisition of control issues in these situations.  However, particularly where voting rights are designed to drop off on death, we think that there are some imperfections in these “saving rules”.

Other Stuff

Another area that we intend to discuss in more detail is trusts and the association rules.  For example, one specific rule deems shares held in a discretionary trust to be owned by each discretionary beneficiary[22]; another rule – also typically applicable to freezes using a family trust - deems common shares having more than 50% of the fair market value of all of the issued common shares to be a control block[23].  While these rules have been around for quite a while, there is a growing realization that, as the freeze “matures”, association issues can sometimes become acute.  Consider, for example, a situation where a freeze is done in favour of a discretionary trust with teenagers as beneficiaries.  The prospect of their kids becoming successful business owners is probably the last thing that most freezors have on their minds.  However, what with high-tech opportunities and the like, it is often not too long before the kids become successful in their own right.  Of course this may give rise to association issues if one or more of them controls his or her own company, including having to share the small business deduction and the potential loss of SR&ED credits.  In the third edition, we will expand the discussion of strategies that can be used to deal with this issue.

In addition to a discussion of the capital gains exemption, including crystallization methodology, we intend to add a discussion of purification strategies that can result in the multiplication of the capital gains exemption, by being able to maintain the corporation as a qualifying small business corporation.  Also added will be new materials pertaining to testamentary trust status, expanded discussion of family business shareholders’ agreements, and many other features.

As discussed above, recent developments are putting more and more emphasis on a detailed knowledge of tax issues – especially pertaining the taxation of private corporations.  My personal belief is that the area of family business succession planning is steadily moving further into this realm.

David Louis, tax partner, Minden Gross LLP, a member of MERITAS law firms worldwide.  David’s practice focuses on tax and estate planning for entrepreneurs and their corporations.  David Louis  Tax and Family Business Succession Planning was recently honoured by being selected by the Financial Post Magazine as a recommended resource for the “Entrepreneur’s Toolkit” as part of their feature on succession planning (Financial Post Magazine, May 2009).