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My Last Words (For Now)

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 # 551, December 2008, CCH Canadian Limited)

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As this is my last article for 2008, I thought I would take this opportunity to update you on some of the articles I have written this year.

For me, the most interesting article of the year was my October article on valuation and family business share structures, focusing on the control premium issue[1].  The article was prompted by a Vancouver tax file that was brought to national attention over the summer, where the CRA is apparently asserting that a significant control premium applies to voting shares held by an estate freezor.  One thing that worried me as I was researching the article was whether I was about to make a fuss over what could be a local issue, or whether this had the makings of a Canada-wide problem for estate planners.  But just as I was polishing off the article, the CRA issued a release confirming that, even in a “thin-voting” situation – where shares have no significant rights other than to vote, the CRA’s opinion is that, while the amount would depend on the particular facts and circumstances, “a hypothetical purchaser would be willing to pay some amount for the voting control of a company”.[2] 

Control Premium and Family Law Issues

At the time I wrote the article, my mindset was on tax issues: obviously, the control premium might increase death tax exposure in an estate freeze.  Also, if the CRA took the position that a very large control premium applied to so-called “exclusionary dividend” shares (e.g., two classes of common shares each entitled to dividends to the exclusion of the other class, but only one class has voting rights), this might undermine structures which seek to multiply the capital gains exemption.

However, I have more recently been focused on the fact that, in Ontario at least, the control premium issue could be significant in the family law context, e.g., where one spouse has voting exclusionary dividend shares and the other has non-voting exclusionary dividend shares or no shares.  This could be a big problem for the spouse with the voting shares, or an opportunity for the other spouse, depending on how you look at it.  I can see these structures becoming a battleground for well-to-do couples on the rocks - assuming, of course, that the business is still worth something.  A key to the situation could be the perceived viability of a hypothetical oppression action against stripping the company.  I think that this may depend a lot on the particular structure. 

The CRA’s policy on control premiums may also have an impact on an article written by my partner, Michael Goldberg, back in February.  In “The Capital Gains Exemption: Keeping It Pure”[3] Michael described a number of structures that could be used to purify a company, so that it can continue to be eligible for the capital gains exemption.  One of these, dubbed by Michael as the “Neuman Strategy”[4], may involve an exclusionary dividend structure whereby freezor, for example, retains one class of common shares (maybe a single share), with a family trust owning many shares of another class.  The idea is that freezor’s shares could be held by a holding company, so as to allow cash to be systematically dividended out to the holdco, enabling the operating company to continually qualify for the capital gains exemption.  If these shares (i.e., held by father’s holdco) are voting, as may often be the case, this could result in a valuation issue[5] which could undermine the freeze.  In one case we are aware of, the CRA may be taking the position that virtually all of the value of a corporation’s shares is attributable to the voting exclusionary dividend common shares. 

Eligible Dividends – Here Today, Gone in 2012?

Back in May, I wrote an article on eligible dividends[6].  The 2008 federal Budget had proposed a change to the eligible dividend rules so that tax rates on eligible dividends would increase - to compensate for corporate tax rate decreases slated to be fully phased-in by 2012.  When I ran the numbers, I just about fell off my chair.  By 2012, the differential at the federal level between eligible and ordinary dividends would be a mere .29%, with any remaining discrepancy attributable to provincial taxation.  With the difference in federal taxation of eligible dividends all but eliminated, it seems hard to believe that the federal government will maintain this complex and often confusing regime.  So in keeping with my theory that a good tax practitioner should be able to predict the future, I predicted that the federal government will put an end to the eligible dividend regime in 2012.  (This is not to be confused with the Mayan prediction that the world will end in that year – which I do not predict.) 

But as we get toward provincial budget season, it will also be interesting to see whether the provinces step in to eliminate the differences in provincial taxation.  Federal reductions begin in 2010 – i.e., just over a year from now.  So if the provinces want to match the phase-in, the next round of provincial budgets could be the time to do it.  If so, we will have two parallel systems of dividend taxation - with all-but-identical results.

Tax Losses and the Market Meltdown

Last month, I wrote an article – “Tax Planning in Recessionary Times”[7] - focusing on tax-loss selling.  The article largely assumed that losses on security sales would be on capital account.  Typically, this is a reasonable assumption.  But I can practically hear the calls from my accountant colleagues in March and April: “David, I have a client that really needs a refund.  Can he claim his stock market losses as fully deductible?”  (I actually received my first enquiry a few minutes after I wrote this paragraph.)

In anticipation of these calls, I have been thinking about it a bit.[8]  One thing that has changed in recent years is that a lot of investors have managed accounts.  In many cases, the manager, who is obviously an investment professional, will make a great many trades, with a short holding period and very little attention to dividend yield.  Some years ago, Ontario attempted to reassess a number of corporate taxpayers with high trading volumes (usually due to managed accounts) on income account[9].  There seem to be very few cases on managed security accounts;[10] a couple of fairly recent cases in the securities trading area have focused on the past consistency of the taxpayer in question.  Advisors should think carefully about whether: their clients want to have a close encounter with the CRA[11]; the CRA may hold them to income treatment if there are future gains; and even the possibility of a reassessment for prior years if the limitation period is still open.  Your clients may tell you they’ll cross these bridges when they come to them; but at least you’ve warned them (for what it’s worth).

For clients who qualify for inventory treatment on a their securities portfolio, one bonus is that, if they missed the 2008 tax-loss selling deadline, it should still be possible to claim an inventory writedown based on year-end values[12] (in fact, the superficial loss I talked about last month and most other stop-loss rules are out the window).  But if the securities start to appreciate in value, they have to be written back up, if they continue to be held by the same taxpayer. 

— David Louis, J.D., C.A., Minden Gross, Toronto, a member of MERITAS law firms worldwide.