HFI Financial

Keith L. Hatton, CFP, CLU, ChFC, TEP

financial planner planners Canadian planning advisor

We are a Canadian Financial services organization specializing in advanced tax sheltering, wealth accumulation planning, business succession, and retirement planning. We have also been very successful in reducing costs of employee programs and providing more tax effective compensation.

health, dental, rrsp, rrif, tax shelter, mutual funds, shared ownership, split dollar, segregated funds, bonds, life insurance, employee benefits, planners, financial, planner, pension plans, offshore, trusts, living buyout, universal life, IPP, rrsp maximums, disability insurance, RCA, levered, financial planning, estate planning, buy sell agreements, group insurance, group RRSP, accident and sickness insurance, Canadians Can Now Purchase an Affordable US Health Care Plan

We are a Canadian Financial services organization specializing in advanced tax sheltering, wealth accumulation planning, business succession, and retirement planning.

Financial, RRSP, Mutual Fund, Estate Planning, IPP, RRIF, Employee Benefits, Life Insurance, Universal Life, Tax Shelter, Living Buyout, Financial Planning, Retirement Planning, Shared Ownership, Pension, Trusts, Offshore, Shareholder Agreements, Accident and Sickness Insurance, Group Insurance, Canadians Can Now Purchase an Affordable US Health Care Plan

Summary 

This Memorandum outlines a charitable giving strategy for shareholders of private corporations.
The purpose of the strategy is twofold:
·        To fund a testamentary charitable gift, and
·        Preserve the donor's estate value 

The strategy creates substantial charitable endowments, enabling a donor to ensure the funding of favorite charitable activities. Life insurance policies are used creatively to deal with substantial tax liabilities that arise on the death of a shareholder. The strategy applies to shareholders of private corporations. With some modifications, it can also apply to shareholders of public corporations. 

Assumptions 

This Memorandum makes the following assumptions:
·        John and Jane Doe, resident Canadians, own all of the issued and outstanding common shares of a Canadiancontrolled private corporation ('Opco')
·        The common shares have a fair market value ('FMV') of $12 million, and nominal adjusted cost base ('ACB') and paid-up capital (`PUC')
·        A disposition of the common shares will not qualify for transitional relief from the application of subsection 112(3) of the Income Tax Act (Canada), RSC 1985, c.1 (5 t" Supplement), as amended (the `Act'). Unless otherwise stated, statutory references in this Memorandum are to the Act. 

Step 1 

The Does exchange their common shares for $12 million of redeemable/retractable preference shares in Opco (reorganization under section 86. The preference shares have the same ACB and PUC as the common shares.A family trust is established, and it subscribes for Opco common shares. The Doe's children are beneficiaries of the trust. 

Under the terms of their wills, each of John and Jane will transfer their respective preference shareholdings to their spouse at death, achieving a spousal rollover (subsection 70(6)). The wills also provide that on the death of the surviving spouse, the shares are transferred to a family trust, and thereafter to their children (in accordance with the terms of the trust). 

Note: If no further planning is carried out, there will be a deemed disposition, on the death of the surviving spouse, of the preference shares (subsection 70(5)(a)). The tax liability is about $4.5 million. 

Step 2 

Opco acquires a joint second to die life insurance policy on the lives of John and Jane - that is, the policy proceeds are payable on the second of them to die. Opco is also the beneficiary of the policy. As the beneficiary, it will be entitled to a credit to its capital dividend account (`CDA') (see definition of `capital dividend account' in subsection 89(1)) to the extent that the `proceeds of disposition' (defined subsection 148(1)) exceed the policy's `adjusted cost basis' (defined paragraph 148(9)(a)).

The policy face amount is $6 million. The annual premium is about $85,000.
It is anticipated that the credit to the CDA will be not less than $6 million. 

Step 3 

On the death of a spouse (say John), his shares are transferred to Jane under his will. The spousal rollover avoids ant tax on his portion of the $12 million capital gain inherent in the preference shares. On Jane's death, Opco collects the proceeds and $6 million is credited to its CDA.
Jane will be deemed on death to have disposed of her preference shares for $12 million. As the ACB is nominal, she has a terminal T1 gain of $12 million, and a tax liability of about $4.5 million. The preference shares are redeemed from the estate of the second spouse to die (say Jane) for $12 million. The transaction proceeds as follows:
·        Jane's estate has a deemed dividend of $12 million
·        The redemption proceeds are paid with  $6 million cash (life insurance policy proceeds), and   $6 million promissory note (secured by a general security agreement and financing statement), or a debenture, bearing commercially reasonable terms
·        The deemed dividend is treated as a $3 million capital dividend, and a $9 million taxable dividend. (For a discussion of issues related to treating a portion of a dividend as a capital dividend, and a portion as a taxable dividend, see Peter W.B. Everett and Chris F. Ireland, "Impact of the Proposed New Stop-Loss Rules," Report of the Proceedings of the Forty-Ninth Tax Conference, 1997 Conference Report (Toronto: Canadian Tax Foundation, 1998), 17:25-6).
·        As the conditions set forth in subparagraph 112(3.2)(a)(iii) have been met (that is, capital dividend not exceeding the thresholds described in the. subparagraph), the estate realizes a $12 million capital loss that is eligible to be carried back to Jane's terminal year pursuant to subsection 164(6). As such, Jane has no tax liability in her terminal year. (For a detailed discussion of this tax planning technique, see Everett and Ireland, ibid. at 17:24-5).
·        Under their wills, John and Jane create a private charitable foundation (Note: the foundation could have been established during lifetime) and Jane donates the note (or debenture as the case may be), to the foundation
·        Properly structured in the will, the gift will be treated as having been made by Jane's estate. It is crucial to this strategy that the estate, and not Jane in her terminal year, make the gift
·        The gift by the estate will not be considered a gift of a 'nonqualifying security' for the purposes of the Act and will be eligible for the charitable contribution tax credit (see discussion of this issue in Window on Canadian Tax, Document 9807000, Question 14)
·        The charitable contribution tax credit, computed at 50% of the FMV of the gift, can be used by Jane's estate to offset its tax liabilities
·        The gift will create a tax credit of $3 million for Jane's estate. Assuming an effective tax rate of 33 1/3% on the dividend (accounting for gross-up and dividend tax credit), the tax liability on the $9 million deemed dividend is $3 million. The credit offsets the tax liability, with the result that no tax is payable by Jane's estate
·        As there is no gain in Jane's terminal year (because of the subsection 164(6) offset arising due to subparagraph 112(3.2)(a)(iii)), and as there is a sufficient tax credit generated in the estate on the gift to the foundation, neither Jane nor her estate pay any tax on her death. 

Step 4 

The trust is wound-up and the property of the trust (Opco common shares) is distributed to the Doe children in satisfaction of their capital interests in the trust (subsection 107(2)). Jane's estate distributes $6 million cash to the Doe children.

Summary 

At the conclusion of the strategy, the following results have been achieved:
·        The Doe children.own all of the shares of Opco, which have a FMV of $6 million ($12 million net of the note gifted to the foundation) - this assumes that Opco has neither increased nor decreased in value since the freeze. If Opco has increased in value, the value of the children's interest in Opco will be greater than $6 million
·        The Doe children have received $6 million cash
·        The foundation has a $6 million asset
·        John and his estate have avoided the payment of tax through the use of the spousal rollover available under subsection 70(6)
·        Jane and her estate have avoided the payment of tax through the use of subparagraph 112(3.2)(a)(iii) and the gift of the note to the foundation
·        Opco retains a $3 million CDA credit as it has used only $3 million of the $6 million credit due to the subparagraph 112(3.2)(a)(iii) limitation. The CDA credit is potentially worth about $1 million (based on a 33 1/3% tax rate otherwise payable on taxable dividends that can be treated as capital dividends). It is difficult to attribute a present value to the $1 million as the timing of the dividends is uncertain, and as discount rates will fluctuate over time as the dividends are paid. However, one can say that the credit has great value, especially given that it is a significant amount. In summary, this strategy presents meaningful, credible and identifiable tax planning strategies for clients.

Information Request Form click here

We are a Canadian Financial services organization specializing in advanced tax sheltering, wealth accumulation planning, business succession, and retirement planning. We have also been very successful in reducing costs of employee programs and providing more tax effective compensation.

health, dental, rrsp, rrif, tax shelter, mutual funds, shared ownership, split dollar, segregated funds, bonds, life insurance, employee benefits, planners, financial, planner, pension plans, offshore, trusts, living buyout, universal life, IPP, rrsp maximums, disability insurance, RCA, levered, financial planning, estate planning, buy sell agreements, group insurance, group RRSP, accident and sickness insurance, Canadians Can Now Purchase an Affordable US Health Care Plan

We are a Canadian Financial services organization specializing in advanced tax sheltering, wealth accumulation planning, business succession, and retirement planning.

Financial, RRSP, Mutual Fund, Estate Planning, IPP, RRIF, Employee Benefits, Life Insurance, Universal Life, Tax Shelter, Living Buyout, Financial Planning, Retirement Planning, Shared Ownership, Pension, Trusts, Offshore, Shareholder Agreements, Accident and Sickness Insurance, Group Insurance, Canadians Can Now Purchase an Affordable US Health Care Plan

Call us toll-free at (866) 444-2745 with questions or comments about this web site.

Copyright © 1996-2008 Hatton Financial Inc.

Last modified: December 14, 2008