Tax strategies

Following are a few topics for consideration by business owners:

1) $800,000 Capital Gains Exemption (indexed to inflation)

Owners of shares of Canadian Controller Private Corporations (“CCPC”) may qualify for a $800,000 (plus inflation adj.) capital gain exemption on their disposal. There are a number of conditions that the share owner and company need to meet to qualify. As this exemption is available on an individual basis, if both spouses are shareholders and active in the business, then the potential exemption can be $1,600,000. One of the key criteria for the company is that it qualifies as an “Active” business for purposes of the small business deduction. Also, all or substantially all of the assets in the company must be attributable to the active business. If not, you must take steps to “purify” or transfer out passive assets, such as extra cash or investments, to ensure qualification. Shareholders must also be active in the business.

2) Small Business Deduction

Currently, associated companies must share the small business deduction. This deduction brings the effective combined federal and provincial corporate tax rate down substantially (currently under 14% in Ontario) on the first $500,000 of taxable income. Separate companies may be controlled and operated by your spouse and/or adult children without being associated with the companies controlled by you. This would provide multiple small business deductions within the related group of companies. There are many rules in this area, including de-facto control rules, which must be considered.

3) Individual Pension Plans (“IPP”)

The IPP is a pension funding obligation between a company and its employee(s). It can be offered selectively and retroactively. The past service aspect may go back to 1991 and provide a very large tax-deductible deposit. The main benefit of this plan is that it provides for more pension room then a traditional RRSP. The advantages generally include;-lower management fees, eligible for the $2,000 pension credit, allows for years of service prior to setting up of the plan, exceeds the RRSP contribution limits, assets are sheltered from creditors, interest on funds borrowed by the company to fund the IPP is deductible where RRSP borrowings are not. The disadvantages are that admin. costs are higher, the IPP’s are locked in until retirement and contributions must be made regularly. Under the right circumstances, IPP’s may be a better alternative then RRSP’s.

4) Inter-convertible common shares

It is now becoming a common strategy to structure common shares into separate inter-convertible common shares having separate classes but otherwise identical. The benefit of this structure is to allow for variable distribution of dividends between, say, different family members. This provides flexibility in income allocation between the difference classes of common shareholders.

5) Scientific Research and Experimental Development (“SR&ED”)

The government provides for SR&ED deductions and investment tax credits (“ITC”) on qualifying expenditures. Many businesses, particularly in the manufacturing, production (and related services) and software development industries spend considerable time and resources researching and developing new or revised processes which may qualify for these claims. CRA provides numerous resources to help businesses assess qualifications and process applications. Refer to my SR&ED Guides to Common Topics in the Resource Centre links.

6) Employee non-taxable gifts and awards

An employer can provide up to two non-taxable gifts or awards per employee per year totaling less than $500 each, including taxes, without this being a taxable benefit to the employee. To qualify, the gifts or awards most not be cash or near cash, reimbursements of a gift or award the employee purchased, hospitality awards such as team-building lunches and “thank you for doing a good job” type of awards, points that are redeemable for air travel and other rewards, gifts and awards to shareholders and their relatives, disguised remuneration (ie, given as a bonus). Gifts for special occasions such as Christmas, birth of a child or marriage are generally acceptable. Awards for recognition of special achievements/milestone such as years of service, meeting or exceeding goals or standards would likely qualify.

7) Private Health Services Plan

The CRA does allow companies to set up their own private health services plan (vs. through an insurance company). The plan must be made available to all employees. Shareholders should not have special treatment. When all employees are also shareholders, the coverage should be similar to that provided to employees of similar size and type of organizations. The benefits provided should be similar for all employees. The plans can provide for escalating benefits depending on years of service or other objective criteria, provided they are available to all employees under the same criteria. If structured properly, the expenses are deductable by the company and non-taxable to the employees.

8) Estate freeze

An estate freeze is a generic term relating to a series of corporate reorganization transactions that alter the share structure of your company with the purpose of transferring ownership and future growth to other family members and/or non-related parties on a tax deferred basis.

There are many estate freeze structures, depending on the needs of the controlling shareholders. In a typical parent(s) to children estate freeze situation, the parent (s) exchange their growth (common) shares for redeemable retractable hi-low special shares with a fixed redemption amount equal to the fair market value of the company. New common shares can now be issued to the parents who can gift them to their children.

These common shares now have a nil or nominal value, because the redemption amount of the special shares carry the full value of the company. Future appreciation in the value of the company now attributes to the common shares owned by the children. The parents can continue to maintain voting control. This reorganization can be structured to provide alternate dividend distributions to family members by setting up various classes of special and common shares, depending on the goals of the controlling shareholders.

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Tax Strategies – Personal

Capital losses

Consider triggering capital losses on investments held as these losses can be carried back three years and offset against prior capital gains.

Interest deductibility

The interest on money borrowed to invest is generally tax deductible. If you have debt, such as a mortgage on your home, where the interest is not deductible and you have significant investments, you may want to consider restructuring to make the interest deductible. This may be done by selling your investments, using the proceeds to pay off the home mortgage, then, at a later date, borrowing to purchase other investments. Note that there is now some “GAAR” risk with this and similar transactions due to the recently released Supreme Court of Canada Lipson case which disallowed the interest deductibility. Talk to Nino.

RESP’s

Registered Education Savings Plan lifetime contribution limits have been increased to $50,000 with no annual limit. The government has increased its grant to 20% per year on contributions up to $2,500 or $500. The lifetime grant limit remains at $7,200.

Pension income splitting

Commencing in 2007, the government allowed the splitting of up to 50% of certain pension income between spouses. The income needs to qualify for the pension income tax credit to qualify.

Proprietorship vs incorporation

There are many issues to review when considering incorporation of a proprietorship. Some of the more common considerations are:

1) legal liability
2) anticipated earnings
3) tax deferrals and savings
4) income splitting
5) estate planning
6) reporting requirements
7) transfer of sole proprietorship to corporation tax issues
8) availability of other tax benefits to incorporated companies such as enhanced SR&ED claims and IPP’s
9) capital gains exemption available on sale of Canadian Controlled Private Corporations shares.

Employment expenses

Certain employees can claim expenses related to their employment provide their employer completes a T2200. Typical employment expenses include your automobile and related operation costs, cel phone, food and entertainment, accounting and legal, advertising and promotion, supplies, assistants and professional fees.

Business use of home

You must meet one of two tests to be able to claim a portion of your home expenses for employment purposes, your home is either 1) your principle place of business, or 2) is not your principle place of business but is BOTH a) used on a regular and continuous basis for meeting your clients/customers/patients and b) used exclusively for earning income. Expenses that can be claimed on a pro-rata basis are property taxes, rent, hydro, heating, repairs and maintenance and insurance. The allowed deductions vary depending on whether or not you receive employment commissions.

Tax-free savings account (“TFSA”)

A TFSA is a registered savings account that allows taxpayers to earn investment income tax-free. Contributions to the account are not tax deductable and withdrawals of contributions and earnings from the account are not taxable. Residents of Canada over 18 are generally eligible to establish an account. Commencing at $5,000 per year in 2009, you can now contribute up to $5,500 per year, with indexing to inflation and rounding to the nearest $500 each few years. Any withdrawals the previous year would be added to the contribution room in the current year. Any unused contribution room from the previous year would be added to the contribution room for the current year. Excess contributions will be subject to a tax of one percent per month.

Generally, you can invest in similar investments that you can make in your RRSP. There are serious tax consequences of investing in non-qualifying investments. Withdrawals can be made at any time without tax withholdings with the contribution room being added for that withdrawal the following year. Tax filers will be notified of their contribution room on the annual Notice of Assessment.

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*This information is provided for educational purposes only and should not be interpreted as a specific treatment plan or course of action and is not a substitute for expert professional accounting and legal advice.