Doctor Jimmy is a single parent, who owns a professional corporation worth FMV of $ 3 million and an ACB of $0. He also has $900,000 in investments worth $3 million. After his death, there could be three layers of taxes.
1. A $3 million capital gain subject to approximately $740,000 in taxes
2. His daughter, Cindy, inherits his shares with a value of $3 million and an ACB of $0. There will be taxes due upon the liquidation of holdings, some of which will be refundable and some of which will be real taxes. This will be close to $1.7 million to be paid as taxable divided income.
3. The dividends will be taxed when distributed to his daughter. The tax bill will cost around $700,000.
Two strategies that could help remove the triple tax are loss carryback and pipeline planning. The combination of these two methods or, depending on the situation, one method could be applied.
Capital loss planning
This strategy is effective when a corporation has a significant CDA or RDTOH. Technically, this strategy involves a trade of capital gains rates for dividend rates. The shares are redeemed, or the corporation is wound up, in the first year of the estate. In both cases, this results in a deemed dividend and capital losses. Capital losses in the first taxation year of the estate can be carried back to the terminal return and used to offset any source of income in that year (but there is no further carryback to the prior year).
Pipeline Planning
Cindy, Jimmy`s daughter, would incorporate a new co subscribing the shares at a nominal subscription price. Cindy would transfer Prof Co shares to New Co at a fair market value of $3 million.The purchase price would be paid using a promissory note. This is recorded as a loan in the new co’s books.The purchase price would be equal to the ACB of shares, so there won’t be any taxable gain or loss to the estate. Newco would own 100% shares of profco. Profco and New Co would merge at some point in the future to form Amalco. Amalco now owns the entire $3 million investment. The income tax act permits the bumping up of the ACB of investment assets with no tax consequences. Eventually, the note is repaid to the estate without triggering the deemed dividend. It converts what would have been a taxable dividend into a debt repayment. Hence, a third layer of tax is potentially eliminated Dividend tax is eliminated in the estate due to the conversion of high-cost basis shares to non share consideration, reducing the effective tax rate from almost 66% to 26%. It saves the estate of Dr. Jimmy $1.7 million in taxable dividends. CRA needs the OPCO to operate for at least one year or longer. After a year, the companies can be amalgamated. Note that bump rules are very complex and the CRA`s permission must be obtained. It is often used when there is no CDA or RDTOH available.
Assume that if life insurance on doctor Jimmy’s life was purchased, it would pay tax-free dividends to Prof. Co. through a capital dividend account. CDA credit would be equal to the death benefit minus the policy`s ACB. When Profco is amalgamated, the insurance proceeds and CDA credit belong to Amalco. The tax bills could be paid through life insurance, allowing the estate to preserve its assets rather than having to sell them to pay.
Important : This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
