Organize your business assets in the most tax-efficient manner
As a business owner, you may have substantial personal assets invested in your business in addition to the longterm commitment you have made to your business and its employees. This can have significant implications, not only for you and your business but also for your family’s financial security.
To protect your investments, both business and personal, your business strategy should include carefully structured tax and estate planning components to ensure you have organized your assets in the most taxeffective manner and utilized the tax planning strategies that are available for the benefit of your business and your family.
Personal tax planning
There are several income-splitting strategies available to owners of private corporations in Canada that may benefit you and your family. They include:
Income splitting by paying a salary to family members
Consider income splitting with lower-income family members by employing them in the corporation and paying them a reasonable salary based on the services they perform. The salary they receive will also create Registered Retirement Savings Plan (RRSP) contribution room for them and generate Canada Pension Plan (CPP)/Quebec Pension Plan (QPP) pensionable earnings. Note that the tax rules provide a disincentive to paying a salary or bonus that exceeds the value of the services rendered.
Income splitting by paying dividends to adult family members
If you have an active corporation, you may be able to transfer some or all of the future growth of the business to the next generation of your family using an estate freeze with a family trust. This common business succession strategy allows you to income split by paying dividends from the corporation to your spouse and adult children. If they have no other income, they may be able to receive substantial tax-free dividends from the corporation (the amount varies depending on the type of dividends and the family member’s province/ territory of residence). While this strategy may help you minimize and defer tax, there may be situations in the future where you may wish to unwind or dissolve the structure. Ensure that this flexibility is available in the design of your estate freeze before it is initially put into place.
Multiplying the capital gains exemption
It is possible to “multiply” the capital gains exemption available to you and your family on the sale of the qualifying shares of your business. This could significantly increase the family’s after-tax assets following the sale. One way to do this is by having your operating company owned by a family trust where your family members are the beneficiaries of the trust. When you sell the qualifying shares owned by the trust, the resulting capital gains can be allocated to each beneficiary and they can each claim their capital gains exemption. For example, a family of four can claim four times the capital gains exemption versus the business owner, who can claim the capital gains exemption only once. This results in additional tax savings for the family.
You may also wish to consider some potential estate planning opportunities. Freezing the value of your estate can help you limit your tax liability on death. You can also defer capital gains on the future growth of the business and attribute them to the next generation while retaining control of the business. This may also allow other family members to use their capital gains exemptions.
Remember that for these strategies to be effective, the interest, dividends and capital gains must be paid or payable by the family trust to the beneficiaries. The funds will no longer belong to you as the parent or business owner, so ensure this is a practical strategy for your circumstances.
Tax planning for your business
If you’re the owner of a private Canadian corporation earning active business income, consider whether the following strategies would work for your business:
Setting up a retirement plan
Consider setting up an Individual Pension Plan (IPP) as part of your retirement plan. An IPP is a defined benefit pension plan that, in certain situations, provides greater annual contribution limits than an RRSP. IPP contributions increase with the age of the plan holder.
Contributions to the IPP are taxdeductible for your corporation. The investments in the IPP grow on a taxdeferred basis and are only taxable when you start withdrawing from the IPP.
If investment earnings in the plan are lower than expected, you may be able to make additional contributions.
IPP assets may offer creditor protection and typically suit business owners who are age 40 or older and earn significant employment income. This means that you will need to draw a salary from your business.
Maintain the status of your corporation as a qualified small business corporation
By maintaining your operating company’s status as a QSBC, when you eventually sell its shares, you may be able to take advantage of the capital gains exemption. This exemption is available to individual shareholders of active Canadian private corporations and can represent sizable tax savings.
To qualify for the exemption, ensure your corporation meets the QSBC status. Certain corporate structures may make this easier. Since surplus assets may limit your ability to claim the exemption, you may want to transfer non-business investments to a holding company. This can “purify” the operating company and reduce the accumulation of non-qualifying assets.
Earning Canadian dividend income in a corporation
Canadian source dividends from corporations that are not controlled by the shareholder corporation are subject to a flat refundable corporate tax. If you are earning Canadian public company dividends in a corporation, consider paying out a dividend in the same year if you will be paying taxes at a lower tax rate personally.
Life insurance as a tax-exempt investment in the corporation
If you have surplus funds accumulating in your corporation, you may be taxed at a higher rate on the investment income earned in the corporation than if you earned this income personally (depending on the province/territory). You may also face double taxation on the assets within the corporation on death. Tax planning solutions are available that may help you address this problem.
A corporate-owned tax-exempt life insurance policy can provide income protection for survivors, fund buy-sell agreements or pay capital gains tax on death. Life insurance premiums are generally not taxdeductible, but it can be advantageous to purchase life insurance through a corporation rather than personally. The corporation’s surplus assets can be invested in the insurance policy, grow on a tax-sheltered basis during your lifetime, provide a supplementary source of retirement income and be paid to your beneficiaries as a tax-free death benefit.
