Post on 15-Jan-2016
Advocis Banff School 2007
The New Dividend Tax Rules’ Impact on Corporate-Owned Life Insurance StrategiesFlorence Marino, B.A., LL.B., TEPAVP Tax & Estate Planning Group, Manulife Financial
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Important Information
Agenda
l New dividend tax rules - backgroundl A word about Provincial variation l Corporate client profilesl Overview of general implications of new
dividend rulesl General impacts on Corporate Owned Life
insurance planningl Understanding impact on Buy Sell and
Business Succession - Case Studiesl Conclusion – Lots of opportunity
New Dividend Rules: Background
l The Old Days: Total tax on dividends paid out of high rate
corporate income from Canadian companies
= 56% (maximum) Effective double tax to shareholders
Maximum tax on income from income trusts
=46% (for individual)
New Dividend Rules: Background
l New dividend regime introduced to “level” playing field Applies to dividends paid after 2005 Canadian companies
Public CCPC’s taxed at general federal tax rate
Not income taxed at small business rate Not investment income that has generated
RDTOH
Eligible dividends – CCPC’s
l Distributions paid after 2005 From active income subject to high
corporate tax rate (post 2000) or From “eligible dividends” received after
2005 Received by a person resident in Canada
l General Rate Income Pool (GRIP) Tracks amount available to pay out eligible
dividends Dividends can be paid 1st from GRIP pool
New dividend rules – Public Companies
l Most dividends received from public companies will be eligible dividends – i.e. portfolio dividends
l Must track “LRIP” (Low Rate Income Pool) LRIP will include
Taxable income that has benefited from SBD (might have occurred while a CCPC)
Non-eligible dividends received Must pay non-eligible dividends (out of LRIP)
first
A word about Provincial variation - 2007 dividend tax rates
Ineligible Eligible Capital Dividends Dividends Gains
British Columbia 31.58% 18.47% 21.85%Alberta 25.21% 17.45%* 19.50%Saskatchewan 30.83% 20.35% 22.00%Manitoba 36.75% 23.83% 23.20%Ontario 31.34% 24.64%** 23.21%Quebec 36.35% 29.69% 24.11%New Brunswick 35.40% 23.18% 23.48%Nova Scotia 33.06% 28.35% 24.13%P.E.I 33.61% 24.44% 23.69%Newfoundland 35.62% 30.63% 23.52%
2007
Not with the program
*14.55% by 2009 **22.37% by 2010
CCPC Client Profiles
Opcosl Earning active business income in
excess of small business threshold l In Ontario, probably non M&P
above claw back range $1.1 million+
l Procorps in active phase
CCPC Client profile
Holdcosl Funnelled eligible dividends from
Opcol Opco sold off assets now Holdcol Procorp after professional diesl Investco receiving public company
dividends
Overview of general implications
l Sale of business Old norm: buyer wants assets; seller wants
to sell shares Shift – seller more likely to sell assets –
difference between post asset sale wind up dividend (if sufficient GRIP) and realizing capital gain not significant
Overview of general implications
l Income splitting Stream eligible dividends to higher rate
taxpayersl Alberta trusts continue to thrivel Holdcos
Generally still a bad idea to “incorporate” investment portfolio
Eligible dividends can be used to recover RDTOH
Overview of general implications
l More likely for companies not to “bonus down” to small business thresholds Leaves more “trapped surplus” at the
corporate level More deferred capital gains tax on CCPC
shares? Increased use of wasting freeze?
Overview of general implications
l Eligible dividends generally cheaper than or close to capital gains tax rates Preference shift to dividend producing
strategies vs. capital gains producing strategies
Post-mortem planning use of 164(6) loss carry-back to eliminate capital gain and be taxed on dividend (with or without insurance)
General impacts on corporate life insurance planning
l Are RCA’s for owner mangers (and therefore insurance funding of them) dead?
l Life insurance for increased corporate retentions Increased capital gains exposure Tax efficient investing
l Generally, eligible dividends preferred to capital gains Changes to buy-sell and succession planning
Impact on buy-sell planning – Case study
Facts: Stephen, 45 Jim, 50 50/50 shareholders of Opco ACB/PUC = 0; FMV $2 million Currently receiving 500,000 bonus/yr each Buy sell agreement on death requires “most
tax effective” method of buy-out 1 million corporate-owned life insurance on
each
Buy-sell planning
Opco
$2 million FMV
Stephen Jim
5050
When Stephen dies….
What is most tax effective?
Options under the old rules
l Sale to Jim – promissory note method (All capital gain): Stephen pays 1,000,000 x 23% = 230,000 Stephen’s estate net cash of 770,000 Jim has 1,000,000 ACB – future capital gains
tax liability of 1,000,000 x 23% - 230,00 No CDA remaining
Options under the old rules
l Redemption 100% capital dividend (Half capital gain): Stephen pays 500,000 x 23% = 115,000 Stephen’s estate receives 885,000 Jim has 0 ACB and future capital gains tax
liability of 2,000,000 x 23% No CDA remaining
Options under old rules
l Redemption 50% capital dividend (Half taxable dividend) Stephen’s estate pays 500,000 x 31% =
155,000 Stephen’s estate receives 845,000 Jim has 0 ACB and future capital gains tax
liability of 2,000,000 x 23% = 460,000 500,000 CDA credit remaining
Tax Recap Old rules
0
100
200
300
400
500
600
Tax in 000's
Stephen Jim Total
Redemption 100%CDAPromissory Note
50% Solution
Tax Recap with eligible dividends
0
100
200
300
400
500
600
Tax in 000's
Stephen Jim Total
Redemption 100%CDAPromissory Note
50% Solution
Tax recap including grandfathered shares or spousal rollover
0
100
200
300
400
500
600
Tax in 000's
Stephen Jim Total
Redemption 100%CDAPromissory Note
50% Solution
Spousal Rollover orGrandfathered
No insurance redemption for full eligible dividend or capital gain vs. with insurance new normal
0
100
200
300
400
500
600
700
Tax in 000's
Stephen Jim Total
Redemption 100%
Promissory Note
Insured Redemption50% Solution
Buy-sell planning conclusions
l Insurance funding always better than no funding
l 50% solution even more efficient now l Implications for drafting buy-sell
agreements: address GRIP/eligible dividends Flexibility Perspective
l hybrid agreement?
Impact on succession planning – Case study
Facts: Dad, age 65, owns $1 million pref shares in
Opco with nominal ACB, PUC Active kids hold common shares (Dad has
done a freeze) GRIP balance = $1 million Contemplating options for Dad with and
without insurance
What if Dad dies tomorrow
l Capital gain on Dad’s deathProceeds of disposition $1,000,000- ACB 0Capital gain to Dad $1,000,000
Tax @ 23%* $230,000
*BC 21.85%, Alta 19.5%, Sask 22%
What if Dad dies tomorrow
l If pref are redeemed within first year of estate can get eligible dividend treatment:Deemed dividend 1,000,000Capital dividend 0Taxable dividend (eligible) 1,000,000Dividend tax @ 22%* 220,000*BC 18.47%, Alta 17.45% going to 14.55%, Sask 20.35%
Capital gain on death 0(Loss carry back wipes out gain)
Comparison of optionsl Redeem pref with corporate funds, no
insurancel Redeem pref with corporate funds and
insurance proceeds, purchase $181,000 corporate-owned insurance to fund dividend tax
l Purchase $1million corporate-owned insurance to redeem pref and use 50% of the CDA (50% solution, full funding)
l Purchase $500,000 of corporate-owned insurance, redeem pref at death with insurance and corporate funds and use all the CDA generated by insurance (50% solution)
Summary of options
Undfunded redemption
1,000,000 0 0
Insure for tax
181,000 181,000 181,000
50% Sol’n – full funding
0 1,000,000 500,000
50% Sol’n – 50% funding
500,000 500,000 500,000
Strategy Corp Funds Insurance Capital Div
Dad’s total tax under various options
0
50
100
150
200
250
Tax in 000's
Dad
No insurance
Buy Insurance fordividend tax100% funding 50%Solution*Fund only 50%solution
*500,000 CDA remaining in corp for kids
Cost compare of options for funding redemption
050,000
100,000150,000200,000250,000300,000350,000400,000450,000500,000
PV of Alternatives
Bank loan
Savings
Lump sum
Life insurance
Conclusion
New rules create opportunity!l Most clients (and many professional
advisors) aren’t aware of the implications of the new rules Revise existing buy-sell agreements? Consider options for business succession planning
l Discuss the planning opportunity Is there sufficient funding? New rules as a door opener
Advanced planning needed!
Advocis Banff School 2007
The New Dividend Tax Rules’ Impact on Corporate-Owned Life Insurance StrategiesFlorence Marino, B.A., LL.B., TEPAVP Tax & Estate Planning Group, Manulife Financial