Net Worth Assessment – Avoid it at all costs

A net worth audit is one of the most powerful techniques available to the Canada Revenue Agency (CRA) to unilaterally deem a taxpayer to have a certain amount of unreported income. The net worth audit is a method which, on its premise, assumes the taxpayer has hidden or failed to disclose annual income, and as a result CRA is not able to rely on the accuracy of the amount of taxpayer income from tax returns filed. Subsequently, CRA will use the results of a net worth audit to deem a taxpayer to have unreported income, resulting in allegations of tax evasion or civil fraud against the taxpayer.

In recent years tax professionals have noticed an increase in CRA’s use of net worth audits against taxpayers. The CRA appears to be targeting their net worth audits to cash-based businesses, owner-manager businesses and illegal businesses (such as drug dealers).

The following will attempt to answer two primary questions, first, what is a net worth audit and second, what is the burden on a taxpayer faced with a net worth audit.

What is a Net Worth Audit?

A net worth audit is a two-step audit by the CRA. First, the Agency will look at the taxpayer’s assets and liabilities at the beginning and end of the tax year and determine the increase and/or decrease in the taxpayer’s net worth. Second, the CRA will review the taxpayer’s expenditures for that same tax year and compare them with standards of expenditures according to Statistics Canada.

The net worth method relies on the concept that when a taxpayer accumulates wealth during a tax year, he shall either invest it or spend it. For an auditor conducting a net worth audit, they will consider an increase in the taxpayer’s net worth throughout the year as taxable income. From that starting point, the auditor will add all non-deductible expenditures to the taxpayer’s net worth and then compare the taxpayer’s net worth at the beginning of the taxation year and the taxpayer’s net worth at the end of the taxation year. Any increase in the taxpayer’s net worth will be considered income for tax purposes.

Interestingly, at the audit stage, the CRA has essentially free reign in their assessment and interpretation of the taxpayer’s net worth. Indeed, CRA may assume facts or use general statistics from Statistic Canada in their assessment; in most instances, to the taxpayer’s detriment.

Burden is on the Taxpayer

It is important to understand that because the Canadian tax system is a self-assessing system, the onus is on the taxpayer to rebut all of the Minister’s assumptions and findings.

The Courts have consistently taken the view that once CRA issues a reassessment based on a net worth audit, the taxpayer must rebut all of CRA’s assumptions and findings by either:

Challenging whether the net worth assessment is needed or is the most appropriate method of computing the taxpayer’s income; or

Challenging every specific aspect of the net worth assessment calculations.

In the context of a net worth audit, the taxpayer’s onus of proof is a considerable one. Indeed, in most net worth audits, the auditor will have requested all available taxpayer records including, but not limited to, a list of all inventories, physical assets, debts to creditors, bank records, securities, and any other statements of assets.

From the documentation provided, the auditor may have interpreted some book entries and assume facts that may not be accurate, however, the onus is on the taxpayer to provide proof to clarify, explain and rebut all of the auditor’s assumptions and interpretation of facts.

When combating a net worth audit, the devil is in the details. Every item, interpretation and assumption of the auditor must be analyzed in great detail and dissected for correctness.

Indeed, with every error found, the trustworthiness of this inherently untrustworthy method is called further into question.

If the matter is to proceed before the Tax Court of Canada, pointing out the auditor’s errors in their interpretation shall contribute to discrediting the auditor’s findings and tilt the judge’s opinion in favor of the taxpayer. However, the taxpayer will also need to provide evidence explaining and clarifying the increase in his net worth over the year.

A valid explanation, such as the receipt of an inheritance, will undoubtly favor the taxpayer in his pursuit of rebutting the auditor’s finding. However, if the taxpayer lacks any evidentiary documentation attesting his point then the matter becomes one of credibility; something a taxpayer should always avoid.

Conclusion

Maintaining well-organized documents and financial records is truly the sole solution for succeeding over a net worth audit. Indeed, documenting all receipts of significant funds received during the taxation year, especially any foreign funds, is the very best way to beat a net worth audit.

My former colleague Arthur Drache once wrote: “good paper almost always will prevail, but in a contest of your unsupported word against CRA, you’ll almost always lose.” This remains the gold standard in a net worth audit.

 If you are the subject of a net worth audit, we highly recommend you consult with your accountant and lawyer. Tierney Stauffer LLP would be glad to assist and advise you. If you have any questions, please do not hesitate to contact us.

Sébastien Desmarais
LL.B., LL.L., J.D.
Lawyer, Tierney Stauffer LLP
This article is provided  as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter  referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship. 

Succession Planning – How to Plan for Passing the Torch

For many business owners, the phrase “succession planning” evokes images of passing the company torch to a family member. But succession planning does not necessarily mean passing a business along to one’s relative. Instead, it refers to planning the way in which you wish to exit your business, and, as this article will  summarize, this can be done in a number of different ways.

The importance of having a  succession plan should not be overlooked. Having a plan in place will help ease the transfer of a business from one owner to another, manage expectations of family members, employees,  managers and business partners who may desire ownership of the business, thereby helping  departing business owners preserve their relationships with these individuals and maximize the net financial return from your business. Placing your business in the hands of another takes time to orchestrate and can raise many issues, including properly valuating your business, assessing tax implications and estate planning issues, and training your successor. Therefore, it is important to begin succession planning early.

When planning the succession of your business, there are a number of options to consider, such as transferring the business to a family member or an employee, manager or partner of the business or selling the business to an unrelated third party. In addition to deciding how your business will be passed on to a new owner, there are a number of other elements which should be considered. Th e following list sets out a few of these items, but should not be considered an exhaustive list.

Choose your Successor

If you wish to keep the business in the family, you will need to determine if this is a viable option. The key question for you to consider is whether there is someone in your family who is interested in owning the business and who has the necessary skill set for running the business? This can be a very difficult element as you will often have a family member who has the interest but not the skill set. Failing a family member, you may consider whether an individual already involved as an employee in the business is a candidate for taking over the business.

After you have chosen your successor, you will need to arrange for his/her training in the business. It is also a good idea to have on-going communication with your successor to keep him/her involved in the succession process. This will allow him/her to understand his/her role in the business and in the overall transition process.

As well, having the potential successor become a minority owner early in the process (subject to the right protective agreements if things don’t work out) is often an excellent method of both “test driving” the potential successor’s involvement, and creating a financial stake for the successor in the business.

If neither of the potential internal buyers is viable, you may need to sell your company to an unrelated third party. In any of these cases, it is always a good idea to consider what other stakeholders (i.e. family members, business partners and/or employees) should be consulted prior to making a decision. If you are concerned that a conflict in the decision-making process might arise, you can implement an agreed-upon conflict resolution mechanism.

Decide on a Timeline

As with any plan, you will need to decide on, and establish, a timeline in which you wish to exit your business and transfer ownership. If you intend on maintaining voting control of the company after you have retired from working for your company, which is often the case if you are owed money from the successor and maintained some ownership then you should, at a minimum, consider what dates you wish to retire, transfer your share ownership and transfer voting control.

Position Your Business For Sale

The income tax rules in place today require businesses to meet certain tests in order for the owners to achieve the best tax results from sales. It is very important that early steps are taken to properly structure your business to maximize your net return on a sale. Your lawyer or accountant should be consulted now as it is often too late once a decision to sell is made to put in place the required structure.

Planning for Unforeseen Circumstances

It is always prudent to have a contingency plan to make sure financial resources are in place to ensure your business could continue in the case of an unforeseen circumstance, such as an accident, illness or death. Life and disability insurance are great tools to consider.

Regular Review of your Succession Plan

Review your succession plan regularly to determine whether it is still appropriate and applicable to your then-current circumstances and to current income tax rules. Ensure you revise the plan if changes are needed. Succession planning will raise financial, tax and legal implications so it is always a good idea to speak with advisors, such as your accountant, lawyer, and banker, before deciding which route is best for you.

Stephen Tierney & Jennifer Brigandi

Stephen Tierney is a Partner and Jennifer Brigandi is an Associate in the Business Law Group of Tierney Stauffer LLP. If you require further details, or require a lawyer to review or help draft your succession plan, please contact Jennifer at (613) 288-3221 or jbrigandi@tslawyers.ca
Tierney Stauffer LLP is a full service law firm with offices in Ottawa, Cornwall and arnprior. We focus on solutions.

Planning Your Business Succession

Every successful business owner will one day be faced with the dilemma of having to choose a successor. Letting go of the reins of his or her business that has been built through years of labor will not be easy and a smooth succession can only be achieved if the business owner is ready to sell or pass the reins to his or her heir(s).

There is no single boilerplate for a succession plan for all businesses as every business succession is unique. However, all successful successions have similarities and I will highlight some of those similarities in this article.

BEAT THE ODDS
The statistics on small business succession are discouraging as approximately 50% of small businesses that pass to the next generation of owners remain in business five years later. The statistics concerning family owned-business are less encouraging as only 30% will survive a next generation and probably only half of those will survive to the following generation.

Although the reasons why some business successions fail while others succeed are vast and open to interpretation, lack of preparation and poor communication are common traits in many failed plans.

SHAREHOLDER AGREEMENT
Most successful entrepreneurs and professionals will agree that a shareholder agreement is important as it establishes a solid business foundation for the shareholders. The shareholder agreement can also provide the initial steps for planning the business succession as it usually maps out the structural transitions of the business in situations such as the death or disability of an owner, a marriage breakdown of a shareholder or the outcome of a feud between co-owners. Essentially, the shareholder agreement is a negotiated document between the shareholders of the business defining the relationship of the shareholders and the future succession of the business.

A well-drafted shareholder agreement provides solutions to those unfortunate situations by inserting specific clauses that pre-determine the outcome. A shareholder agreement should include clauses such as:

• Disability – addressing how and when the shares of a co-owner who becomes permanently disabled can be bought out.
• Death – determining how to deal with the deceased owner’s shares.
• Retirement – determining the retirement income for the owners who cease to work actively in the business.

In our opinion, a shareholder agreement should always be part of the business succession discussion.

HAVE A PLAN
Business succession planning is a process that should be considered sooner rather than later. To achieve a smooth succession of the business it is best to develop a comprehensive plan that both achieves the retiring owner’s objectives and serves the successor’s needs.

In an ideal scenario, the business owner(s) and the “next generation” would meet with a group of professionals (accountant, lawyer and advisors) to discuss their individual goals and the various options to attain these specific goals. The design of the plan should be viewed with an open mind as compromises are inevitable and without the input of all the succession would be vulnerable.

The succession plan should address three main areas:

• The transfer of labour
• The transfer of management and decision-making (control)
• The transfer of ownership.

However, the main issue to address in any succession plan is: who is/are the successor(s) and how it will be accomplished. The answers to those questions will provide the basis for the structure of the business succession plan.

IMPLEMENTING THE PLAN
Establishing a succession plan is only the first step of the business succession; that plan must then be implemented. It is often at this stage that plans derail because of a lack of willpower on behalf of the parties or because the plans are put on the backburner.

Once a succession plan has been agreed upon, someone must take the leadership role and establish the timetable for the stages of the succession. The leader must make sure that all parties involved (owners, accountant, lawyer and advisor) are made aware of the deadlines and, more importantly, he or she must ensure those deadlines are met.

It is possible that the succession plan may change in light of unforeseeable events so the parties involved must remain flexible and open-minded. However, unless those unanticipated events jeopardize the entire succession plan (such as the death of the owner), the succession plan should only be postponed and not dismissed in its entirety.

TAX CONSEQUENCES
You must take into consideration tax consequences when implementing an estate and business succession plan.

If one voluntarily avoids preparing a business succession plan, at his or her death he or she will be deemed to have disposed of all his or her assets at fair market value potentially resulting in a significant tax debt payable by the estate and the business being left in complete disarray.

Deemed Disposition at Fair Market Value
One of the greatest concerns business owners face when planning for their estate and the business succession is how he or she can minimize the capital gains tax that will arise on the sale or other type of transfer of ownership.

As mentioned above, although avoiding the issue and letting his or her Will dictate the business succession is probably the worst choice one can make, unfortunately many owners prefer opting for this option in hopes of avoiding conflict because of the succession. If the business owner decides to leave their shares of their company to their children under their Will, they will be deemed to have disposed of these shares at fair market value triggering a capital gain which may potentially deplete the value of their Estate.

Capital Gains Exemption
Every individual resident in Canada is entitled to a lifetime capital gains exemption of up to $750,000 upon disposition of shares of a qualifying small business corporation. To qualify for the exemptions the following criteria have to be met:

1.  The shares must have been owned throughout the 24 month period preceding the date the shares were disposed of;
2. At least 50% of the fair market value of the business’s assets must be used in the course of carrying on an active business in Canada;
3. At the date the shares are disposed, approximately 90% of the fair market value of the business’s assets must be used in the course of carrying on an active business in Canada.

The capital gains exemption allows the business owner to contemplate several succession strategies such as an estate freeze

Estate Freeze
One strategy that is often mentioned is the estate freeze; a technique that limits the growth of your capital property and the resulting tax on death during your lifetime by transferring the future growth in the capital property to your heirs.
In order to protect their Estate by preventing its value to grow to a size that might incur considerable taxes and probate fees, the business owner will:

1. exchange their common shares for preferred shares of equal value where the new preferred shares would not grow; and
2.  family members (wife, children and grandchildren) would be given common shares and all future growth would attach to those common shares.

An estate freeze allows for a tax deferral for a period commencing when the family members acquire the new preferred shares until the sale of those shares. The estate freeze allows the business owner to minimize the taxes arising at his death.

However, it is important to understand that an estate freeze involves major changes on the part of the business owner and the family. Several issues will also need to be addressed as a result of the freeze and we recommend that anyone who is contemplating an estate freeze consult their accountant and their lawyer in order to fully understand the implications of a freeze for the business and for the family members.

The estate freeze is the most common technique used when a business succession is contemplated but it is not the only technique. Depending on the situation, there are other techniques that are more complex and beyond the scope of this Newsletter. For more information, we recommend you consult your accountant and lawyer.

SUCCESSION OF THE FAMILY BUSINESS – A WEB OF COMPLEXITIES?
Succession of the family business is more delicate as it often involves the varying interests of the children and the parents’ concerns of being fair toward them; it is a balancing act between the realities of the business and the family.
First, one must ask whether there is a viable family successor(s). It is also important to identify the goals of that successor(s) and to develop the right succession plan in light of those goals.

Second, involving family members in the business at an early stage provides an opportunity for the next generation to familiarize themselves with the requirements of managing the business to be involved in the decision-making process. Family involvement should be a key component of the family business succession plan.

Third, it will be necessary for the family to address important and difficult issues such as management authority and family participation. The emergence of a strong corporate governance plan will only be possible if all related parties participate in the generation of the plan and all recognize their responsibility in this plan. The ultimate goal is to have the parent recognize will be in the need to pass the reins to the next generation and having confidence that business is in good hands and will continue to thrive in the future.

CONSULT WITH PROFESSIONALS
Business succession planning can strain the personal relationship of co-owners or your family members. However, maintaining the status quo and doing nothing is the worst option as it only postpones the issues and your legacy could be jeopardized.

Letting go is seldom easy but making well-informed decisions will make the transition less stressful and ensure your business transition results in a lasting and profitable gift. In contemplating retirement and handing the reins of your business to your successor(s), we recommend consulting with your accountant, lawyer, and any other professional advisor that may be necessary for your particular business, in order to be thoroughly advised.

REVIEW YOUR WILL
After all this planning, don’t forget to review your Will. At Tierney Stauffer LLP, we will gladly review your Will with you and discuss more advanced estate planning aimed at maximizing the value of your estate while minimizing the taxes and probate fees.

Planning the succession of your business is not easy so reduce the stress and complexities by seeking proper advice. Don’t forget that this is in your own best interests as well as the best interests of your loved ones.

If you have questions regarding this issue or any other issue pertaining to Wills and Estates Planning, please contact Sebastien Desmarais at (613) 288-3220 or sdesmarais@tslawyers.ca.

Sébastien Desmarais
LL.B., LL.L., J.D.
Associate, Tierney Stauffer LLP

 

This article is provided  as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter  referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship. 

 

Shareholders’ Agreement & Tax Implications: Are You Informed?

When two people decide to begin a business venture, the implementation of a shareholders’ agreement is a key to preventing unfortunate consequences at a later time. The primary purpose of a shareholders’ agreement is to define the relationship amongst the parties and should include the procedure and actions to be taken in the event the relationship
sours over time or in the event that the parties change due to disability or death. Ultimately, a shareholders’ agreement aims at establishing provisions for future key decisions to deal eff ectively with any possible event and circumstance
that may arise.

However, as each situation is unique and requires an agreement that meets the intention of the parties it is preferable to avoid a “boilerplate agreement”, which are oft en ill-suited to the specifics of the shareholders’ goals and may fail to result in the most tax efficient outcome.

The following sets out a few provisions that should always be carefully considered and fully understood.

Survivorship Arrangements
One of the primary functions of a shareholders’ agreement is to provide for a buy-sell arrangement upon the death of a shareholder. Provisions are made for how a deceased shareholder’s shares will be dealt with and how the obligations of the surviving shareholders will be funded. These provisions should be structured so as to provide the most tax efficient result for all parties involved.

Certainly, one of the most tax effective strategies to fund such a buy-sell arrangement is to purchase life insurance on the
lives of each shareholder and designate the corporation as the beneficiary. The life insurance proceeds are received on a taxfree basis by the corporation and will thereby increase the capital dividend account. Depending on the shareholders’ agreement, the corporation may then issue a tax-free capital dividend to the surviving shareholders in order for them to purchase the shares from the estate. Such a clause is best implemented when the deceased shareholder has not claimed his or her capital gain exemption prior to death.

If the deceased shareholder has already claimed his or her capital gain exemption, then it may be  the shareholders’ agreement that the corporation will redeem the deceased shareholders’ shares. Again, the goal is to have the corporation receive the life insurance proceeds in order to increase the capital dividend account. The corporation would then repurchase the deceased’s shares by issuing a tax-free capital dividend to the estate.

All survivorship arrangements in a shareholders’ agreement have tax implications that must be considered. There is no “magical template” as all shareholders’ agreements should be tailored specifically to the shareholders’ goal and  intentions.

Control and the Association Rules
Another provision that requires careful consideration in a shareholders’ agreement is the avoidance of the association rules. Where a shareholder, or a related group of shareholders, owns or controls more than 50% of the voting shares of a corporation, that shareholder or group will control the corporation. Consequently, any other corporation controlled by the controlling shareholder or group may be found to be associated with the first corporation.

If two or more corporations are found to be associated, it will trigger a number of income tax consequences including, inter alia, a requirement to share the small business deduction as well as other deductions in computing income. Sections 256 of the Income Tax Act defines the association rules and these rules should be fully understood by the drafter of the shareholder’s agreement as well as all parties involved in order to avoid regrettable tax consequences.

Other Provisions to Consider
Th ere are several other provisions commonly included in a shareholders’ agreement that, unless carefully considered, may have adverse income tax consequences. One example is where a shareholders’ agreement provides for a “call option” allowing the majority shareholder to require that a minority shareholder sell his or her shares at a fixed price or at a price determined by a formula which could potentially exceed the fair market value of the shares at the time the call option is exercised.

In that case, the shares held by the minority shareholder will be considered to be short term preferred shares from the moment of their issuance. Th is may result in the acquisition price being based on the fair market value of the shares at the time the agreement was entered into rather than at the time of acquisition.

Another example of a potential planning pitfall is in the drafting of provisions for arrangements to be made in the event a shareholder becomes disabled who can no longer return to full-time activity. Another buy-sell provision may be considered as it would avoid such a situation becoming a burden for the other shareholders who would otherwise have to provide continuing support for the disabled shareholder for a lengthy period of time.

How can one fund such a buy-sell arrangement? Although income replacement insurance may be an option, it is  important to note that proceeds of income replacement insurance do not increase the capital dividend account of the corporation and, therefore, cannot be transferred to the shareholder on a tax-free basis. If the shareholders opt for a corporate repurchase of the shares, consideration should be given to reorganizing the share capital of the corporation allowing for the creation of frozen, redeemable preferred shares which can be redeemed or purchased over time; for the disabled shareholder this would only trigger a tax liability as the proceeds are received and it also completely avoids depletion of the reserves of the corporations.

Where a shareholder of a corporation is another corporation and the holding corporation is used to hold the shares of the operating corporation, the buy-sell arrangements may be amended to provide for the most tax efficient result  possible. In such a case who shall hold the life insurance policy?  Who shall pay the premiums? Can we avoid a shareholder benefit? Should be we consider use intercorporate tax-free dividends to repay the payment of premiums  thus avoiding a shareholder benefit? These are all questions that should be answered prior to the drafting of the shareholders’ agreement.

Conclusion
Th e foregoing are just a few examples of issues that should be discussed prior to the drafting of the shareholders’  agreement.

As previously mentioned, using a “boilerplate agreement” may result in undesirable tax outcomes that could have been completely avoided had the drafter foreseen the potential pitfalls and fully understood the fiscal repercussions of the various provisions.

We always recommend shareholders implement a shareholders’ agreement at the commencement of business while all the parties are on good terms. We also recommend shareholders’ seek professional advice from the outset as any attempts to resolve issues “after the fact” may turn out to be catastrophic for the shareholders and for the business and the costs will most surely exceed the initial expense of a well draft ed shareholders’ agreement prepared by a fully informed professional advisor.

Sébastien Desmarais
LL.B., LL.L., J.D.
Associate, Tierney Stauffer LLP

This article is provided  as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter  referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship. 

Trustees Controlling the Corporation – a Challenging Situation

Estate planning intrinsically results in tax planning; one cannot dissociate the two. Indeed, the easiest manner to maximize the value of an estate is by minimizing the tax payable at death. The same approach applies to the successful business owner; maximizing profit by minimizing taxes.

Trusts are oft enused to accomplish eff ective tax/estate planning. However, the use of a trust to control a private  corporation imposes fiduciary obligations on the part of the trustees to administer the corporation for both the shareholders and the beneficiaries of the trust; a challenging balancing act for the trustees at the best of times.

This newsletter will explore the various duties of trustees and some of the conflicts of interest that can arise.

Powers and Authority of Trustees and Directors
Trustees have a duty to carry their powers and authority in accordance with the Deed of Trust whereas Estate Trustees have a duty to act in accordance with the instructions conferred by the Testator’s Will. Trustees have a fiduciary duty to act in the best interest of the beneficiaries; that is a duty of loyalty and a duty of care toward the beneficiaries.

Trustees have three fundamental duties they must always comply with:

• they may not delegate their duties to a third-party;
• they may not profit personally from their dealings with the trust property; and
• they must act honestly, with prudence and reasonableness.

Trustees also have a duty to act personally, with care and in good faith and must avoid conflicts of interest.

Directors, on the other hand, owe a fiduciary duty to the corporation, and only the corporation. Directors are intended to make policy and specific decisions concerning a variety of business risks as long as it is for the best of the corporation.
It is said that the directors are considered to be the alter ego of a corporation.

Trustees Controlling a Corporation
In many tax planning strategies such as an estate freeze, a family trust is introduced as the majority shareholder of the corporation holding the shares that will represent the future growth of the corporation.

The introduction of a family trust as the majority shareholder is usually viewed as providing greater flexibility in tax planning strategies and estate planning but results in different considerations for decision-making: the duties of the
directors versus the duties of the trustees.

Trustees holding the majority of the shares of a company face the possibility of having to make decisions that may impact the viability and value of the corporation and intrinsically affect the beneficiaries’ interest in the trust. It is nearly impossible to avoid some conflict of interest in these circumstances; indeed when acting as both a trustee and a director, the individual has a duality of fiduciary duties which may ultimately conflict. Where trustees hold shares representing voting control of the corporation, it is difficult to imagine how they can exercise their fiduciary duty without being appointed on the board of directors of the company. They may elect to only have one of them appointed but such does not discharge the other trustees of their fiduciary duties; they nonetheless must place themselves in a position to make informed decisions concerning the company in order to protect the assets of the trust.

If the trustees decide that all of them will be elected to the board of directors, they must vote in accordance with their fiduciary duties as trustees. If the Deed of Trust or the Will requires a decision by vote by majority, then the trustees must vote and make decisions as directors in a fashion similar to casting their vote as trustees.

There are significant differences in the operation of trust law and corporate law. The trustees who must act appropriately as directors must also act in the best interest of the beneficiaries which can sometimes conflict with what is in the best
interest of the shareholders; not always an easy juggling act.

Estate Trustees Controlling a Corporation 
Estate trustees are faced with the same challenges stated above and, further, they must as well meet their fiduciary  duties toward the beneficiaries of the estate. The issue is therefore how can you balance the duty of care to the
beneficiaries of the estate and the corporation??

Estate trustees must also deal with estate planning strategies that render their decision-making even more difficult as they are required to consider different beneficiaries who may have different interests. For example, what if the testator
leaves a life interest of the income of the corporation to his spouse but on her death the shares including all income not paid to the spouse, are to be equally divided amongst his children. In whose interest do they manage the corporation,
the spouse or the children?

This is just one example of the complex issues that can arise from the duality of acting as estate trustee and director of a corporation. A well drafted Will should provide clear instructions to the estate trustee for such circumstances but
often it does not, leaving the estate trustee in a thorny situation.

It is noteworthy that if the estate is dependent upon an income stream from a corporation, the estate trustee must serve as a director to ensure that the appropriate business decisions are made on timing and distributions of profit of a business.

However, an estate trustee/director  of a corporation is caught in an impossible situation that can only result in a conflict of interest. The estate trustee/director must then face the possibility of having their decisions reviewed by either the shareholders or the beneficiaries of the estate.

Jurisprudence appears to indicate that the beneficiary of an estate is not entitled to any disclosure of the corporate and financial records of the corporation. However, as long as the beneficiary’s interest is involved, the beneficiary is entitled and may seek from the estate trustee all documents or communications between the trustee and the corporation.

Furthermore, trustees may also see their actions as director questioned by the beneficiaries claiming an “oppression remedy.” Professionals who advise on estate planning ought to consider this remedy when discussing estate planning with the testator.

The decision of the trustee/director may always be subject to review and remediation in accordance with the available remedy under the legislation or equity.

Conclusion
We have seen that it is nearly impossible to avoid a conflict of interest when one is acting as both a trustee and a director.  In those instances, the trustees/directors have a duality of fiduciary duties which may ultimately result in a conflict.

Many professionals view this “conflict” as a novel concept and dismiss it on the basis that in practice, the trustees and directors have the discretion to administer the trust and the corporation “as they see fit.”

I submit that such view fails to properly advise trustees who must carry both the duties of trusteeship and directorship. It is true that trustees may be absolved of any personal liability if the Deed of Trust or the Will so states. However, that is only partially true as they can still be held liable under equitable remedies or under corporate legislation.

If you are acting as both trustee and director, it is essential that you recognize your fiduciary duties and to whom to you owe such duties. Failure to do so could result in untenable positions and potential personal liability. If you have any questions concerning the duties of a director or trustee, please do not hesitate to contact me directly at 613-288-
3220 or by email at sdesmarais@tslawyers.ca

Sebastian Desmarias
Associate, Tierney Stauffer LLP

This article is provided  as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter  referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship. 

Succession and Tax Planning for Farmers

In Canada, farming is perceived to be significant business where thousands of farms are generating billions of dollars for the Canadian economy, and considered by many to be a cornerstone of the foundation of the traditional Canadian identity. More than a job or singular career, most farmers would agree that farming is a lifestyle and a life-long commitment in which they take great pride.

Often a family business, the knowledge of the business of farming, and ultimately the business itself, is passed from one generation to the next. For many farmers reaching an age of retirement, important decisions concerning the future of their farm must be made and the options available are limited.

That is why many farmers will agree that envisioning their farm succession is neither a pleasant nor an easy task. However, if farmers view their farm succession as a positive “mandatory” process instead of a disruptive isolated event, it may ease the transition.

In most cases three possible choices are considered:

1. Transfer the farm operation to the children and maintain the farm in the family;
2. Sell the farm to a third-party and use the after-tax proceeds of the sale for retirement;
3. Retain ownership of the farm and simply deal with the succession of the farm in one’s last Will and Testament.

Each of these options has its own set of implications that require careful consideration in order to preserve the family’s unity and ensure fiscal responsibility and stability.

For more information about these options see the full article available on the Tierney Stauffer website.

Sébastien Desmarais, LL.B., LL.L., J.D.
Associate 

Details, Details: the Importance of the Minute Book

It is important for business owners, directors, officers and managers of a company to maintain accurate corporate records in their corporate minute book.

Minute books are meant to serve as the official source of all corporate records. They should contain such documents as the articles of incorporation/amendment/ amalgamation, corporate bylaws, and minutes of shareholders’ and directors’ meetings. Ensuring the minute book is up-to-date helps to ensure that all vital corporate documents are in one place. This way, such documents can be easily found, retrieved and consulted when and if needed.

The minute book should properly identify the shareholders of the company, and document all share issuances and transfers. The minute book must also properly identify the decision makers of the corporation (i.e. directors and officers), when such decision makers were elected/appointed and when they ceased their functions. The corporate records should properly demonstrate that the directors and officers were granted their authority to act. The minute book share ledgers and shareholder, director and officer registers should be updated each time there is a change. These registers will often be used to quickly identify who the directors, officers and shareholders are, or were, on any given date.

A minute book that is accurate will also show the official standing of the corporation. Such information will be vital to facilitating many corporate transactions, such as a potential sale of a company. For example, shareholders are required to approve the sale of a business. If share transfers and/or issuances were never documented, or improperly documented, it may be difficult to quickly and accurately identify the current shareholders in order to obtain their consent to the sale. If your company’s minute book is out-of-date, a generally straight-forward transaction may become lengthier and much more expensive.

There may also be times when third parties will need to examine your minute book. For example, in the case of an audit by the Canada Revenue Agency (“CRA”), the minute book can help to establish effective dates for tax purposes, and can serve as a record of bonuses and dividends the corporation has paid out. The CRA may disallow dividends if the appropriate resolutions are not prepared, signed and included in the minute book. The Workplace Safety and Insurance Board may also examine the book to assess compliance under the Workplace Safety and Insurance Act.

Having an out-of-date minute book can have both practical and legal implications. Practically speaking, and in addition to those implications already discussed, if a company is being sold, the buyer will likely require a legal opinion relating to various corporate matters. Such opinions will not be able to be drafted until all corporate documents have been properly executed and the minute book has been updated accordingly. Having an up-to-date minute book can help avoid any such delays related to the legal opinion. An out-of-date minute book and improperly kept corporate records may also cause delays in obtaining financing.

Moreover, if the minute book is missing documents demonstrating that certain directors and officers have been properly elected or appointed, their authority to make decisions may be subject to challenge.

From a legal perspective, a corporation that fails to comply with requirements to maintain certain corporate records may be found guilty of an offence and liable to a fine.

If your corporate minute book is not up-to-date, there are methods of rectifying such deficiencies in the corporate records. A corporate lawyer will be able to perform a proper review of your minute book to identify any deficiencies and will be able to prepare the necessary documentation to resolve any problems. Ensuring your minute book is properly updated now may help prevent any future delays and expenses associated with updating your corporate records.

Jennifer Brigandi, Associate

 

This article is provided as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions.

 

Do I need a shareholders’ agreement for my new business?

Here is a typical scenario:  2 or more colleagues join together to start up a business.  They incorporate and organize a company.  Then they ask themselves whether they should enter into a shareholders’ agreement.

A shareholders’ agreement is an agreement among the shareholders of a corporation setting out their agreement on how the company will operate. Typically, it deals with issues such as: (1) who will be the directors and officers of the company; (2) how the start-up costs and ongoing costs will be funded; (3) what are the restrictions on the transfer of shares; (4) what happens if new shares are being issued; (5) how are disputes resolved; (6) what happens on the death, bankruptcy, divorce or incompetence of any of the shareholders; and (7) how are major decisions approved.

A major benefit of a shareholders’ agreement includes the ability to clearly set out how the company will be run.

Firstly, when people start up a business they are usually cordial and optimistic.  Later on, if the business is not doing so well and animosity sets in, it’s hard at that point for the parties to agree on issues such as those set out above.  For example, how much should each shareholder contribute to the $100,000 needed to carry the company through the year?   This issue is easier to deal with when the company is starting as opposed to when the company is going through a tough time and no one wants to put in more money.

Secondly, you want to deal with issues before it’s too late.  What happens if Shareholder A dies suddenly? Without a shareholders’ agreement, the shares go to his beneficiary under his Will who is usually the spouse.   Shareholder B knew Shareholder A and could work with him. Now the spouse steps into the role of a shareholder and with it a say on how the company is to be run.  A shareholders’ agreement may say that upon death the other shareholders or the company will buy back the deceased shareholder’s share at their fair market value.  The spouse is treated fairly because he or she receives the fair value of the shares but the company or other shareholders don’t have to deal with the spouse and all of the uncertainty that may bring.

Thirdly, you may want to modify what the law would “default” to in the circumstances.  For example, under the Ontario Business Corporations Act most fundamental decisions (i.e. major decisions) require 66.7% of shareholder approval.  But what if you want a greater approval for some major decisions?

If you are starting up a corporation with a number of other people, consider the above issues and consult a lawyer to see if it makes sense in your case to get a shareholders’ agreement drawn up.

If you have any questions about shareholders’ agreements or concerning other legal aspects of setting up a business, please do not hesitate to contact me directly at 613.288.3226 or by e-mail at meng@tslawyers.ca.

Michael Eng, Associate

 

This article is provided as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions.

Trusts and the 21-Year Rule

Trusts, once considered a tool exclusively for the wealthy, have become enormously popular in the last ten years for middle income persons and for good reasons: trusts provide great flexibility in tax planning strategies and estate planning.  

Trusts are subject to specific tax rules that ought to be fully understood and complied with.  One of those is the “21-year deemed disposition” rule where, for tax purposes, a trust is deemed to dispose of certain types of property for fair market value proceeds.  Failing to acknowledge this rule may result in the trust realizing capital gains, ordinary income or recapture without receiving actual proceeds of disposition.

This newsletter will review the 21-year deemed disposition rules and some tax strategies to help avoid or defer the tax implications.

The 21-Year Deemed Disposition Rule

The 21-year deemed disposition rule exists in order to prevent property held by a trust from being passed from generation to generation on a tax-free basis. 

The 21-year deemed disposition rule does not apply to all trusts or all types of assets held in a trust. Indeed, the rule applies to trusts which hold depreciable property, non-depreciable capital property, Canadian and foreign resource properties, land inventory and NISA funds No. 2.  More specifically, the deemed disposition rule applies to:

§  Qualified small business corporation shares

§  Qualified farm property and qualified fishing property

§  Mutual funds and other shares

§  Real estate and depreciable property, bonds, debentures, promissory notes and other properties

§  Personal-use property

§  Listed personal property (as defined by the ITA)

§  Land held as inventory

Interestingly, for estate planning purposes, life insurance does not fall into any of the above classifications and therefore is not subject to the deemed disposition rule.

Strategies for Dealing with the 21-Year Rule

For obvious reasons, trustees and beneficiaries want to avoid the 21-year deemed disposition rule as no one wants to pay taxes if they can be avoided. Happily, there exists several strategies allowing for the deferral or avoidance of the 21-year rule.

The easiest way to avoid the 21-year deemed disposition rule is to simply have the trust property distributed to the Canadian resident beneficiary on a tax-free basis (the Income Tax Act allows such tax-free distribution). One of the drawbacks of this option is that the beneficiaries lose their opportunity for income splitting and other tax planning strategies and the trustees lose control of the assets.

Depending on the assets held by the trust, another option is to distribute only a portion of the trust’s assets to the capital beneficiaries.  Essentially, all assets with accrued gains would be distributed to capital beneficiaries on a tax free basis while the assets that do not have a component capital gains could be retained by the trust. 

If a trust holds shares of a private corporation the trustees must consider the 21-year deemed disposition rule because failure to do so could result in double taxation; indeed the trust would realize a capital gain on the deemed disposition of the shares and, if the shares were later redeemed, the trust would also realize a deemed dividend. 

To avoid any double taxation, one strategy is to incorporating a new company (Newco) which shares will be owned by a new trust (most likely with the same trustees and beneficiaries as the first trust).  The trustees of the first trust would then make Newco a beneficiary of the first trust (if there is a power to appoint new beneficiaries).  Then, the first trust would distribute the Oldco shares to Newco prior to the 21-year deemed disposition date. 

There are other very similar strategies, to the one above, when dealing with a trust holding shares of a private corporation and the 21-year deemed disposition rule and the trustee(s) should consult with his or her tax advisors as to which strategy might be best.  The trustees must also be aware of the uncertain nature of the GAAR (General Anti-Avoidance Rules under the Income Tax Act) when implementing a 21-year deemed disposition strategies.

Estate Planning, the use of Trusts and the 21-Year Deemed Disposition rule

In estate planning, it is common to establish a trust under the Last Will and Testament and fund such trust with assets flowing through the estate of the deceased.  Such trusts are referred to as a “testamentary trust:” a trust that arose as a consequence of the death of a testator.  Testamentary trusts provide a unique opportunity as they pay tax on a graduated basis allowing for a variety of tax savings and income splitting.

In estate planning, the 21-year deemed disposition rule is often misunderstood and too often we have advisors recommending that the testator or the estate trustee avoid the 21-year rule “at all costs.”  As a result, the Will may have a clause requiring the trustee of the testamentary trust (or the estate trustee) to distribute the capital of the trust to the beneficiary before the 21-year deemed disposition in order to avoid a capital gain. 

Although such advice is not technically wrong, it is often given without an adequate explanation or understanding of the 21-year deemed disposition rule and may not realize the maximum benefit from the trust.  For instance, what if the assets of the trust do not have a capital gain component, i.e., no capital gain is arising at 21 year limit?  What if the tax savings of a testamentary trust in the long run are far greater than the capital gain to be realized on the 21 year deemed disposition?  In these two examples, why would someone want to lose the tax savings and income splitting opportunity simply to avoid a small capital gain, if any?

As an aside for estate matters, it is important to know that the 21-year deemed disposition timeline commences at the death of the testator/settlor and not on the day the residual beneficiary receives his or her share in a testamentary trust.

Conclusion

We can see that a trust may be viewed as a vehicle that provides a 21-year window of tax opportunities.  The 21-year deemed disposition rule ought to be reviewed and fully understood by any trustee of a trust; whether a family trust, a testamentary trust, an alter ego trust, a spousal trust, etc., in order to take advantage of those opportunities and realize the maximum benefit from a trust.

If you have any questions concerning the 21-year deemed disposition rule or concerning trusts in general, please do not hesitate to contact me directly 613.288.3220 or by email at sdesmarais@tslawyers.ca

Sébastien Desmarais
Lawyer

 

This article is provided as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions.

Buying your first home? When will you be able to move in?

The time you are able to move your things into the new house depends on what time the deal “closes”.  A closing is completed when money has changed hands and the property is registered in your name. After these two things have happened your lawyer can release the keys to you.

  However, a closing can happen any time during the day, up to 5pm. Often, there is a “completion” time listed in your Agreement of Purchase and Sale, which states that deal does not have to close until the end of the day.

   Sometimes, mortgage funds are not received until later in the day. When this happens it pushes the closing time back until later in the day as well. These delays can be unpredictable, as each bank’s system for sending out the funds is different. It is not unusual for mortgage funds to be received mid-afternoon. Keys are commonly released in the 3:30-5:30 pm time frame.

   A closing may (and often does) happen before the end of the day, but you need to be prepared in case it does not. The best advice for moving into your new home is to plan your truck/van for later in the evening or the following day.    That way, if there are delays, you are not stuck waiting with a truck full of your things which can be a waste of both your time and money.

If you have any questions, please do not hesitate to contact me directly 613.623.3177 or by email to ddingman@tslawyers.ca

Dana Dingman, Associate
Arnprior, Ontario

This article is provided as an information resource and is not intended to replace advice from a quaified legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions.