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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:
- The shares must have been owned throughout the 24 month period preceding the date the shares were disposed of;
- 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;
- 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:
- exchange their common shares for preferred shares of equal value where the new preferred shares would not grow; and
- 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:
- Transfer the farm operation to the children and maintain the farm in the family;
- Sell the farm to a third-party and use the after-tax proceeds of the sale for retirement;
- 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
Estate Planning and the Use of the Henson Trust and RDSP
Many families include a disabled child or adult and the parents are usually the child’s primary safety net. The onus is on the parents (or parent as the case may be) to provide core support to their children whether financial, physical or emotional and the list of duties for the disabled child may well escalate to a point where many are overwhelmed.
The Ontario government can assist by offering a variety of valuable services that will assist the disabled child and his or her family. In Ontario, one can turn to the Ontario Disability Support Program (ODSP) which was established to help people with disabilities in financial need pay for living expenses such as food and housing.
Given the circumstance a child’s disability will require lifelong treatment and support, a great concern for their parents is how to effectively plan for the care and protection for their child after the parents are no longer living. In fact, special considerations are necessary for parents of a disabled child or adult to ensure the child’s ODSP’s benefits are not compromised by their estate planning. This is a situation where guidance from a professional advisor could provide great benefit.
The Smith Family
As an example of an estate planning strategy involving a disabled child, I introduce the Smith family.
The Smiths have two children, Corey and Ryan, who are both over the age of majority. Ryan is a disabled child who receives ODSP benefits. The Smiths’ combined Estate consists of their principal residence, RRSPs and other investments for a net value of $1,000,000.
The Smiths are making their Wills and although they wish to have their Estate distributed in equal shares between their children their primary concern is to ensure that their estate planning does not disqualify Ryan from his ODSP benefits. They know the ODSP rules are complex.
What options are available to them?
Henson Trust
The popular and preferred option is the use of an Absolute Discretionary Trust (commonly referred as a “Henson Trust”) created under the parents’ Wills. The Henson Trust allows their Estate Trustee, Corey, complete discretion over the trust so that he may continue to pay the necessary expenses of the disabled child. As a result of the Henson Trust, the Smiths have the assurance that Ryan shall be provided for in the years to come while knowing that he cannot compel Corey to make payments.
Ryan’s ODSP benefits shall not be compromised since the funds held in the Henson Trust are not considered his assets for ODSP purposes; that is because Corey, as Estate Trustee, has absolute discretion in the management of the trust. Furthermore, Ryan’s income from the Henson Trust for non-disability related expenses, such as food, clothing, housing and entertainment, can be substantially supplemented without suspending or affecting the ODSP benefits.
Also, depending on the parents’ wishes and in appropriate circumstances, the Henson Trust may also allow for income sprinkling by empowering the Trustee to “sprinkle” income among several beneficiaries.
ODSP guidelines recognizes the Henson Trust as an exempt asset of the disabled child and as a result, it remains the most valuable option available as it represents a safety net for Ryan after the death of his parents.
Registered Disability Savings Plan
The Registered Disability Savings Plan (“RDSP”) was introduced in December 2008. The RDSP allows for a combination of individual, family and government financial assistance contributions to assist people with disabilities to grow, manage and control a financial asset.
To open an RDSP, one must qualify for the Federal Disability Tax Credit (DTC). If a child or grandchild qualifies for the DTC the parent, grandparents or other legal representative may establish and contribute to an RDSP up to a lifetime maximum of $200,000. The DTC-eligible person shall be the sole beneficiary of the RDSP.
As a result of opening an RDSP, annual contributions will attract:
- Canada Disability Savings Grants (CDSGs) at a matching rate of 100, 200 or 300 percent depending on the family income and the amount contributed up to a maximum lifetime CDSG limit of $70,000; and
- Canada Disability Savings Bonds (CDSBs) of up to $1,000 per year for low and modest-income families[1] for a lifetime maximum of $20,000.
The most obvious thorn in establishing an RDSP is the matter of capital contributions (which are not deductible) as not everyone is in a position to fund such a plan. One strategy is to insert a clause in the parents’ Wills instructing the Estate Trustee to fund the RDSP with the disabled child’s share.
The RDSP, like the Henson Trust, is an exempt asset for ODSP purposes and therefore the benefits of the disabled child contained therein will not be compromised.
The 2011 Federal Budget addressed the difficulty of funding an RDSP by creating a new funding option permitting conditional rollovers of RRSPs into RDSPs. Indeed, as of July 1, 2011, for deaths occurring after March 3, 2010, one may now roll the deceased parent’s RRSP proceeds into the RDSP of the disabled child on a tax-free basis. This new rule extends to amounts transferred to an RDSP from the proceeds of a Registered Retirement Income Fund (RRIF) and certain lump-sum amounts paid from Registered Pension Plans (RPP).
Ideal Estate Planning for the Smiths
The Smiths now have two valuable options available to them where they can provide for Ryan with the assurance that his ODSP benefits will not be jeopardized. Their Wills could provide that their RRSPs (or a portion of them) be rolled into an RDSP on a tax-free basis. If there is still “room” in the RDSP (that is if the RRSPs have not reached $200,000.00), then their Wills may also provide for a portion of Ryan’s share in the Estate to be paid into the RDSP up to the threshold value. The remainder of Ryan’s share in the Estate shall be transferred into a Henson Trust for his benefit. Corey would be the Trustee of the Henson Trust and would administer the trust for Ryan’s benefit.
If the Smiths each maintained a modest life insurance policy (of $50,000 for example), they could name both of their children as alternate beneficiaries (the surviving spouse would be the first named beneficiary). If that is the case, Ryan and Cory would both receive $50,000. In such instance, a life insurance trust could be created in which he would deposit the life insurance proceeds. Such a life insurance trust has a threshold of $100,000.
The proceeding examples explain how the Smiths are able to provide for Ryan without compromising his ODSP benefits through careful estate planning.
Cautions
There are drawbacks to both a Henson Trust and RDSP that ought to be considered. We recommend you consult with a professional so that those drawbacks be clearly highlighted and discussed. Ultimately, the estate planning must be tailored to the circumstances and the parents must decide what is feasible given their intentions and their means and the size of their family.
Conclusion
From the foregoing one can appreciate the tremendous advantage of Ontario parents having effective Wills in place is underscored when their child is disabled. The impact on that child’s future may be profoundly affected for the better.
If you have any questions, please do not hesitate to contact me directly 613.288.3220 or by email at sdesmarais@tslawyers.ca
Sébastien Desmarais, 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.
[1] When the household net income is under $21,816.00.
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 effectively 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 often 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 tax-free 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 preferable to include a clause in 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
There 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. This 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.
In the not-so-uncommon situation 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 inter-corporate 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
The 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 drafted shareholders’ agreement prepared by a fully informed professional advisor.
Sébastien G. Desmarais
Lawyer
Tierney Stauffer LLP
Life Insurance and Business Succession Planning – Tax Advantages
The Role of Life Insurance in a Business Succession Plan
When developing a business succession plan, one to consider the use of life insurance as a source of funding to provide for the needs of the business upon the death of the business owner, a key executive, or shareholder. There are several key tax advantages in using life insurance proceeds.
One of the main tax advantages is arranging for the life insurance proceeds to be payable to the corporation on a tax-free basis. As a result, the proceeds of the life insurance (over the adjusted cost base of the policy) will increase the capital dividend account of the corporation thereby allowing for the payment of tax-free capital dividends to the shareholders of the corporation or to the estate of the deceased shareholder. Depending on the Will of the deceased shareholder, the surviving spouse may receive tax-free capital dividends in a spousal testamentary trust allowing for income splitting.
Life insurance can also be an efficient means of funding the obligations under a buy/sell agreement found in a shareholder agreement. The life insurance proceeds would be paid to the corporation thereby increasing the capital dividend account allowing for tax-free capital dividends to be available for purchase by the surviving shareholders from the deceased shareholder. If the shareholder agreement provides for such a buy/sell agreement, the estate may also be entitled to claim the capital gain exemption on the sale of the shares to the surviving shareholders. In order for this to occur, the shares must meet the definition of “qualified small business corporation shares” as defined in the Income Tax Act. If so, the estate would be eligible to receive up to $750,000 in tax-free shares.
The business succession options set out above must be carefully implemented otherwise the business owner or the corporation might be assessed a taxable shareholder benefit by the Canada Revenue Agency. It is not uncommon for a business owner to own the shares of a holding company which in turn own shares of the operating company. In those situations, there are a number of factual and tax considerations that must be considered in determining who will be the owner and beneficiary of the insurance policy; and which entity must pay the insurance premiums.
Life insurance may be used for reasons other than estate and business succession. Indeed, it may be possible to use some life insurance to fund the business owner’s retirement or for the company to offer some form of “supplementary executive retirement plan” to an executive person.
The success of your estate planning relies on a clear understanding of the rules of taxation upon death and the rules of taxation of life insurance. Seek professional advice when planning your estate, especially if you are considering implementing a business or succession plan with the use of life insurance, because an error could result in adverse tax consequences.
If you have any questions concerning estate or tax planning, please do not hesitate to contact me directly.
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