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Rectification in Tax and Estate Matters Part I – Tax
Confucius said “A man who has committed a mistake and doesn’t correct it is committing another mistake.”
When we are dealing with tax and estate matters, even a simple mistake may have disastrous consequences. One way such a mistake may be corrected is by way of a rectification order. Indeed, rectification is an important remedy that allows for the correction of errors or mistakes in legal instruments that have resulted in an unintended result. This newsletter will review the doctrine of rectification as it applies to tax matters. Our next newsletter will focus on rectification in estate matters.
What is Rectification?
A rectification order is an equitable remedy to correct errors in legal instruments that do not reflect the true intention of the parties resulting in unintended and, likely, unfortunate results. A rectification order allows the affected parties to rectify the terms of a transaction as was initially intended by the parties. The effect of the rectification is retroactive.
The remedy of rectification is available only under certain defined circumstances; essentially to correct a mistake. However, rectification is not permitted if the intention of the parties is simply to alter the terms of an instrument nor can it be invoked in an attempt to correct every mistake in order to alter unwanted results.
In order for a rectification order to be granted, one must file an Application to the Superior Court of Ontario; only a court may grant such remedy. Interestingly, the Tax Court of Canada cannot grant equitable remedies, and, as a result, rectification of a tax matter can only be heard by the appropriate forum, the Superior Court of Ontario. The duty of the Court is to examine the evidence and assess the facts in order to determine whether the application is truly one to correct a mistake which result in an unintended legal effect or an undesirable legal consequence. The Court must ensure that the parties are not just changing their minds “in the middle of a transaction.” The evidence is the key to the determination.
To be successful in obtaining a rectification order, one must establish:
- the existence and nature of the common intention of the parties prior to preparation of the instrument alleged to be deficient;
- that the common intention remained unchanged at the time the document was made; and
- that the instrument, by mistake, does not reflect that initial common intention.
If one can prove the above, the Court may grant a rectification order thus restoring the party(ies) to their initial common intention. Applicants should be aware that rectification orders are a discretionary remedy granted at the discretion of the Court and one should not anticipate the granting of an order.
Rectification in Tax Matters
In tax matters where unintended tax consequences arise as a result of a mistake, rectification may be a valuable tool, if not a “life saver,” for taxpayers who find themselves in a situation where their tax planning went awry.
Although the equitable doctrine of rectification is not new, it only truly emerged as a valuable tool in tax matters in the last decade or so. The leading case, Canada v. Juliar, has been a key decision in establishing such remedy to taxpayers. Indeed, in Juliar, the Court granted a rectification order in a tax matter which ultimately fixed a mistake in a document intended for tax planning purposes. The granting of the rectification order enabled the taxpayer to avoid having to face a tax liability from an unanticipated outcome. Interestingly, the Court had no issue with the fact that the taxpayers’ intention throughout the transaction was to avoid immediate tax consequences.
Since the Juliar decision, the law and the doctrine of rectification in tax matters has expanded considerably. Taxpayers appear to show a willingness to consider an application for rectification to correct/rectify transactions that achieved unintended tax consequences. Notably, the jurisprudence has acknowledged that the avoidance of tax is a legitimate intention in rectification matters involving a tax issue. As a result, rectification may be available where transactions that resulted in unintended tax consequences might be altered in order to achieve the initial tax intention; that is the avoidance or minimization of tax.
A more recent decision from the Supreme Court of British Columbia, McPeake v. Canada, is also instructive as to how and when granting a rectification order may be appropriate in tax matters. The McPeake decision is consistent with prior cases where the taxpayers demonstrate an intention to avoid tax but the documents or transactions failed to reflect their true intentions.
The McPeake decision stands out also on the basis that in tax matters, the taxpayers must convince the Court that their initial intention was to avoid tax. Another interesting point of that decision is the fact that the Court accepted that it ought to consider the unfairness or harm the taxpayer may suffer should the rectification order not be granted (thus allowing a tax liability to arise although the avoidance of such liability is what gave rise to the transaction in the first place).
Rectification Application and the Crown
The Crown also distinguishes between an error in implementation and an error in tax planning and the Agency will vigorously oppose rectification orders disguised as an attempt to implement a form of retroactive tax planning.
The Crown’s position is that a taxpayer requesting a rectification order should provide the Agency with notice of the application; especially in instances where the rectification application is being made on the basis that the taxpayer is alleging unintended tax consequences.
However, whether or not the Crown should be notified of any particular application for rectification is a dilemma for the taxpayer and his lawyer to resolve. There is a valid argument to be made that since the Crown may not be a party to the original instrument and the original transaction, it has no interest in the application to rectify the written instrument and the transactions. There is jurisprudence where the Court has said that notice to the Crown was “appropriate” or a matter of courtesy; however, the Court has never said it is mandatory.
In reality, the decision of whether to serve notice to the Crown or not is essentially a matter of assessing the basis of the application and ultimately, it is a strategic decision. Further, should one serve notice to the Crown, they risk having the Crown oppose the application. However, opting not to serve notice may result in the judge requesting notice be served prior to rendering his or her decision. Having to serve the Crown after the initial application is likely to raise suspicion from the Crown.
It is important to know that the Department of Justice has a rectification committee which discusses and decides whether to oppose an application. The CRA and the Department of Justice have established a procedure to be followed when applying to the Court for a rectification order; notably, that a letter be sent to the Director of the Tax Services Office advising rectification will be sough, that the CRA should be named as a party in the Motion and that the Department of Justice be served with the Notice of Motion.
Once served, the rectification committee will review and discuss the merit of the application and inform the party(ies) whether it intends to oppose the application.
Conclusion
In tax matters, an application for a rectification order remains a valuable tool for taxpayers and should be considered when adverse tax consequences are erroneously triggered by an error or errors in implementing a transaction.
An application for a rectification should be considered by tax advisors, including accountants, lawyers and any other tax advisors. Indeed, rectification may be the key to correct an oversight in their tax planning memorandum or an error in the drafting of an instrument. Rectification may translate into a lifeline for their mistake, thus avoiding a liability; something well worth considering.
Ultimately, the original intent is the key determining factor in the decision whether to grant a rectification order.
In our next newsletter, we will address rectification in estate matters.
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.
Voluntary Disclosure Program – It’s worth considering under the right circumstances
The Voluntary Disclosure Program (VDP) is an initiative from the Canada Revenue Agency (CRA) designed to encourage taxpayers to be more compliant with their income tax filings and to correct omissions or errors which may be considered “negligent” from previous income tax returns.
The VDP offers taxpayers an opportunity to correct inaccurate or incomplete information or to correct previous erroneous information without penalties or prosecution.
One of the major incentives of proceeding by way of a voluntary disclosure is the assurance of knowing that IF his/her disclosure is accepted by the CRA, the taxpayer is assured of not facing tax evasion charges.
Criteria for a VD to be Valid
For a voluntary disclosure to be valid, it must meet certain specific criteria. If the taxpayer fails to meet any of these criteria, the voluntary disclosure will be considered potentially invalid resulting in penalties and prosecution.
The CRA is unequivocal that a valid voluntary disclosure must be
(1) voluntary,
(2) complete,
(3) involve a monetary penalty, and
(4) involve information that is one year or more overdue.
Timing
Timing is crucial when filing a voluntary disclosure. The CRA and the jurisprudence are clear: a disclosure may not qualify as a voluntary disclosure if it is found to have been made with the knowledge of an audit, investigation or other enforcement action that has been initiated by the CRA or other authorities or an administration with which the CRA has information exchange agreements.
It is crucial that the taxpayer be unaware of any audit, investigation or enforcement procedure when filing a voluntary disclosure. This means that if there is any direct contact by the CRA (such as a telephone call from a CRA agent or receiving a letter or a requirement to file from the Agency), the voluntary disclosure will be denied on the basis that it is not voluntary.
Furthermore, if a third party closely associated with the taxpayer receives a communication from the Agency or if any enforcement action against that third party is initiated and such action is sufficiently related to the taxpayer in the eyes of the CRA, the taxpayer’s voluntary disclosure may be denied on the basis it is not voluntary.
Completeness
The CRA is unequivocal that the taxpayer must provide full and accurate facts and documentation for all taxation years where there was previously inaccurate, incomplete or unreported information. In most instances, the agent reviewing the voluntary disclosure will most likely request additional specific documents or information corroborating the initial application.
Should the taxpayer fail to provide the information requested, or should the facts in the initial application not withstand the scrutiny of the CRA, the voluntary disclosure will likely be denied.
As is always the case in tax matters, the onus of proof lies with the taxpayer. It is the responsibility of the taxpayer to prove that the information submitted provides a complete and accurate account of the facts involved.
However, it is worth noting that minor errors or omissions shall not disqualify the disclosure. Further, the CRA clearly states that each submission will be reviewed on its own merits.
Monetary Penalty
Another criterion is the obligation that the voluntary disclosure must involve the application, or potential application, of a monetary penalty. There are different reasons as to why a penalty would be levied (such as a late filing penalty, a failure to remit penalty, an installment penalty or a discretionary penalty) but in order for a voluntary disclosure to be valid, it must involve a monetary penalty applying to one reporting period.
One Year Past Due
The last criterion for a valid disclosure is that it must include information that is (1) at least one year past due, or (2) the disclosure is to correct a previously filed return.
10 Year Limitation
CRA will only grant penalty relief for a period of 10 years. (§220(3.1) of the Income Tax Act was amended in 2004 to only provide relief for a period of 10 years prior to the application for relief of interest and penalties).
This is quite unfortunate as a taxpayer that would like to rectify past filings must take into consideration this 10 year limit. Indeed, should a taxpayer opt to file a disclosure concerning taxation years dating back more than 10 years from the application, they run the risk of being liable for penalties.
CRA does not advertise such a limitation period and this further emphasises the importance of seeking professional assistance prior to proceeding with a voluntary disclosure.
Conclusion
The VDP is worthy of consideration by any taxpayer that wishes to rectify a previous filing and avoid any penalties or prosecution.
However, the criteria of a valid voluntary disclosure are precise and one should always seek professional assistance given the significant risks that an invalid application may invoke.
Should you be interested in proceeding by way of a voluntary disclosure, 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.
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.
U.S. Estate Tax – Should You be Concerned?
We have all heard the saying that there are two things in life that are certain: death and taxes. For tax and estate professionals, both are always concerns but especially so for clients owning U.S. properties or assets. This is due to the U.S. estate tax.
Canada does not impose an estate tax upon the death of an individual. In fact, when Canadians die they are deemed to dispose of all their capital property at fair market value.
The U.S. system works differently: upon the death of a U.S. citizen, a tax is levied on the fair market value of the deceased’s world-wide property. Furthermore, the U.S. estate tax applies to all property situated in the U.S. including property owned by non-residents of the U.S. (oft en referred to as “Canadian Snowbirds”).
Consequently, upon death, a Canadian resident who owns U.S. real property or U.S. stocks may be regarded to have a large “deemed” capital gain with respect to such property in addition to a possible U.S. estate tax liability depending on the value of their U.S. properties or assets.
The first $3.5 million USD of a U.S. citizens’ estate is exempt from tax. However, non-residents, including Canadians, are only entitled to a pro-rated exemption under the Canada-U.S. Tax Treaty. This exemption is equal to $3.5 million USD multiplied by the ratio of U.S. property to your worldwide estate. Essentially, if your worldwide estate is worth less than $3.5 million, you need not worry about paying U.S. estate tax … at least for now.
In June 2001, the U.S. passed a law that commenced the phasing-out of the estate tax over the following decade. Essentially, the estate tax rate has been gradually reduced and the exemption amount increased and, based on the legislation, the estate tax will be repealed for the 2010 tax year. However, this may not be permanent as the legislation contains a “sunset clause” whereby, unless further steps are taken by Congress, the repeal of the estate tax will only last for one year, being 2010.
In 2011, the estate tax rules will revert back to the rules applied before 2001 resulting in the effective exemption of only $1 million USD (compared to $3.5 USD in 2009) and a maximum estate tax rate of 55% (compared to 45% in 2009). Many U.S. tax experts expect this issue to be addressed by Congress already proposed legislation that would cap the top estate tax rate at 35% and maintain the personal exemption at $3.5 million USD.
Nonetheless, Canadians who own U.S. property or assets should consult their tax professionals until Congress legislates on this issue. Until Congress acts on this issue, Canadian Snowbirds should review the U.S. estate tax with their estate planning advisor.
Canadians who have an estate worth more than $1 million USD may be at risk of having to pay U.S. estate tax.
If you have questions regarding this issue or any other issue pertaining to your estate, please contact Sebastien Desmarais, Associate, Tierney Stauff er LLP 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.
Estate Planning and Probate Tax
Probate is a legal process that confirms and validates the last Will and Testament of a deceased person.
There is no specific law in Ontario that requires the Will of a deceased person to be probated. As a general rule, the larger and more complex the assets held by the deceased, the more likely the probating of the Will shall be required. Probate tax is calculated at an approximate rate of $5.00 per thousand dollars for the first $50,000 in the Estate and $15.00 per thousand for every thousand dollars over and above $50,000 in the Estate.
Depending on how the assets of the Estate are held, probate tax can be reduced or even avoided altogether.
With the proper estate planning, a business owner can eliminate some of the probate fees that are triggered by his or her death and the ensuing transfer of property. One way to do this is through the use of “double Wills” where one Will deals with assets requiring probate (such as cash and real estate) and the other deals with assets that do not require probate such as shares of a corporation.
If ou have any questions concerning the termination of an employee or employment law in general, please do not hesitate to contact David Sinclair directly 613.288.3226 or by email at dsinclair@tslawyers.ca.
David Sinclair
B.Com., B.A., LL.B.
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.
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.
Dealing with the Canada Revenue Agency
It is not uncommon for people, often in a dire state, to seek advice after receiving a notice of assessment or reassessment from the Canada Revenue Agency (the “CRA”). When it comes to effectively addressing tax issues and notices of assessment or reassessment, there are several rules and deadlines that we should be aware of in order to avoid the pitfalls The following sets out and discusses some of the key relevant deadlines and rules governing dealings with the CRA.
Role of the CRA
The Canadian tax system is a self-assessing system. As a result, the CRA has broad powers and authority to audit and investigate information provided by taxpayers to ensure compliance with the Income Tax Act (the “ITA”). These powers and authority range from requisitioning documents or other information for their review, conducting audits and inspections, formal searches and seizure of documents under a search warrant and formal inquiries and investigation authorized by the CRA.
The CRA is required to examine the return and make an assessment “with all due dispatch” following receipt of the taxpayer’s return. Although “all due dispatch” is not defined in the ITA and does not refer to a specific period of time, the jurisprudence establishes a criterion of reasonableness depending on the facts of the matter.
Upon reviewing the taxpayer’s income tax return and all other documentation requested, the auditor will issue his final report and, if he believes amendments to the return are required, the CRA will issue a notice of assessment or reassessment setting out the amendments to the taxation year at issue.
Notice of Assessment/Reassessment
The CRA has three years from the date of mailing the notice of assessment to issue a notice of reassessment or a further notice of assessment and this interval is referred to as the “normal reassessment period.”
If the taxpayer disagrees with the Minister’s notice of assessment or reassessment, he is entitled to file a notice of objection within 90 days from the date the notice of assessment or reassessment is mailed.
The notice of objection must be in writing and must set out all relevant material facts, reasons and grounds on which the taxpayer is relying. It is important to understand that the onus is on the taxpayer to rebut all of the Minister’s assumptions and findings within the notice of objection.
Failure to object to all of the Minister’s findings will result in the taxpayer’s objection being “incomplete” and the Minister’s obligation is only to review the arguments raised in the notice of objection. This potentially leaves the taxpayer with the unfortunate result of having to pay taxes because some grounds were not raised in the notice of objection.
The Minister will only review those points of objection that are raised in the notice of objection. Consequently, it is advisable that the person drafting the notice of objection consult with the taxpayer, the taxpayer’s accountant and the taxpayer’s lawyer to ensure all points are covered.
Appealing to the Tax Court of Canada
Once the Minister has issued its final ruling on the taxpayer’s objection, he will issue a confirmation or a reassessment. From the date of the issuance of the confirmation or reassessment, the taxpayer has 90 days to appeal to the Tax Court of Canada (the “TCC”).
There are two sets of Rules governing an appeal before the TCC and, depending on the amount of money at issue, the taxpayer may have to choose whether to appeal under the Informal Procedure or the General Procedure.
If the aggregate amount at issue is equal to or less than $12,000.00 or the amount of the loss is equal to or less than $24,000.00, the taxpayer may elect to file his notice of appeal under the Informal Procedure. If the amount at issue exceeds the two thresholds, the taxpayer must then appeal under the General Procedure.
If the taxpayer appeals under the General Procedure Rules, the notice of appeal must state all material facts, all grounds of appeal, alternative arguments and any specific relief sought. The notice of appeal must also refer to the statutory provisions relied upon.
Final Thoughts
For many, dealings with the CRA represent a period of severe stress and frustration. Seeking proper advice and guidance from experienced professionals (lawyer, accountant and others) is essential to insure that your interests are well protected. If you have any questions concerning tax reassessment, please do not hesitate to contact me directly.
Sébastien Desmarais,
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.
Taxation of Damages – What a Difference It Can Make
At the conclusion of a long litigation matter, two questions sure to arise – how much was awarded and whether or not that award is taxable. Everyone agrees that a tax-free award is most desirable to the plaintiff . Whether or not a particular award of damages is to be received on a tax-free basis depends upon the characteristics of the action, the pleadings, the methodology used by the trial judge and the actual calculation of the damages.
Lawyers and their clients would be well advised to consider the tax implications of the damages sought from the outset. In some instances, the nature of the action clearly determines whether the damages will be taxable by rule of law.
In other cases, there may be the possibility of framing the cause of action for tax purposes; whether the damages are deemed income and, if so, are they capital gains or income.
Damages Related to Personal Injury or Death
Th e characterization of damages awarded in the context of an injured individual is key to determining whether the award may be received on a tax-free basis. Damages awarded in respect to a personal injury or death are to be
received by the injured party, or by the dependant of a deceased party, on a tax-free basis as long as the damages are special damages, general damages or pre-judgment damages.
Special damages in the context of personal injury relate to compensation such as out-of-pocket expenses (for medical and/or hospital expenses) and accrued or future loss of earning. However, an amount which can reasonably be considered to be income from employment rather than an award of damages will not be excluded from income.
General damages in the context of personal injury relate to compensation for pain and suff ering, loss of amenities of life, loss of earning capacity, the shortened expectation of life and the loss of financial support caused by the death of the
supporting individual (a parent for example).
Furthermore, damages that are awarded to be paid over a period of time by periodic installments are also to be received on a taxfree basis by the injured party; notwithstanding that it appears to be an annuity. The CRA confi rmed in its IT Bulletin 365 that damages for personal injury or death that are ordered to be paid in periodic payments are not, despite such periodic payments, considered to be an annuity contract and the periodic payments themselves are not considered to be annuity payments.
An annuity contract purchased by a taxpayer or a taxpayer’s representative with proceeds of a lump sum award received for damages for personal injury or death will be considered an annuity contract and will likely be taxable, with
some limited exceptions.
Business Related Damages
Determining the characterization of damages awarded on business matters and the resulting tax treatment can be difficult. The general principle is that damages in lieu of receipts that would have been taxable as income remain taxable.
Determining whether those damages are deemed income or nontaxable receipts depends on the nature of the legal right at issue.
One must carefully review the facts and determine the purpose of the remedy; i.e., for what do the damages compensate?
If the damages awarded are for loss of income, then the general principle is that they will be considered business income and therefore taxable.
If the damages awarded relate to the loss of an income-producing asset, it will be considered to be a capital receipt and non-taxable. As one can imagine, the difference between loss of income and the loss of an income producing asset can be nuanced and there exists no bright-line test to diff erentiate the two; it is always a question of fact. Essentially, if the damages received are for the failure to receive a sum of money that would have been income had it been received, the
damages are likely deemed income receipt and taxable. Also, if the damages awarded are essentially a surrogatum for future profits surrendered, the damages will likely be treated as revenue receipts, not a capital receipt, and be taxable.
Employment Related Damages
In most instances, employment related damages are awarded as compensation for a loss of employment and are specifically dealt within the Income Tax Act as “retiring allowances.” Under the Income Tax Act, retiring allowances
are fully taxable as income.
As a result, damages for wrongful dismissal, damages for compensation for lost earnings or damages on account of a contractually agreed settlement (such as a signing bonus) will all be taxable in the hand of the recipient. Damages awarded by the Workers’ Compensation Board for illness, injury or death ought to be included as income but the recipient is entitled to a deduction which essentially off sets the inclusion by excluding the damages award.
Also, damages awarded in context of a human rights violation, personal injuries (e.g. defamation or harassment) or tortuous conduct by an employer are usually viewed as general damages unrelated to the loss of employment and are therefore non-taxable. Once again, the determination is a factual one.
Conclusion
Th e taxation of damages awarded will inevitably aff ect the ultimate cost of recovery or indemnity. In some instances, the Income Tax Act will clearly dictate whether the damages are taxable. In other cases, a proper determination can only be made sometime aft er the commencement of the litigation process.
Ultimately, the only certainty is that some damages are taxable while others are not, that the analysis is a factual one and that the framing of the cause of action and the pleadings may formulate the determination.
Tierney Stauff er LLP, you can be sure that lawyers litigate with their clients’ best interest in mind and that always includes making informed decisions with respect to taxation.
If you have any questions concerning the taxation of damages, please do not hesitate to contact me directly at 613.288.3220
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.
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.
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.
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