Chapter 2: Financial Planning for Business Owners Flashcards
What is a capital gains rollover?
When a taxpayer sells a business and then invests in another business. The rollover is available when the taxpayer sells shares of a corp. that they have owned for at least 185 days, then uses the proceeds to buy shares of a different company. The newly purchased shares must be purchased from treasury (cannot purchase someone else’s shares).
What is the purpose of the capital gains rollover?
Compels the seller of a business to invest the proceeds of the sale into another business.
What are the tax consequences of a capital gains rollover?
Whatever capital gain is deferred would be applied to reduce the ACB of the newly acquired shares.
What is the purpose of the capital gains reserve?
Allows a taxpayer to spread a capital gain over several years.
What is a QSBC?
Qualified Small Business Corporation
How does the capital gains reserve work?
Allows a taxpayer to spread a capital gain over a maximum of 5 years (10 years for disposition of QSBC shares, farming property or fishing property to a taxpayer’s child). The cash exchanged for the disposition must be received in the same schedule and the gains cannot be loaded at the back (payment received must be equal to or greater than subsequent payments received).
When would the capital gains reserve be used?
If a business is being disposed of and it does not qualify as a QSBC (so the Lifetime Capital Gains Exemption is not available) or if the LCGE has been used up (or will be used up entirely by this sale).
Can variable payments based on the profitability of a business be used under the Capital Gains Reserve? What is this called?
This is called an “earn out” and would likely not be permissable as it would be taxed as income, not capital gains.
How does the Capital Gains Reserve benefit the vendor and the purchaser of a business?
The vendor benefits as the capital gains can be more easily managed.
The purchaser benefits because it encourages the vendor to take payment over multiple years (instead of all upfront).
What is the primary risk for the vendor of a business associated with using the Capital Gains Reserve?
The purchaser could default on their obligations. Even with a security agreement stating that if the purchaser defaults, the shares can be reclaimed, this poses a significant risk. If the business fails, there would be no recourse as the shares would be worthless.
How is the rollover of farming/fishing property from one generation to the next treated for tax purposes?
The transferee would inherit the property with the same tax consequences as the transferor (same ACB), assuming the continued operation that qualifies the property as a farming/fishing property.
How does a farming/fishing property qualify as having active farming income?
Property owned prior to June 18, 1987 (can be grandfathered): property must be principally (more than 50%) used in farming in the year of sale and for 5 years total in the property’s entire lifetime.
After June 18, 1987: must have been owned for 24 months prior to disposition. Must have been at least 2 years where farming income was the majority of at least one of the individual’s who owns the farm’s income and at least 2 years during which the farm was actively farmed.
What is the Elected Transfer Price in relation to farming/fishing property?
When transferring property to a “child”, the ITA allows for the selection of any price from $0 to the FMV of the property being transferred (only for farming/fishing property, otherwise double taxation would occur).
For non-depreciable assets, the child can pay with a promissory note for an amount based on the parent’s ACB + the parent’s available LCGE + any additional credits. The parent can then use their tax benefits while the childs increases their ACB without having to pay any tax at the time of disposition.
For depreciable assets, the chosen transfer price shouldn’t be higher than the Undepreciated Capital Cost (UCC) as this would result in a recapture of depreciation and the LCGE could not be used. (These assets are normally gifted to retain the parents’ UCC).
How do the rules for a rollover of farming/fishing property to a spouse work?
More restrictive than what’s available for a rollover to a child. It is not possible to elect a higher transfer price, so the assets can only roll over at a maximum of the ACB (or UCC).
How does attribution work when dealing with a spousal rollover of farming/fishing property?
If the property is rolled to a spouse during their lifetime (no attribution after death) and the receiving spouse does not work in the business, there will likely be attribution of income back to the transferor.
Who is eligible to set up a Health Spending Account (HSA)?
Incorporated business owners or unincorporated businesses with arm’s length employees.
What is the tax impact of HSA claims?
Deductible for the employer (amounts deposited to plan + fees), received tax-free by employee.
Why would a business owner avoid giving themselves a generous HSA while giving employees a significantly smaller amount?
The CRA may determine it to be a “shareholder benefit”. If that happens, the employer contributions will be disallowed and the bsuienss owner would be taxed on any benefits received.
Can income splitting via share ownership be used for a services business or professional corporation?
Not available if 90% or more of the income of the business originates from services or for Professional Corporations.
When is income splitting via share ownership allowed?
- If the shareholder who is receiving dividend income is at least 18 and works at least 20 hours per week in the business (and once this has been true at least once in the past 5 years, this right to split income is grandfathered).
- If the shareholder is 18-24 and contributed capital to the corp., they can take dividends back at the prescribed rate without any concerns about attribution. ($1000 capital at 2% prescribed rate means $20 dividends annually).
- If the shareholder is 25+ and can be shown to have acquired shares representing 10% or more of the votes and value of the opco with their own resources, no income splitting would apply.
- An owner-operator age 65+ can engage in income splitting with a spouse via share ownership, even if the business is a services business or professional corp.
What is the votes and value exemption?
If a family member age 25+ can be shown to have acquired, with their own resources, shares representing 10% or more of the votes and value of a opco, the tax on split income will not apply.
What is “kiddie tax”?
When a minor child earns dividend or interest income, that income will be taxed at the highest marginal tax rate (except for shares of publicly traded companies or in situations where a child has legitimately incorporated their own business. It also does not apply to orphans or children with no parents in Canada).
What is the purpose of “kiddie tax”?
Designed to prevent parents from establishing their minor children as shareholders of their corps as a method of income splitting.
How are dividends of private corporations taxed for minor (<18) shareholders?
Taxed in the highest marginal tax bracket. A minor child can use the dividend tax credit, but the basic exemption is not available.