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.
What is the Lifetime Capital Gains Exemption (LCGE)?
Business owners can exempt up to ($971K in 2023, indexed from $800K in 2014) of capital gains from the sale of incorporated businesses in their lifetimes.
If the 2023 LCGE is $971K and a business owner sells their incorporated business with a $700K capital gain, how much LCGE would they have left?
$271K would be left.
Which types of property is the Lifetime Capital Gains Exemption (LCGE) available on?
- Qualified Small Business Corporation (QSBC) shares.
- Qualified farming property.
- Qualified fishing property.
What are the criteria for a business to be a Qualified Small Business Corporation (QSBC) and qualify for the LCGE?
Shares must represent ownership of a Canadian Controlled Private Corporation that is carrying on business primarily in Canada (50% or more). Must also be primarily (50% or more) engaged in active business activities within the last 24 months prior to the disposition of any assets. At the time of sale, 90% or more of the business’ assets must be dedicated to earning active business income. Seller must have owned share for 24 months prior to sale and must have been indefeasibly owned (seller is free to sell shares as he sees fit).
What does it mean to “purify” a business and when would this be done?
Often consists of transferring inactive assets to the owner of some other entity in the form of a dividend. Often done to permit the seller of a business to use the LCGE by qualifying it as a QSBC (90% or more of the business assets must be dedicated to earning active business income at time of sale).
What would happen with the LCGE if a business owner sells an opco but retains a holdco with significant passive income earning assets?
This could put the whole sale offside for the LCGE as the business must have been primarily (50%+) engaged in activities business activities in the 24 moths prior to a sale and must be almost exclusively (90%+) engaged in active business activities at the time of sale.
When would a business that earns income outside of Canada qualify as a QSBC for the LCGE?
If less than 50% of the assets of the business are dedicated to earning income outside of Canada, and more than 50% is dedicated to earning income in Canada.
What is “indefeasible ownership”?
Seller is free to sell shares as they see fit. This is a qualifier for the LCGE - it would not apply if the shares simply passed through somebody’s hands and that person was compelled to sell the shares to another party by some agreement.
How much is the LCGE for farming/fishing property?
$1,000,000, not indexed to inflation
What is considered qualifying farming property for the purpose of the LCGE?
- Shares in a family farm corporation
- Interest in a family farm partnership
- Real property used in farming
- Intangible farming assets (such as rights and quotas)
How long must a farming/fishing property be primarily used for farming or fishing purposes to qualify for the LCGE?
Primarily used for farming or fishing purposes over the previous 24 months.
