Creative tax strategies for clients with corporations

Clients with their own corporations face tax challenges in numerous areas. But there are innovative solutions for a couple of common scenarios, according to tax expert Tim Cestnick of the Waterstreet Group, who spoke Thursday at the Advocis annual conference in Victoria.

One frequent issue involves clients who want to borrow from their own corporation. CRA regards that as a temporary loan, making it taxable. But you can escape the taxation by repaying the loan by the end of the corporation’s next fiscal year. Not easy, Cestnick admits, but it can be done through a spousal share transfer.

In this scenario, the business owner’s spouse borrows money from a bank, equal to the amount loaned from the corporation. With that cash, the spouse buys the same amount in shares of the company. The owner then has the cash to pay back the loan.

That solves the tax problem, since anything transferred to a spouse takes place at cost, not fair market value.

The general anti-avoidance rule will not apply under this structure, Cestnick notes, since CRA took a similar case to court earlier this year, lost and has said it will not appeal.

For company owners close to retirement and interested in strategic philanthropy, Cestnick suggests an insured share bequest. Under this plan, usually involving a holding company, the holdco’s assets are frozen and a life insurance policy is taken out in the amount of half of the assets.

“The result is going to be a significant donation to charity, no taxes and greater value in the hands of the heirs,” says Cestnick.

The holdco is the owner and beneficiary of the life insurance policy. In Cestnick’s example, the company’s frozen assets are $2 million and the insurance policy is worth $1 million. The annual cost for the policy, assuming both spouses are 60 years old, is around $9,500, making the total cost about $238,000 to age 85.

When the company owner dies, and the shares are sold at fair market value, the tax would be $464,000. But if one half of those shares, or $1 million, is left to charity, that creates a tax credit of $464,000, exactly the amount needed to offset the tax owing.

The death benefit from the $1 million insurance policy is paid into the holdco, which then uses the proceeds to redeem the shares bequeathed to charity. The holdco then repurchases the remaining $1 million shares from the estate. A capital loss in the estate of $500,000 results, saving the deceased $116,000 in taxes.

If the company owner doesn’t follow Cestnick’s strategy, the heirs would be left with $1.54 million of the holdco’s $2 million in assets and the remaining $464,000 would be paid to CRA.

Filed by Doug Watt, Advisor.ca, doug.watt@advisor.rogers.com