Archive July 2017

NEW TAX RULES EFFECTING PRIVATE CORPORATIONS

On July 18, 2017, the Liberal government and the Department of Finance issued draft legislation which significantly alters the tax planning available for private corporations. The following is a brief summary of each of the proposed new rules. We strongly suggest you consult your Segal advisor to discuss how these rules affect you and your business.

Income Splitting

It has been common tax practice to set up a structure whereby a trust owns shares in an operating company with both minor and adult beneficiaries. Alternatively, family members owned shares directly in the operating company. In the past, dividends could be paid to the adult family members who would pay tax at their graduated tax rate. For those adult family members who earned no other income, such as a student, the tax owing could be low on those dividends.

The new legislation proposes to tax those dividends at the highest tax rate. As well, the new rules propose to tax other kinds of income paid to related adult family members. There is relief if the adult family member contributes to the corporation by way of capital or involvement. CRA will have discretion to determine if the amounts paid to the related adult family member are reasonable in the circumstances. These rules are effective in 2018.

Multiplication of the Capital Gains Exemption

In the structure noted above, if a trust owns shares in an operating company, it is possible that a capital gain realized by the trust could be allocated to the beneficiaries and the beneficiaries could claim the capital gains exemption. The new rules would eliminate the ability for a trust to have a capital gain subject to the exemption. Moreover, any gain on a share owned by a trust would not be eligible for the capital gains exemption. This would also apply where family members acquired shares for a nominal amount without the use of a trust. If shares were owned by a minor, and the shares were ultimately disposed when that individual became an adult, the gain that would have accrued while the individual was a minor could not be sheltered by the capital gains exemption. The capital gains exemption will not be available to family members who are subject to the income splitting rules noted above.

There is a rule that will allow for trusts and family members to make an election to crystallize the capital gains exemption in 2018. However, this crystallization will only be available to adult beneficiaries and adult family member shareholders. These rules are effective in 2018.

Conversion of Dividend Income to Capital Gains

There is a significant difference in the tax rate of a dividend (39.34 or 45.30%) and capital gains (26.76%). Historically, with tax planning, one could convert what otherwise might have been a dividend into a capital gain. The new rules propose to convert the capital gains realized between non-arm’s length parties into a deemed dividend. This would mean that the tax-free portion of the capital gain would not be added to the capital dividend account. Moreover, it appears that there would not be an increase of the cost base of the shares that were received as consideration which could possibly result in double taxation.

There are also new rules that propose treating payments out of the capital dividend account as a taxable dividend where the capital dividend account was created by transactions whose goal was to reduce the personal income tax of the shareholder.

These rules could also affect post-mortem planning. These rules are effective for transactions and amounts paid or payable after July 18, 2017.

Making Investments in an Operating Company

While still in the public consultation phase, the government has proposed to increase the tax burden on an active corporation investing surplus funds. Those investments would no longer enjoy preferential tax treatment and access to the refundable tax regime and capital dividends. The government appears to be concerned that an active company subject to low tax rates would have significantly more to invest than if the funds were paid to the individual shareholder and all taxes were paid.

This issue gets complicated in terms of tracking which investments are from surplus funds and what the actual income related to those surplus funds are. The government has asked for input on how to apply their proposals.

Summary

These proposals are significant on their own and collectively will change the tax planning landscape for all privately held businesses and their shareholders. Every situation where a trust owns shares in a private corporation must now be evaluated to determine what the best tax planning is on a go forward basis.

Please contact your Segal advisor as soon as possible so that planning can start now.

Segal LLP | Tax Advisory

Dealing with a Layoff or Forced Retirement

lores_hr_cost_cutting_fired_terminated_envelope_job_employment_words_amIt doesn’t matter whether you’re employed in the private or public sector – companies and government agencies equally struggle to boos the bottom line and stay within tight budget constraints.

Those efforts can sometimes result in downsizing. With little notice in many cases, employees are presented with severance packages or incentives to retire early.

If that unfortunate scenario occurs, you may not be in the state of mind, or have sufficient knowledge, to properly evaluate the offer. Downsizing packages often involve decisions that go beyond severance pay, including benefit replacement and pension considerations. A qualified financial planner can help you assess the package and consider the following issues:

Family finances. Income uncertainty can be a challenge, especially if you’re facing post-secondary education costs for children and other major ongoing expenses, such as a mortgage. The impact on your spouse, especially if he or she is still working, should also be addressed.

Tax planning. Your package may include a significant lump sum, which means you need a strategy to minimize taxes. For example, you might review your RRSP contribution limits and consider using the “retiring allowance” to defer much of the income tax as possible. Or some of the money could be applied to your spouse’s RRSP. In some cases, an employer may agree to make payments over two years. Proper planning in this area is essential, as some of these tax-planning opportunities are only available during the year of severance.

Spending habits. Compile a budget to track monthly expenses. A budget also helps you make changes to your spending patterns. You may decide to impose some restrictions and consolidate debts to reduce interest costs.

Pension choices. This can be one of the most critical financial choices. You should fully understand pension options, because the decision is permanent. If you plan to draw on your pension, determine whether a single or joint life pension is needed, as well as whether you want a guarantee on future income.

If you’re not at pension age yet, you may elect to have a deferred pension or take a “commuted value” out of the plan to rollover to your own locked-in RRSP.

Group benefit replacement. Determine if any employee benefits will continue. You may have to add to your budget premiums for health, dental, life and critical illness insurance to replace lost benefits. An assessment of whether to “self-insure” some of the costs or pay premiums to an insurance company to cover the potential risk needs to be completed. You may be able to apply to become a dependant under your spouse’s group insurance plan. Some coverage, such as disability insurance, will be discontinued because you’re no longer employed.

Income and asset review. By calculating your assets and potential sources of income, you can determine any shortfall in your budget. Income from your spouse or partner may help defray expenses. Consider all assets and sources, such as RRSPs, savings, and Canada Pension and Old Age Security. Review investments. Your risk tolerance has probably changed as a result of your unemployed status.

By using the services of a qualified financial professional, you can get the most out of your severance or early retirement package. Call our firm for help developing a realistic plan that reflects your personal situation and allows you to get on with life.

Tee Off for Success

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A Smart Venue for Business

Golf has its detractors but one thing is clear: The game is a valuable way for companies to bring in revenue.

“Eighteen holes of match or medal play will teach you more about your foe than will 18 years of dealing with him across a desk.”

— Sportswriter Grantland Rice

Scoring an Eagle

Golf can drive home some lucrative business. Here are some of the ways executives believe the sport helps:

It’s a good way to establish close business relationships and make new business contacts.

  • The way people play golf is similar to how they conduct business.
  • Golf demonstrates levels of competitiveness and motivation and provides time to get to know a person’s character. A person who cheats on the golf course would probably cheat in business. Similarly, a bad temper on the course probably means a bad temper in the office.
  • Some of the biggest deals involve time on the golf course and most are closed a few days after a round of golf.
  • The time spent immediately after a round eating and socializing (the “19th hole”) is a key part of doing business.
  • On the course, the back nine is the best time to bring up business.

Many executives believe golf is an essential business tool and that behaviour on the golf course indicates behaviour in business. But strategic golf isn’t the same as recreational golf. Courting business on the course means keeping your business purpose in mind and focusing on your customers. You need to shift effortlessly between business and the sport.

Golf can be expensive but it’s widely viewed as a profitable investment. According to some estimates, Canadian businesses bring in more than $1,500 in business revenue for every dollar spent on strategic golfing. That may explain why the golf course outscores the hockey arena as a venue for business. (It comes in second place just below restaurants.)

But, like any other business investment, you want to maximize the return in terms of the amount of money and time spent.

To help with that goal, here are seven rules to help keep the game above par when playing with business associates:

1. Assess your corporate goals. Prepare for the day as you would for any business or board meeting. Think about what you want to accomplish, whether it’s to network, lay the foundation for new business, or strengthen a customer relationship.

2. Know the game. New golfers should have played at least five rounds of golf and have a few lessons before attempting to play business golf. If you score higher than average, let the rest of the group know in advance to save yourself some embarrassment.

3. Stay professional and polite. As a representative of your company, show professionalism in the way you play and adhere to dress codes. If in doubt, call the club to get the policy. Never wear jeans or tee shirts.

Obviously, don’t criticize how others are playing, don’t give advice unless asked, and don’t brag about your performance. In addition, don’t lose your temper, swear, or show rudeness. People who cheat at golf are often seen as likely to cheat in business.

And forget the cell phone. Many courses ban them and even if they don’t, turn yours off. A sure way to lose a sale is to have your cell phone ring or play a song just as your prospective customer is taking aim at a putt that’s going to win the round. Checking your e-mail messages on your PDA? That’s considered rude on the course.

4. Find the right mix. Put together a foursome with similar golfing abilities and temperaments. Ask if they prefer mornings or late-afternoon tee times. Introduce everyone so they feel at ease and consider providing a short advance bio of the players.

5. Let the client bring up business. Tolerance levels for business chat on the course varies widely, so follow the lead of fellow players. Don’t put business ahead of relationship building. Formal business discussions will follow on another day. If the conversation turns to business, keep it light and brief.

6. Don’t forget the 19th Hole.  After the round is over, make sure to allow time for some food, drinks and socializing. This is the time to talk business. Mix the discussions with talk about how the game went. Focus on the highlights, not the bad shots. If the game went badly, this is also a good time to smooth things over.

7. Follow through. After the round, make a phone call or arrange a visit and, hopefully, secure a signed contract. Otherwise, you haven’t finished the game or maximized your investment.

If you really hate golf, don’t bother with it. Pretending you’re having a great time when you’re miserable probably won’t work. The time and mental investment involved in golf is too great and the return will likely be too small. There are other ways to entertain prospects that everyone will enjoy.

Find Your Niche Market

thmb_blue_cool_lightbulb_idea_energy_amBe a Pioneer

Let’s face it; if you own a small or mid-sized company, you can’t compete with, say, Hudson’s Bay, Magna, Wal-Mart or Microsoft.

But you might find a niche those big corporations are ignoring and exploit it. The key to success for many companies is coming up with a specialized product or service aimed at a specific group of consumers. For example:

Position Your Niche

After deciding on a niche, you need to promote it.

Position the product or service as unique or a distinctive alternative to the competition. Of course, promotion strategies generally depend on the type of business and your marketing budget.

Nevertheless, there are some common elements in marketing strategies:

1. Identify customer needs and be responsive to them.

2. Offer reliable and competent service.

3. Know the competition and be on the lookout for new competitors.

4. Know the break-even point and set prices that recover the cost while still attracting customers.

5. Spend as much as you can on a regular basis to promote the niche.

6. Highlight the features that distinguish your product or service from the competition.

  • One grocery store in Vancouver caters to specific customer tastes by offering nearly 40 varieties of hot sauces.
  • A Saskatchewan business sells gourmet chocolates filled with Saskatoon berries.
  • An Ontario man started a business that searches for reliable suppliers and quotes for individuals and businesses, He got the idea when he bought aluminum siding after getting only three quotes and wondered how many others purchase big-ticket items based on only a couple of quotes.

Even if you’ve been in business for 20 years, you may still come across a niche that can add to your company’s success, offer a new career or just allow you to follow a dream.

For example, cattle farmers could focus on serving a demanding consumer market by raising certified organic beef, natural beef or certified hormone-free beef. That’s assuming the niche idea is good, they’ve done research and come up with a good marketing strategy.

Niche ideas come from many sources: a skill or hobby; a new way of doing something; or frustration when searching for a product or service and realizing others are probably going through the same thing.

Here are some steps that can help you come up with ideas and evaluate their potential:

Make a list. Include hobbies, skills and interests, as well as things you hear people complain about. Ever hear someone say: “I wish someone would think of a way…? Brainstorm with employees, colleagues, friends and family for potential niche candidates.

Devise keywords. To get a rough idea of demand, turn your ideas into keywords. Then go to Internet search engines and type in “Overture Search Term Suggestion Tool”. Enter one of your keywords into the tool and in about 30 seconds, you will get a list of how many searches were made in one month on that keyword and variations. For example, a search for espresso maker found a total of 7,995 searches in one month. Of course this shows only the number of Internet searches, but it can help get a sense of potential demand.

Research seriously. When examining a market, answer these questions, among others:

1. What is the demand for the product?
2. Who are the consumers, where do they live and how do they shop?
3. How extensive is the market?
4. How much of the market can you expect to capture?
5. Is it a growth area?
6. How will your product or service fit in?
7. What does the competition look like?

Interview potential customers, talk to other entrepreneurs and use resources such as the local chamber of commerce, hobby and trade magazines, Industry Canada, Statistics Canada, as well as other government agencies and industry associations.

Databases can help determine buying habits in specific areas. For example, do shoppers in Ontario tend to buy high price, high quality products? Or do shoppers in Alberta tend to look for a good deal?

As you develop a niche, try to find the optimal mix of product, demand, services, price and marketing strategy (see right-hand box above for a few marketing tips). You don’t want a $3,000 product if you can only sell a few each year.

Have Fun: In any business, it helps to enjoy what you’re doing. Passion for your business can make the difference between success and failure.

CRA Gets Tough On Real Estate Tax Cheats

062317_Thinkstock_501212115_lores_kwCanada Revenue Agency (CRA) says it has taken significant steps to address tax cheating in the real estate sector.

The CRA says that, in recent years, it has increased its real estate audits, particularly in the Greater Vancouver and the Greater Toronto areas, where increased real estate speculation has heated the market. From April 2015 to March 2017, CRA audits of real estate transactions scooped up more than $329.4 million in unreported taxable income.

Protecting Tax Fairness and Integrity

The feds have taken other measures to curb tax cheating in real estate deals. Specifically, in a change aimed at making sure only eligible home owners claim a principal residence exemption from paying taxes on capital gains, you are now obliged to report the sale of principal residences to the CRA. Before the 2016 tax year, if the property was your principal residence for every year you owned it, you didn’t have to report the sale on your income tax and benefit return.

National Revenue Minister Diane Lebouthillier explains, “For many Canadians, buying a home is one of their proudest moments and represents one of their most important investments. Our Government has committed to protecting the fairness and integrity of the tax system for all Canadians, notably by cracking down on tax cheating in real estate transactions. This means that, without exception, every taxpayer abides by the same tax laws.”

The CRA says it plans to enhance its ability to combat tax evasion and avoidance by strengthening relationships with such key partners as provinces, territories and municipalities to expand, obtain and exchange information on real estate transactions. The agency also seeks the help of taxpayers. If you suspect that someone hasn’t reported income or GST/HST related to a real estate transaction, the CRA urges you to contact the National Leads Centre. Your identity won’t be disclosed, and you can provide information anonymously. Your tax advisor can provide you with the details.

In the midst of the recent heated real estate market, questions have been raised about what federal tax obligations the buyers and sellers of real estate must meet, and how the CRA ensures tax compliance on these transactions.

The Key Areas of Compliance Risk in Real Estate

There are five main areas of concern:

1. Questionable sources of funds. The sources of funds used to buy or maintain Canadian properties could be an unreported spring of money that was never taxed, either in Canada or another country. In certain circumstances, a large down payment on a home, or a property that is expensive to maintain, may indicate:

  • Unreported income, if the lifestyle of the buyer isn’t compatible with the income reported,
  • Tax evasion, or
  • Purchase of real estate by a low-income person concealing a wealthy buyer.

The CRA can establish correlations between a taxpayer’s reported income and his or her lifestyle. The acquisition of expensive assets, such as a high-end home, without an obvious source of income, can be an indicator of potential unreported income earned from legal or illegal sources.

2. Property flipping. People, including real estate agents, who buy and resell homes in a short period for a profit are engaged in what is known as “property flipping.” There are three main categories of people engaged in this:

  • Professional contractors who sometimes demolish or renovate a property.
  • Speculators or middle investors who, for a profit, buy a property and assign the right to sell to another speculator or the final buyer. (This is called “shadow flipping” and it can occur many times between the first and final sale of a property. The original seller often doesn’t know that the property has been assigned to another buyer until the signing date.)
  • Individuals who buy real estate, renovate it, live in it for a short time and sell it to claim the principal residence exemption several times in their lifetimes.

The CRA acquires and analyzes third-party data and has found that some flips aren’t being reported or are being reported incorrectly. The profits from flipping real estate are generally considered to be fully taxable as business income, but there may be circumstances where they’re considered capital gains. The facts of each case determine whether such profits should be reported as business income or as a capital gain.

3. Unreported GST/HST. Generally, the builder of a new or substantially renovated home must charge and collect GST/HST when the home is sold and report that tax to the CRA.

If a builder leases a new or substantially renovated home, the builder is deemed to have sold the home to himself or herself. The GST/HST is payable on the fair market value of the home, including the land value, and the builder must report that tax to the CRA.

Generally, the deemed sale of a new or substantially renovated home isn’t considered to have occurred if:

  • A builder constructs or substantially renovates a home to be used primarily (more than 50%) as his or her place of residence, or a residence for a relative, and
  • The builder hasn’t claimed an input tax credit to recover any GST/HST payable for the construction or renovation

There may also be GST/HST implications for flipping transactions, if a property is new or has been substantially renovated. In most cases, the sale of used housing is exempt from GST/HST. One of the main conditions for the new housing rebate to be available is that you must buy or build the home as your or a relative’s principal residence.

If you buy or build a new home in Canada, but your principal place of residence is outside Canada, the house in Canada would be a secondary place of residence and wouldn’t qualify for the new housing rebate.

Also, if the intention at the outset is to flip the property, the eligibility requirement for the new housing rebate isn’t satisfied, as confirmed by several recent court decisions.

4. Unreported capital gains on the sale of property. Selling a property for more than it cost generally leads to capital gain. In most cases, capital gains are taxable and must be reported. Whether the gain is taxable depends on whether the property is a principal residence or whether the seller is a resident or nonresident of Canada. Consult with your tax advisor.

5. Unreported worldwide income. Residents must report their worldwide income. Nonresidents have to report only Canadian-sourced income, unless a tax treaty provides otherwise. Your tax advisor can discuss how residency is determined.

If you are involved in real estate, regardless of the degree, consult with your tax advisor to help ensure you are complying with CRA rules. And if for any reason you reported such income incorrectly, you advisor can help you file an amended return.