DAVID WILKENFELD, CPA, CA, canadian tax CONSULTANT

Posts Tagged ‘capital gains exemption’

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What’s Your Tax Issue?

In Canadian Income Tax, Non-residents, Personal Tax, Principal Residence on March 15, 2011 at 4:10 pm

Tax season is upon us, and here at The Tax Issue, the questions are streaming in at a furious pace. I had a few free minutes this afternoon, so I thought I’d tackle some of the backlog.

The Tax Issue:

My partner and I each have holding companies that have joint ownership of our operating company.  If we wanted to sell a 1/3rd share in the operating company is there a mechanism to utilize our personal capital gains exemption?

The Answer:

The capital gains exemption is a $750,000 lifetime limit available to all Canadian resident individuals. It can be used to shelter capital gains on the sale of either qualified farm property or qualified shares of a small business corporation.

Since the shares of your operating company are held through a holding company, the exemption would not be available in the situation you describe. Your holding company would be the vendor of the shares and the exemption is available to individuals only.

Having said that, there may be some “reorganization” of shares you could perform to get you into a better position. Such planning would go beyond what I could explain here, so I would explore these options with a tax professional.

The Tax Issue:

I am a Canadian living/working in the US and considered non-resident of Canada for tax purposes. I do have a rental property in Canada and looking for an easy way to file my income tax on the rental property. What I have read so far makes me believe that I must file my taxes through an agent in Canada. I am wondering if I can file my taxes without using an agent and what is the process to do that.

The Answer:

The short answer is that you do not need to file a tax return through an agent.

Since you are a non-resident of Canada, the Canadian person who pays you rent must withhold taxes and remit them to the CRA on a regular basis. This person could be your tenant directly, or a Canadian agent who manages the property and collects rent on your behalf. Either way, there has to be a Canadian responsible for withholding and remitting these taxes.

You then have the option of filing a tax return under section 216 of the Income Tax Act. The taxes previously withheld would be treated as a credit against your taxes payable. There are two options for withholding and filing under section 216. I have discussed this mechanism in a previous post. Check it out. Also, the CRA has an extensive section on their web site dealing with the issue.

The Tax Issue:

My mother passed away in 1995 and my father gifted her 50% portion of a house to me, however kept himself on title for the other 50%.   He had another house that he resided in.   He kept his name on solely to protect my interest in case of divorce.    He passed away in May 2010 and now I’m told that I may have to pay capital gains.   I don’t understand why I have to pay capital gains if I’m not selling the property and the property has been my principal residence.   He had nothing to do with the house.   Is there anything I can do to avoid paying this capital gains tax?

The Answer:

Unfortunately, it sounds like your father was the owner of more than one principal residence. Upon the death of an individual, he is deemed to have disposed of all his capital property at fair market value. That includes any real estate he owned. There is an exemption for a principal residence. The definition of “principal residence” includes, not only the house he lived in, but can also include a house occupied by his child. The downside is that his estate can only claim one property as a principal residence.

Your father’s executor will have to determine which of the properties he should claim as his principal residence in order to minimize the taxes on his death. I would call in the help of a good tax accountant to crunch those numbers.

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The Corporate Beneficiary

In Canadian Income Tax, Estates and trusts on October 25, 2010 at 3:46 pm

The family trust is alive these days and thriving more than ever. More and more taxpayers are beginning to appreciate the tax saving possibilities of income-splitting. The trustee has the absolute power to allocate income or capital of the trust to any beneficiary of his choice with no restrictions.

In a simple structure, a trust is created, with children as beneficiaries. The trust owns shares of an operating company (“Opco”) which pays annual dividends to the trust. The dividends are then distributed to the beneficiaries and taxed at their graduating marginal rates.

One spin on the family trust is to add a corporation to the list of trust beneficiaries. This option provides even more flexibility and advantages to the common family trust.

In an income splitting situation, it may not be desirable to pay dividends to the trust over a certain amount – that is the amount that would yield the lowest rates of tax when distributed to beneficiaries. For example, a Quebec taxpayer with no other income may earn up to $12,500 in dividends before paying any tax. The trustee may not wish to distribute more than this amount to the beneficiaries annually. If Opco has high income, its directors may find such a limitation restraining.

Adding a holding company (“Holdco”) to the list of beneficiaries wipes out this limitation. Opco could pay a large dividend to the trust. The trustee would allocate a portion of the dividend to the individual beneficiaries, and the excess would be assigned to Holdco.

A dividend paid by one corporation to a connected company is non-taxable. However, since Holdco does not own any shares directly in Opco, care would have to be exercised to ensure that the two companies were technically connected for tax purposes. Generally, this could be accomplished if the trust controlled Opco, or Opco and Holdco were controlled by persons who do not deal at arm’s length with each other.

Where Opco generates high levels of cash, the ability to pay dividends in this manner provides certain advantages. First, it allows protection from creditors in that cash may easily be moved out through dividends and away from potential claims.

Where individual beneficiaries have not claimed their capital gains exemption, this structure provides an easy means of having the company qualify as a small business corporation by paying excess “non business” cash out as a dividend.

Sometimes, the implementation of a family trust involves an estate freeze. In such a case, corporate attribution rules may apply to assign deemed dividends to the value of preferred shares issued to a parent as part of the freeze. One exception to this rule is to ensure Opco remains a small business corporation throughout the year. The ability to pay unlimited dividends to the trust on an ongoing basis would allow Opco to retain its small business corporation status so the exception applies.

Finally, if the trust is wound up, it may be possible to distribute the Opco shares to Holdco free of tax, thereby eliminating the need to give up eventual ownership of the shares to children.

Before implementing any such complex structure, care should be taken to ensure that all legal requirements are met, and that the tax advantages are worth the added costs.

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What’s Your Tax Issue? Gift or Sale to Kids

In Canadian Income Tax, Personal Tax on November 19, 2009 at 6:11 pm

The Tax Issue:

I am a partner in a Canadian co-ownership of real estate rental property and my siblings and my mother are also part owners. I would like to make a gift of my share to my children. Can this be done tax-free? Could I sell the property to them for a dollar?

The Answer:

In Canada, we don’t have a gift tax. However, when a gift is made between family members there is a deemed disposition at fair market value. So any gain that has accrued on your share of the co-ownership will be realized and you will be taxed. I’m not sure of your particular situation, but you might want to check your 1994 income tax return (if you can find it). That’s the year that the $100,000 general capital gains exemption was repealed. A special election was available to make one final use of the exemption and “bump up” the cost base of capital assets. If  you made the election on your real  estate venture, that could shelter part of the tax on a future disposition.

Special rules would also apply to your kids if you make this gift to them. Their cost amount for depreciation purposes could be reduced by the amount of your proceeds that results in the non-taxable portion of a capital  gain.

One of my pet peeves is when people make the mistake of thinking that a sale for a dollar is the same as a gift. It isn’t. A sale at an amount less than fair market value is not a gift, and different, much harsher rules apply. Your proceeds will still be equal to fair market value, but the cost base to the purchasers will be equal to exactly what they pay, i.e. one dollar. Then, when they decide to sell, they would be paying tax again on the full amount of proceeds. This “double tax” is the penalty for making a sale to a related person at an amount less than fair market value.

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What’s Your Tax Issue?: Surplus Stripping

In Canadian Income Tax, Tax Avoidance on October 1, 2009 at 5:50 pm

The Tax Issue:

Can I claim the capital gains exemption if I sell my shares to my brother’s company?

The Answer:

This could be the most common question I get on this topic. The capital gains exemption is intended to shelter the gains from the sale of private company shares. The exemption is available to individuals only, up to a lifetime cumulative limit of $750,000. The shares must meet certain tests which are too complicated to get into here. Suffice to say, you would not want to claim the exemption without consulting a tax professional first.

Generally, any sale of shares that qualifies should be eligible for the exemption, even a sale to a non-arm’s length party, such as your brother’s company. However, if you plan on receiving any consideration other than shares, such as cash, forget it.

Let’s cut to the real question. What you are really asking is, “can I get cash out of a non-arm’s length company without paying tax?” What the CRA calls this is “surplus stripping”, and there are rules in place to stop you.

Specifically, the most common anti-surplus-stripping rule in the Income Tax Act is found in section 84.1, which will convert your capital gain into a taxable dividend if you receive cash as part of your proceeds from the sale of shares to a non-arm’s length company.

If you wish to take back shares of your brother’s company as your proceeds, that’s ok, but any subsequent redemption of those shares will be taxed as a dividend.