DAVID WILKENFELD, CPA, CA, canadian tax CONSULTANT

The Corporate Beneficiary

In Canadian Income Tax, Estates and trusts on February 23, 2012 at 10:16 pm

The brain is a wonderful organ. It starts working the moment you get up  in the morning and does not stop until you get into the office.     –Robert Frost

Despite the limitations placed upon it by recent legislation and unfavourable court rulings, the family trust remains alive and thriving more than ever. More and more taxpayers are beginning to appreciate the tax saving possibilities of income-splitting.

The discretionary family trust generally provides for maximum flexibility with respect to income splitting. The trustee has the power to allocate income or capital of the trust to the beneficiary of his choice.

In a simple structure, a trust is created, with children and/or a spouse 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 interesting spin on the family trust is to add a corporation to the list of trust beneficiaries. This option, although it involves more legal and accounting costs, provides even more flexibility and advantages to the common family trust.

In an income splitting situation, it may not be desirable to pay more dividends to the beneficiaries than they require. If Opco has high retained earnings, 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 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.

Of course, 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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