Davies Academy for Continuing Legal Education Fred Purkey Marie-Emmanuelle Vaillancourt

Transcription

1 Tax Tips for Commercial Lawyers Davies Academy for Continuing Legal Education Fred Purkey Marie-Emmanuelle Vaillancourt October 1, 2009

2 Disclaimer This presentation is intended to provide readers with general information on Canadian tax rules only. It should not be relied upon as legal or tax advice, and readers should consult with their professional advisers before undertaking any planning strategies, including those mentioned in the presentation. 2

3 Overview

4 Types of Property under the ITA Different types of property are taxed differently while held and on disposition Capital property Non-depreciable, such as land and shares. No depreciation Depreciable, such as equipment and buildings. Can claim depreciation as a deduction, with the rate depending on the kind of property The disposition of capital property gives rise to capital gains/losses and recapture/terminal losses Inventory The disposition of inventory gives rise to ordinary income/losses 4

5 Types of Property under the ITA Eligible Capital Property ("ECP") Such as goodwill, unlimited life licenses, government quotas ¾ of ECP is depreciable at 7% per year on a declining balance basis, so there can be a deduction from income The disposition of ECP gives rise to business income (only ½ of which is taxable if representing a gain) 5

6 Taxation Rates for Individuals Also, different kinds of income are taxed differently Québec Ontario Alberta Capital Gains 24.11% 23.21% 19.50% Dividends (eligible/ineligible) 29.69/36.36% 23.96/31.34% 16/26.46% Other Income (salary, interest, etc.) 48.22% 46.41% 39% 6

7 Taxation Rates for Corporations Québec Ontario Alberta Basic Business 30.90% 33.00% 29.00% Investment Income (CCPC) 46.57% 48.67% 44.67% Investment Income (CCPC net of dividend refund) 19.90% 22.00% 18.00% 7

8 Basis

9 Adjusted Cost Base (ACB) ACB refers to the cost of a capital property as adjusted for tax purposes Generally, the cost of a capital property is equal to the outlay or expense incurred to acquire the property ACB is averaged among identical properties, such as shares of the same class (in case of successive acquisitions) There is generally no "ordering" rule, where for example shares purchased first with a low ACB are deemed sold first for a higher gain 9

10 Paid-up Capital (PUC) A share's PUC is equal to its "stated capital" for corporate law purposes, as adjusted for tax purposes Generally, stated capital = the consideration for which shares are issued PUC is your friend: PUC allows a shareholder to extract its investment from a private corporation tax-free despite the fact that the company has retained earnings The ability to make a tax-free return of PUC is available to public companies in very limited circumstances PUC is averaged across all shares of a class, regardless of shareholder, and remains unchanged when the shares are sold to another person 10

11 Paid-up Capital (PUC) If shares are being acquired from treasury for an amount greater than the current PUC, consider having the new shareholder subscribe for shares of a new class instead to prevent averaging down of the PUC 11

12 ACB/PUC Example Mr. X subscribes for 100 common shares for $100. His PUC is $100 (if there is no averaging), and his ACB is $100 Mr. X later sells the shares to Ms. Y for $500 Ms. Y s ACB is what she paid for the shares: $500 Ms. Y s PUC is $100 PUC remains unchanged even when the shares are sold to another person 12

13 Dividends

14 Dividends Currently taxed at a higher rate than capital gains Can be absorbed by non-capital losses (i.e., regular business losses), but not by capital losses However, Intercorporate dividends may be tax free under certain circumstances Different rates for individuals receiving eligible or ineligible dividends Dividends can be tax free if from the Capital Dividend Account (for any Canadian resident shareholder, not only for corporate shareholders) 14

15 Eligible / Ineligible Dividends Québec taxes individuals at a rate of 29.69% on eligible dividends, and 36.36% on ineligible dividends Generally, eligible dividends include dividends paid by: Canadian-controlled private corporations (CCPCs), to the extent that their income is: not investment income (other than eligible dividends from public corporations) subject to the general federal corporate income tax rate (so the income is active business income not subject to the federal small business rate) public corporations or other corporations that are not CCPCs, that are: resident in Canada subject to the federal general corporate income tax rate 15

16 Capital Dividend Account The ½ of a capital gain that is not taxable is added to a private corporation's Capital Dividend Account (CDA), as are: CDA dividends from other corporations life insurance proceeds the non-taxable portion of the proceeds of disposition of eligible capital property (such as goodwill) CDA can be paid as a tax-free dividend to a Canadian resident shareholder. Tax-Free! CDA paid to a non-resident is subject to Canadian withholding tax. Consider reorganizing the share capital so the CDA is paid on a class of shares where only Canadian residents are shareholders 16

17 Capital Dividend Account Losses on the sale of capital property (like shares or land) reduce the CDA, so pay CDA out when you can (as soon as CDA is positive) If the CDA election form is not filed, then it is not a CDA dividend (late filing is possible with penalties) CDA dividend includes a deemed dividend on redemption, or on a PUC increase 17

18 Making intercorporate dividends taxable: Section 55 Turns otherwise "tax-free" intercorporate dividends into taxable capital gains Unless the dividend is paid out of its "safe income" Safe income is essentially taxed retained earnings, but with so many adjustments and exceptions that the calculation of safe income is usually left to the accountants If there is no unrelated person involved in the entire "series of transactions", section 55 does not apply, even if the dividend is in excess of safe income (i.e. for transactions between related persons, safe income is irrelevant and dividends can be paid "tax-free" in all cases) "Series of transactions" is very broad, and can span years 18

19 Making intercorporate dividends taxable: Part IV Tax There is a refundable Part IV tax of 33 1/3 % on dividends received by a private corporation Tax is paid by the recipient corporation Applies if the payor and recipient are not connected. Connected means the dividend recipient owns shares with more than 10% of the votes and value, or controls (alone or with non-arm s length persons) the payor; or if the dividend entitles the payor to an RDTOH refund) This tax is refundable if dividends are later paid by the recipient corporation 19

20 Making intercorporate dividends taxable: Part VI.1 Tax paid by the payor corporation if VI.1 applies A dividend payor corporation may be required to pay Part VI.1 tax of up to 50% on the dividends, if: Dividends are paid in excess of $500,000 for the year by the corporation or any associated corporation Paid on taxable preferred shares: Start worrying if the shares are anything other than vanilla common Shareholder owns less than 25% of the payor (there are many conditions to be met for this) and is unrelated 20

21 Sale of a Business

22 Sale of a Business Sell assets or shares? Rule of thumb: B.A.S.S. Buyer wants to buy Assets Seller wants to sell Shares 22

23 Sale of Assets Why does buyer want to buy assets? Gets full basis in the depreciable assets, can start claiming depreciation Does not get a corporation with all its potential liabilities 23

24 Sale of Assets: Price Allocation When selling assets, do not simply sell for one global price. Allocate the sale price between the different types of assets so as to give the best tax result There are restrictions on how sale price is allocated between assets, but there is also a certain amount of leeway For example, land (non-depreciable) and building (depreciable) are being sold for $1000 total The purchaser has income, and wants maximum deductions from that income The parties could allocate $500 to the land, and $500 to the building 24

25 Sale of Assets: Price Allocation The cost to the purchaser would then be $500 for the land, and $500 for the building It would be better for the purchaser to allocate more of the sale price to the building ($700 for example), on which the purchaser can claim depreciation, than to the land, on which he cannot It might be better for the vendor to allocate more to the land ($700) than to the building. He might rather have more of a gain on the land (capital gain only 50% taxed), than on the building (potential recapture taxed at 100%) Negotiation 25

26 Sale of Shares Why does seller want to sell shares? No recapture (which is taxed as ordinary income) of depreciation previously claimed on depreciable property Capital gain, only ½ included in income Gets rid of corporation with all its potential liabilities No GST or QST on a share sale Individuals can claim $750,000 Capital Gains Deduction on the sale of shares of a Canadian-controlled private corporation ("CCPC") carrying on an active business A sale of shares only gives rise to capital losses if sold for less than ACB. 26

27 Gains and Losses Only ½ of capital gains are included in income Only ½ of capital losses can be applied against capital gains Capital losses can only be applied against capital gains Capital losses can be carried back to offset capital gains realized in the last three years, or carried forward forever Non-capital losses (i.e., regular business losses) can be applied against capital gains or regular income, can be carried back 3 years or forward 7-20 years, depending on when the losses were incurred 27

28 Stop & Superficial Loss Rules The seller may not always be able to trigger the losses he wants The stop / superficial loss rules apply to dispositions of shares and other capital property where an affiliated person (corporations controlled by the same person, spouse, etc.) holds that property or an identical property 30 days later If vendor is a corporation: Loss suspended until an unaffiliated person acquires the property If vendor is an individual: Loss denied, but may be added to the ACB of substituted property There are stop loss rules for depreciable property as well, but not for inventory 28

29 Restrictive Covenants (RCs) In a sale, often the vendors agree not to compete with the purchasers: A restrictive covenant Caselaw states that portion of purchase price allocated to RCs, specifically non-competes, is not taxable New tax rules treat amounts allocated to RCs as ordinary income AND grant CRA the authority to re-allocate purchase price to RCs In some cases, elections are available to treat amounts allocated to RCs as capital gains or gains from the disposition of ECP To pre-empt CRA, consider allocating a modest amount to RCs and covenanting to make such elections 29

30 Issues to Consider on Acquiring a Business

31 Acquisition of Control Where there is an acquisition of control of a corporation (e.g. a shareholder acquires more than 50% of the shares), then: A fiscal year-end is triggered immediately before the acquisition of control, so tax returns must be prepared and filed, certain tax accounts are prorated for the short year, and business losses are aging by a year All losses except for business losses (NOLs) disappear Business losses may be carried forward but only if certain conditions are met 31

32 Acquisition of Control Scientific research and experimental development (SR&ED) expenses and credits expire, with certain exceptions Unrealized capital losses are triggered on the acquisition of control but you can elect to trigger gains on other capital property 32

33 Acquisition of Control Election under 111(5) - Example M.A. owns all the shares of Aco Aco has capital losses of $100 and owns shares of Bco with an inherent gain of $100 M.A. sells the shares of Aco to Zco, capital losses disappear Aco can elect to trigger a deemed disposition of the shares of Bco immediately before the acquisition of control to realize a $100 capital gain and be able to use the $100 capital loss 33

34 Business Losses Generally Business losses can be applied against capital gains or ordinary income and can be carried forward 7-20 years, depending on when the losses were incurred Losses in tax years ending before March 23, 2004: 7-year carryforward Losses in tax years ending from March 23, 2004 to December 31, 2005: 10 year carryforward Losses in tax years ending after that: 20-year carryforward 34

35 Business Losses on an Acquisition Business losses may be carried forward and used in taxation years ending after an acquisition of control if two tests are met Firstly, the business that gave rise to the loss must be carried on by the corporation for profit (or with a reasonable expectation of profit) throughout the particular taxation year to which the non-capital loss is to be carried forward (the "same business test") Secondly, the business loss may only be used in such year to the extent of the corporation's income for that year from that business (the "income test") Be careful when acquiring a Lossco to ensure that the losses are not about to expire 35

36 Non-Arm s Length Sale: Too Little Sale to a non-arm's length person for less than fair market value: Problem! For example, vendor owns land with an ACB of $100 and a value of $1000 Vendor sells the land to his sister for $100 Section 69 causes vendor to be deemed to have received $1000 proceeds, so he has a $900 capital gain and is taxed accordingly The ACB of the land for vendor s sister is only $100, so if he sells, she will have a $900 capital gain This results in double taxation 36

37 Non-Arm s Length Sale: Too Much Sale for more than value to non-arm's length person: Problem! Vendor has full proceeds as a gain Purchaser only has ACB equal to value, so would have a greater gain (or a lesser loss) upon sale Thus if the value is $600 and the ACB is $100, if the property is sold to a nonarm's length person for $1000, the vendor has a $900 gain, and the purchaser only has an ACB of $600 37

38 Reorganizations

39 Tax-Deferred Exchanges Section 85 rollover : Transfer property to a corporation in exchange for consideration which includes at least one share and elect for the transfer to occur on a non-recognition basis For example, land with an ACB $100 and value of $500, could be transferred on a rollover basis to a corporation for shares thereof Transferor could receive shares with a PUC/ACB of $100 and a value of $500, with no tax on the transfer Alternatively, the transferor could receive $100 cash and shares with a PUC/ACB of $0 and a value of $400, with no tax on the transfer Can elect to transfer at a gain, which could be absorbed by capital losses, or by the capital gains deduction (for certain shares only) 39

40 Tax-Deferred Exchanges There are other kinds of exchanges as well, which apply automatically (if certain conditions are met): Section 51: Internal exchange of shares Section 86: Internal exchange of shares Section 85.1: Exchange shares of Canadian corporation for shares of another Canadian corporation, or shares of a foreign corporation for shares of another foreign corporation (to ensure that s.85.1 does not apply, add consideration other than share) 40

41 Amalgamation Two or more Canadian corporations amalgamate to form one corporation that is a continuation of the predecessors for corporate law purposes, but is deemed to be a new corporation for federal tax purposes (not for Québec tax purposes) Assets of predecessor corporations are "transferred" on a tax deferred basis to the amalgamated corporation ("Amalco") if all the conditions under section 87 ITA are satisfied Fiscal year of predecessors ends the day before the date indicated on the certificate of amalgamation, so obtain a June 1 certificate if a May 31 year-end is desirable This is a tax-deferred transaction for shareholders of predecessor companies, provided they receive only shares of Amalco in exchange for their shares of the predecessors 41

42 Wind-Up Section 88(1) wind-up of a Canadian subsidiary into its Canadian parent: Tax- deferred Subsidiary is a corporation, all or substantially all (90%+) of the shares of which are owned by its parent, and any other shares are held by arm's length persons Section 88(2) wind-up of a Canadian corporation in all other cases: Not tax- deferred Section 88(3) wind-up of a foreign affiliate, such as a US subsidiary, into its Canadian parent: Rules are in flux Before winding-up a corporation, make sure that there are no licenses, leases, agreements, or contractual arrangements which will be adversely affected 42

43 Wind-up If no clearance certificates are obtained under federal subsection 159(2), and Québec section 14 LMR, the liquidators can be personally liable for unpaid taxes of the dissolving corporation If the certificate of dissolution is obtained, any tax refunds owing to the corporation are likely lost Make sure any property is transferred out before the certificate of dissolution is issued, such as real estate or marketable securities, as it can be hard to do so later 43

44 The Bump A beneficial effect of a winding-up further to an acquisition of control is that it can give rise to a step-up or "bump" in the ACB of the non-depreciable capital property of the target, such as shares of a subsidiary of the target Where there is an acquisition of control of a target and the ACB of the shares in the target (i.e., the outside basis) exceeds the tax cost of the net assets of the target (i.e., the inside basis) then the ACB of any non-depreciable capital property distributed to the parent on the winding up of the target can be increased: This is the "bump" Higher cost = less gain on a future sale There are complex restrictions on the bump The bump is also available on a vertical amalgamation 44

45 The Bump The Bump Example Acquisico acquires all the shares of Targetco for $100 The sole asset of Targetco is its interest in Publico. ACB = $10, FMV = $100 Bump allows Acquisico to increase the cost (ACB) of the shares of Publico to $100 on the winding up of Targetco 45

46 Tax-Deferred Divisive Reorganization Known as a "Butterfly" transaction Split-Up: one or more corporate shareholders receive their pro-rata share of each type of property of the distributing company (DC) Spin-off: the current shareholders form a new corporation (Newco) which they own in the same proportion as the DC, and Newco receives a proportionate amount of the property of the DC If the DC is a public corporation, there is no pro-rata requirement 46

47 Non-Resident Issues

48 Part XIII Withholding on Dividends paid to Non- Residents Payor must withhold 25% of dividends (including deemed dividends such as on a share redemption or repurchase) paid to non-residents of Canada Also applies to rent, royalties, and other similar passive-investment payments made to non-residents Payor is liable for the tax if fails to withhold and remit If the payor is unsure whether to withhold, then withhold, and the recipient may be able to claim a refund Income Tax Conventions (treaties) may reduce the withholding rate, if applicable There is no provincial Part XIII withholding tax Also applies to otherwise non-taxable capital dividends 48

49 Sale of TCP by Non-Resident: s.116 Section 116 may subject a purchaser of taxable Canadian property ( TCP ) to withholding tax of up to 80% of the purchase price, even if: There is no gain or a loss on the disposition The disposition is otherwise tax-deferred under Canadian rules The gain is treaty-exempt (unless the new treaty-protected property rules apply) TCP includes: Real property in Canada Property used in carrying on a business in Canada Shares of a private Canadian corporation Applies on share redemptions and exchanges as well Applies whether or not the purchaser is a resident 49

50 Section 116: Withholding Absent a section 116 compliance certificate (and perhaps the Quebec equivalent, if the property is in Québec) or other exemption, the purchaser must withhold a portion of the purchase price on account of the vendor s potential Canadian tax liability Withholding rates: Problem: Federal: 25% on non-depreciable property (land, shares, trust & partnership interest) Federal: 50% on depreciable property (building, business assets) Québec: 12% on non-depreciable property Québec: 30% on depreciable property When there is not enough cash on which to withhold, such as when assuming a mortgage as part of the consideration There is not enough time to obtain a certificate 50

51 New s.116 Rules: Sale of TPP New rules to eliminate the compliance certificate and withholding requirements in respect of dispositions of treaty-protected property ( TPP ) Sale of TPP to an unrelated purchaser This renders the property excluded property for s.116 purposes No form T2062C notice requirement Absolute test for TPP status: So if purchaser is wrong about it being TPP, then he is liable Sale of TPP to a related purchaser This renders the property excluded property for s.116 purposes Requirement for purchaser to file form T2062C under s.116(5.02) Absolute test for TPP status: So if purchaser is wrong about it being TPP, then he is liable even if form T2062C has been filed 51

52 New s.116 Rules: Sale of TPP Sale of TPP to a related or unrelated purchaser, but file T2062C for some protection Perhaps not excluded property for s.116 purposes, but not subject to s.116 withholding as per 116(5)(a.1) or 116(5.3)(a) Unlike for excluded property, vendor still subject to notification requirements under s.116(3) Purchaser must file form T2062C under s.116(5.01) and (5.02) Reasonable inquiry test for residency in a treaty country, which is helped if Vendor completes and signs form as well Absolute test for TPP status: So if purchaser is wrong about it being TPP, then under the law he is liable even if this notice has been filed, but the notice can help administratively Such an assessment will generally not be issued if the purchaser has made every reasonable effort to determine that the property qualifies as treaty-protected and purchaser notification of the transaction (Form T2062C) is received by the CRA within 30 days." - CRA 52

53 Transfer Pricing Brotherco is in a high-tax country and needs all of the deductions it can get Sisterco, a related corporation, is in a low-tax country So when Sisterco sells raw materials to Brotherco, an excessively high price is charged This gives Brotherco a greater deduction, and more profit to Sisterco in the low-tax jurisdiction Since both are owned by the same Parentco, overall Parentco is better off The transfer pricing rules are designed to prevent this 53

54 Transfer Pricing The transfer pricing rules adjust amounts otherwise determined to the amounts that would have been determined if the persons had been dealing at arm's length with each other. Downward adjustments are possible Taxpayers are required to document their non-arm's length transactions, and file an information return in respect of them Penalties may apply where the adjustment exceeds a certain threshold, and the taxpayer failed to use reasonable efforts to determine and use arm's length transfer prices The CRA has the authority to recharacterize a transaction where it is one that arm's length persons would not enter into and the transaction is primarily taxmotivated 54

55 Payment for NR Services Payment for services rendered in Canada by a non-resident employee or independent contractor Federal withholding of 15% Québec withholding of 9%, so a total of 24% Applies even if the payor is a non-resident Payor liable for a penalty if fails to withhold If treaty relief, a waiver is possible but needs to be obtained before the services are rendered 55

56 Operational Issues

57 Employee Stock Options Value of the share at the time of exercise, minus exercise price, equals employment benefit, which is generally taxable at the time of exercise The employment benefit is added to ACB of shares 50% deduction from employment benefit (i.e., similar to a capital gain) if at the moment the stock option was granted the value of the share was equal to, or less than, the exercise price, and the share is "common share type" Only 25% deduction for Québec tax unless corporation satisfies certain requirements (small and medium size enterprises) 57

58 Employee Stock Options If the corporation is a Canadian-controlled private corporation (CCPC), then: The employment benefit income inclusion is deferred until the share is sold; and The 50% deduction is available if the shares are held for at least 2 years (whether or not the aforementioned value test is met) There is also a deferral regime for stock options of public corporations, under certain circumstances 58

59 Shareholder Loan Shareholder may have to include in income amounts the shareholder owes the corporation May apply to any amount owed to the corporation by the shareholder or by a person connected to the shareholder not just formal loans Not included in income if repaid within one year after the end of the lender's taxation year: A January 1, 2004 loan, where the corporation has a December 31 yearend, gives the shareholder until December 31, 2005 to repay without there being an income inclusion 59

60 Debt Forgiveness When a creditor lends money to a debtor, and that debt is later cancelled for less than the remaining amount owing, there can be negative tax consequences Debt forgiveness has the effect of: Reducing tax accounts of the debtor, such as losses, cost of capital property, UCC of depreciable property, etc. After all of those beneficial tax accounts have been reduced to nil, ½ of the amount remaining is included in the income of the debtor Note that exchanging debt for shares or other property with a value lower than the principal amount of the debt can result in debt forgiveness 60

61 GST / QST The GST and QST: Does not just apply to consumer goods Applies as well to sales of commercial real estate, and business assets, but certain relieving provisions are available Applies to most sales of property and services rendered, with certain exceptions If it is not shares or debt being transferred, then assume there is GST/QST until established otherwise 61

62 GST / QST All of the provinces, except Alberta, have their own sales tax in addition to the GST, either in the form of a GST equivalent (HST or QST) or a retail tax For example, the combined federal & Québec rate is % Vendor charges GST/QST on taxable supplies (such as the supply of goods and services) made in Canada, and remits this tax to the authorities Purchaser obtains a refund (input tax credit) for GST/QST paid in the course of commercial activities, if it is in the business of making taxable or zero-rated supplies 62

63 Scientific Research and Experimental Development

64 Scientific Research and Experimental Development ("SR&ED") Canada provides important tax incentives for SR&ED SR&ED means systematic investigation or search carried out in a field of science or technology that is basic or applied research or experimental development, including work with respect to engineering, design, operations research, mathematical analysis and testing Some activities are explicitly excluded from SR&ED, including marketing, quality control, social science research, mineral or oil and gas exploration or production, commercial production and routine data collection 64

65 Scientific Research and Experimental Development ("SR&ED") (contd.) SR&ED expenses generally include all expenses directly related to research and development, such as salaries and equipment costs Payments to third parties for SR&ED conducted in Canada on behalf of the payor can also be included in SR&ED expenditures Broadly speaking, SR&ED incentives take the form of a 20% investment tax credit that may be applied to reduce income taxes owing 65

66 Scientific Research and Experimental Development ("SR&ED") (contd.) Investment tax credits may be carried over and applied against federal taxes payable in the 20 subsequent years or the 3 prior years More generous, refundable SR&ED incentives are available to qualifying CCPCs Generally, 35% of the first $3 million of SR&ED current expenditures per year is fully refundable and 20% of current and capital SR&ED expenditures above $3 million is 40% refundable 66

67 Provincial SR&ED Many provinces provide incentives for SR&ED carried on within their jurisdiction For example, Québec provides for fully refundable income tax credits of up to 37.5% on the first $3 million of salaries related to SR&ED undertaken in Québec by a CCPC The credits are refundable at the rate of 17.5% on the portion of SR & ED expenditures in excess of $3 million For non-ccpc, the credits are always refundable at the rate of 17.5% 67

68 Questions

69 Thank you This presentation is available for download at Fred Purkey Marie-Emmanuelle Vaillancourt