Advocis Banff School 2007

The New Dividend Tax Rules’ Impact on Corporate-Owned Life Insurance StrategiesFlorence Marino, B.A., LL.B., TEPAVP Tax & Estate Planning Group, Manulife Financial

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Important Information

Agenda

l New dividend tax rules - backgroundl A word about Provincial variation l Corporate client profilesl Overview of general implications of new

dividend rulesl General impacts on Corporate Owned Life

insurance planningl Understanding impact on Buy Sell and

Business Succession - Case Studiesl Conclusion – Lots of opportunity

New Dividend Rules: Background

l The Old Days: Total tax on dividends paid out of high rate

corporate income from Canadian companies

= 56% (maximum) Effective double tax to shareholders

Maximum tax on income from income trusts

=46% (for individual)

New Dividend Rules: Background

l New dividend regime introduced to “level” playing field Applies to dividends paid after 2005 Canadian companies

Public CCPC’s taxed at general federal tax rate

Not income taxed at small business rate Not investment income that has generated

RDTOH

Eligible dividends – CCPC’s

l Distributions paid after 2005 From active income subject to high

corporate tax rate (post 2000) or From “eligible dividends” received after

2005 Received by a person resident in Canada

l General Rate Income Pool (GRIP) Tracks amount available to pay out eligible

dividends Dividends can be paid 1st from GRIP pool

New dividend rules – Public Companies

l Most dividends received from public companies will be eligible dividends – i.e. portfolio dividends

l Must track “LRIP” (Low Rate Income Pool) LRIP will include

Taxable income that has benefited from SBD (might have occurred while a CCPC)

Non-eligible dividends received Must pay non-eligible dividends (out of LRIP)

first

A word about Provincial variation - 2007 dividend tax rates

Ineligible Eligible Capital Dividends Dividends Gains

British Columbia 31.58% 18.47% 21.85%Alberta 25.21% 17.45%* 19.50%Saskatchewan 30.83% 20.35% 22.00%Manitoba 36.75% 23.83% 23.20%Ontario 31.34% 24.64%** 23.21%Quebec 36.35% 29.69% 24.11%New Brunswick 35.40% 23.18% 23.48%Nova Scotia 33.06% 28.35% 24.13%P.E.I 33.61% 24.44% 23.69%Newfoundland 35.62% 30.63% 23.52%

2007

Not with the program

*14.55% by 2009 **22.37% by 2010

CCPC Client Profiles

Opcosl Earning active business income in

excess of small business threshold l In Ontario, probably non M&P

above claw back range $1.1 million+

l Procorps in active phase

CCPC Client profile

Holdcosl Funnelled eligible dividends from

Opcol Opco sold off assets now Holdcol Procorp after professional diesl Investco receiving public company

dividends

Overview of general implications

l Sale of business Old norm: buyer wants assets; seller wants

to sell shares Shift – seller more likely to sell assets –

difference between post asset sale wind up dividend (if sufficient GRIP) and realizing capital gain not significant

Overview of general implications

l Income splitting Stream eligible dividends to higher rate

taxpayersl Alberta trusts continue to thrivel Holdcos

Generally still a bad idea to “incorporate” investment portfolio

Eligible dividends can be used to recover RDTOH

Overview of general implications

l More likely for companies not to “bonus down” to small business thresholds Leaves more “trapped surplus” at the

corporate level More deferred capital gains tax on CCPC

shares? Increased use of wasting freeze?

Overview of general implications

l Eligible dividends generally cheaper than or close to capital gains tax rates Preference shift to dividend producing

strategies vs. capital gains producing strategies

Post-mortem planning use of 164(6) loss carry-back to eliminate capital gain and be taxed on dividend (with or without insurance)

General impacts on corporate life insurance planning

l Are RCA’s for owner mangers (and therefore insurance funding of them) dead?

l Life insurance for increased corporate retentions Increased capital gains exposure Tax efficient investing

l Generally, eligible dividends preferred to capital gains Changes to buy-sell and succession planning

Impact on buy-sell planning – Case study

Facts: Stephen, 45 Jim, 50 50/50 shareholders of Opco ACB/PUC = 0; FMV $2 million Currently receiving 500,000 bonus/yr each Buy sell agreement on death requires “most

tax effective” method of buy-out 1 million corporate-owned life insurance on

each

Buy-sell planning

Opco

$2 million FMV

Stephen Jim

5050

When Stephen dies….

What is most tax effective?

Options under the old rules

l Sale to Jim – promissory note method (All capital gain): Stephen pays 1,000,000 x 23% = 230,000 Stephen’s estate net cash of 770,000 Jim has 1,000,000 ACB – future capital gains

tax liability of 1,000,000 x 23% - 230,00 No CDA remaining

Options under the old rules

l Redemption 100% capital dividend (Half capital gain): Stephen pays 500,000 x 23% = 115,000 Stephen’s estate receives 885,000 Jim has 0 ACB and future capital gains tax

liability of 2,000,000 x 23% No CDA remaining

Options under old rules

l Redemption 50% capital dividend (Half taxable dividend) Stephen’s estate pays 500,000 x 31% =

155,000 Stephen’s estate receives 845,000 Jim has 0 ACB and future capital gains tax

liability of 2,000,000 x 23% = 460,000 500,000 CDA credit remaining

Tax Recap Old rules

0

100

200

300

400

500

600

Tax in 000's

Stephen Jim Total

Redemption 100%CDAPromissory Note

50% Solution

Tax Recap with eligible dividends

0

100

200

300

400

500

600

Tax in 000's

Stephen Jim Total

Redemption 100%CDAPromissory Note

50% Solution

Tax recap including grandfathered shares or spousal rollover

0

100

200

300

400

500

600

Tax in 000's

Stephen Jim Total

Redemption 100%CDAPromissory Note

50% Solution

Spousal Rollover orGrandfathered

No insurance redemption for full eligible dividend or capital gain vs. with insurance new normal

0

100

200

300

400

500

600

700

Tax in 000's

Stephen Jim Total

Redemption 100%

Promissory Note

Insured Redemption50% Solution

Buy-sell planning conclusions

l Insurance funding always better than no funding

l 50% solution even more efficient now l Implications for drafting buy-sell

agreements: address GRIP/eligible dividends Flexibility Perspective

l hybrid agreement?

Impact on succession planning – Case study

Facts: Dad, age 65, owns $1 million pref shares in

Opco with nominal ACB, PUC Active kids hold common shares (Dad has

done a freeze) GRIP balance = $1 million Contemplating options for Dad with and

without insurance

What if Dad dies tomorrow

l Capital gain on Dad’s deathProceeds of disposition $1,000,000- ACB 0Capital gain to Dad $1,000,000

Tax @ 23%* $230,000

*BC 21.85%, Alta 19.5%, Sask 22%

What if Dad dies tomorrow

l If pref are redeemed within first year of estate can get eligible dividend treatment:Deemed dividend 1,000,000Capital dividend 0Taxable dividend (eligible) 1,000,000Dividend tax @ 22%* 220,000*BC 18.47%, Alta 17.45% going to 14.55%, Sask 20.35%

Capital gain on death 0(Loss carry back wipes out gain)

Comparison of optionsl Redeem pref with corporate funds, no

insurancel Redeem pref with corporate funds and

insurance proceeds, purchase $181,000 corporate-owned insurance to fund dividend tax

l Purchase $1million corporate-owned insurance to redeem pref and use 50% of the CDA (50% solution, full funding)

l Purchase $500,000 of corporate-owned insurance, redeem pref at death with insurance and corporate funds and use all the CDA generated by insurance (50% solution)

Summary of options

Undfunded redemption

1,000,000 0 0

Insure for tax

181,000 181,000 181,000

50% Sol’n – full funding

0 1,000,000 500,000

50% Sol’n – 50% funding

500,000 500,000 500,000

Strategy Corp Funds Insurance Capital Div

Dad’s total tax under various options

0

50

100

150

200

250

Tax in 000's

Dad

No insurance

Buy Insurance fordividend tax100% funding 50%Solution*Fund only 50%solution

*500,000 CDA remaining in corp for kids

Cost compare of options for funding redemption

050,000

100,000150,000200,000250,000300,000350,000400,000450,000500,000

PV of Alternatives

Bank loan

Savings

Lump sum

Life insurance

Conclusion

New rules create opportunity!l Most clients (and many professional

advisors) aren’t aware of the implications of the new rules Revise existing buy-sell agreements? Consider options for business succession planning

l Discuss the planning opportunity Is there sufficient funding? New rules as a door opener

Advanced planning needed!

Advocis Banff School 2007

The New Dividend Tax Rules’ Impact on Corporate-Owned Life Insurance StrategiesFlorence Marino, B.A., LL.B., TEPAVP Tax & Estate Planning Group, Manulife Financial