Second Life for Post Mortem Tax Planning
The Department of Finance released potential changes to the Income Tax Act on July 18, 2017, that would restrict the conversion of income into capital gains. Based on the initial proposals, this would significantly affect how private corporation shares would be taxed on death.
On death, a taxpayer is deemed to have disposed of their private corporation shares and other assets at fair market value, typically creating a taxable event in the form of a capital gain. When that private corporation distributes property or pays dividends to the beneficiaries of the deceased person’s estate, those dividends are also taxable. Essentially, those same shares are taxed twice.
Traditionally, there have been two ways to address this issue. The first is a plan that is known in the tax community as a “pipeline” plan, which effectively tries to eliminate the double tax problem and reduce the burden to one level of taxation, being the deemed capital gain. This plan would have been fundamentally lost under the July 18 proposals, since those proposals would usually trigger a deemed dividend on those private company shares, notwithstanding the steps taken. While the Department of Finance informally indicated earlier this month that they may provide some relief for estates triggered before July 18, 2017, no formal solutions were presented.
The other strategy to mitigate the double tax problem is known as the “subsection 164(6) loss carry-back”. This type of planning must be implemented within one year after death, which can sometimes pose a practical problem. This plan also often requires a wind-up of the corporation to avoid the application of certain loss restriction or “stop loss” rules. The end result of this strategy is that the capital gain is offset, and only the tax on the deemed dividends are payable.
Effectively, the “pipeline” eliminates double tax by reducing the tax burden to only the capital gains tax, while a loss carry-back plan reduces the tax burden to only the dividend tax. This loss carry-back strategy is typically not as effective as the pipeline because dividends are taxed at a significantly higher rate than capital gains in most cases, but this depends largely on the specific tax attributes of the corporation and the persons involved. Together with the practical issues involved in loss carry-back planning, it has historically been considered reasonable and acceptable to implement “pipeline” strategies for many small and medium sized businesses.
Many estates are not in the position to make filings or undertake post mortem planning at that stage as there may be other complications in the estate. While there was some discussion from senior members of the Department of Finance that the time period may be extended, this remains unclear. It appeared that post-mortem planning was about to be dead and buried.
On October 19th, the Department of Finance released a statement indicating that the Government will not be moving ahead with the proposed changes relating to conversion of income into capital gains.
In this announcement, the Government indicated that they had concerns leading to this decision, especially concerns “in respect of taxation upon death and intergenerational transfers of businesses.” It is likely that this means pipeline planning will make its return.
While the announcement relating to this change relates to farming businesses, the Government did specifically refer to intergenerational transfers of small businesses in their general release.
Ultimately, the final form of this legislation is yet to be released. The government was clear in its assertion that it “will work with family businesses, including farming and fishing businesses, to make it more efficient, or less difficult, to hand down their businesses to the next generation.” Fortunately, it does appear that practitioners will again be able to provide a greater range of options to prevent double taxation upon death.
Regardless of the final form, it is important for executors and legal representatives of estates to reach out to qualified lawyers, accountants and advisors at the earliest possible stage to ascertain what types of post mortem planning are suitable for their respective estate. Even prior to death, we recommend you meet with an estate planning lawyer to prepare a comprehensive plan for your executors, business partners and family to follow.
Invitation for Discussion:
In many instances, it is possible to reduce the risk of double taxation at death by engaging in succession planning and creating succession structures during life. If you would like to discuss this in greater detail, or any other business law matter, please do not hesitate to contact one of the lawyers in the Tax & Estate Planning group at Nerland Lindsey LLP.
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.
 Department of Finance, “Targeted Tax Fairness Measures Will Protect Small Business Owners Including Farmers and Fishers”, accessed October 20, 2017
Supra at para 3.