Expansion, growth and new objectives may require some form of corporate reorganization. Often owner managers wish to add family members or key employees as shareholders. In order to avoid adverse income tax implications, the issuance of shares has to be implemented properly.
First freezing the value of the present shareholders interest before issuing shares to family members is recommended to avoid the conferral of benefits to the present shareholder(s). Family shareholders may hold voting or non-voting, participating or non-participating shares. The opportunity to income-split dividend income to lower income bracket individuals as opposed to the higher income tax bracket shareholder may result in years of benefits, especially if the dividends will be used to fund post-secondary education and other expenditures.
Generally a family trust will own non-voting common shares while the parent continues to hold voting shares. A properly structured family trust will provide the trustees with the discretion to pay dividends or capital from the trust to beneficiaries of the trust, thereby accomplishing an efficient income splitting strategy for family members. A T3 tax return for a family trust is due for filing on March 31st because the year end is always the calendar year.
If there is a share sale, the capital gain may be allocated among more than one beneficiary. If the shares are qualified small business corporation shares (“QSBC”), each beneficiary may be entitled to their capital gains exemption, as opposed to having only one $750K exemption for the present shareholder. The capital gains exemption is multiplied by the number of beneficiaries. If structured properly, the trust may not have to own the shares for 24 months for a beneficiary to be eligible for the capital gains exemption. Draft legislation notes that the exemption will increase to $800K commencing in 2014 and will be inflation-adjusted.Read more
The most popular method is to utilize a stock option agreement for the key employee to have the right to purchase common shares at a predetermined purchase price over a short period. This is generally done where the employee can’t afford a fair market value purchase price.
The alternative is to freeze the company and issue new shares for a nominal amount to the employee with the present shareholder holding both (i) fixed value shares equal to the value at the time of the freeze and (ii) controlling voting shares. At some later date, the employee may acquire the funding to purchase the fixed value shares held by the controlling shareholder.
Corporations that accumulate excess cash or investments not needed for working capital requirements may not entitle individual shareholders to utilize their capital gains exemption because 90% of the fair market value of the company’s assets are not used in an active business. I advise owners to transfer the passive assets on a timely tax-deferred basis to another corporation. This type of transaction insulates the passive assets from the business operations of the operating corporation.
Numerous times, clients are in receipt of an offer from an unrelated party to sell their shares when the company will not qualify as a QSBC. The foregoing tax-deferred transaction to purify the company may not be accomplished successfully if it is contemplated as part of the series of transactions to sell the company.
It is imperative that the company have a mechanism on hand to purify the company on a timely basis, or at a minimum, to ensure that the shares of the company are QSBC shares for a period of 2 years prior to a sale to an unrelated third party.