Do you have Cash trapped in your Corporation?. Unlocking Trapped Surplus… The Corporate Estate Transfer. Insurance Concepts. This presentation is for educational or informational purposes only.
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Unlocking Trapped Surplus…
The Corporate Estate Transfer
This presentation is for educational or informational purposes only.
It is not intended to provide anyone with legal, taxation, accounting or other professional advice and no one should act upon the information provided here without a thorough review of the specific facts with the appropriate professional advisory team.
These assets, locked within the corporation can usually be only paid out to the individual shareholders as taxable distributions unless there is a Capital Dividend Account (CDA)
Holding Companies (Holdcos) are usually created to protect retained earnings of an Operating Company (Opco) from potential liabilities.
Excess funds are transferred to maintain small business status and therefore attract a lower tax rate.
Personal tax rates apply when a dividend is taken.
As a result, active income can be earned by an operating company, taxed at a low rate, and transferred to a Holdco for investment.
By transferring assets to the Holdco, the active business corporation can maintain it’s small business corporation status for purposes of claiming the Capital Gains Exemption, currently $500,000
So a tax-free transfer can occur between corporations and no personal tax is payable until the earnings are removed from the Holding Company.
Not only do the Holdcos provide good wealth accumulation vehicles, but by removing assets from the Opco, an additional level of creditor protection is provided for the transferred retained earnings.
Passive Investment Income - attracts tax at the top corporate rate (does not qualify for the small business deduction)
Alberta Income 2003
PassiveActive Business Income 000’s
($0 - 225) ($225 - $300)** ($300 - $400) ($400+)
Net Federal tax28.00%13.12% 22.12% 24.12% 24.12%
Add surtax (4)%1.12%
Refundable tax* 6.67%
Alberta tax12.50%4.00% 4.00% 4.00% 12.50%
TotalTax48.29%17.12% 26.12% 28.12% 36.62%
* Passive investment income is subject to an additional refundable
tax of 62/3 % of taxable investment income.
** The Feb/03 Federal budget proposes an increase of $25,000/yr to 2006
and a general rate decrease on all active business income above 300,000
(net 22.12%) after 2004. Alberta proposes a decrease in tax rates on all
income after April 2005 to 8% - maximum tax rate in Alberta would be 30.12%.
The previous table illustrates that passive investment income in a corporation is taxed at a significantly higher rate than active business income.
Investment Holding Companies that have passive investments will not benefit from the lower rates on active business income, but will be subject to the high rate of tax.
If we could shelter the the income subject to the high tax rate and receive dividends from an Opco that paid the low tax rate, then we would achieve an optimal advantage.
Should the Retained Earnings be kept in the Holdco and pay top rates on investment income
Pay out the Retained Earnings to the shareholders who will pay personal tax on the dividend, thereby eliminating 24% of the investment to dividend tax immediately.
$300,000 Trapped Surplus
DIVIDEND - $300,000
TAX @ 24% $ 72,000
Note that the shares may be transferred on a rollover basis to the spouse at death, but the Capital Gains tax liability will appear on the spouse’s death – it just doesn’t go away.
Or does it?
We will see how insurance can help us…
remove funds from Holdco,
reducing Capital Gains exposure.
Should we pay out the $300,000 accumulated funds and lose $72,000 to tax immediately or leave it in the corporation and pay the top tax rate?
Best of both worlds……
Don’t pay the funds out, save $72,000 in taxes and pay no tax on the accumulating income by tax sheltering funds in a Universal Life policy
Consider the following………
A Holdco has $300,000 of retained earnings invested in GIC’s
Interest rate is 6% per annum
Corporate tax rate 48.29%
Let’s look at investing in a Joint Last to Die Universal Life on
$2,500,000 Universal Life, automatic tax sheltering optimized
Male Age 40, Non-smoker
Female Age 40, Non-smoker
Lump sum deposit $300,000
Rate of return selected for illustration purposes 5%
guaranteed principal. Taxes must be paid on an annual basis,
and the principal & interest may be subject to probate tax on
the death of the shareholder as the share price is included in
The shareholder can also purchase GIC’s held within a
properly structured Universal Life plan. The Income Tax Act
allows these investments to grow on a tax deferred basis for as
long as those funds stay in the plan, ultimately being paid to
the heirs, tax and probate free.
Although it is necessary to incur insurance charges, once the Universal is funded, the charges are less expensive than the taxes that would be payable in a conventional GIC.
In addition, there is a significant enhancement to the estate.
This table shows on an annual basis, the cost of tax in relation to the cost of the insurance of a Universal Life policy, using our case study.
The chart shows the cost of tax relative to the cost of insurance in our case study, on a
cumulative basis over 40 years
Corporate Estate Transfer
The planning objectives of the Corporate Estate Transfer (CET) are threefold:
1.To earn a higher after-tax rate of return on the corporation’s surplus than available from
2. Transform the taxable surplus into non-taxable surplus, and
3. Reduce capital gains tax on the corporate shares
AInvesting Trapped Surplus
WHICH IS BEST?
CORPORATE ESTATE TRANSFER
opportunity to transfer assets to a tax sheltered Universal Life
that will increase the estate value with tax-free capital
A further bonus is the opportunity to access funds in the policy
by use of leveraging. In other words, the insured gets
compounded tax sheltered assets with the accessibility for
business or personal use.
The alternative of the taxable investment does not give
the opportunity to transfer corporate assets to the
estate on a tax-free basis.
Tax-Free Death Benefit
Death Benefit proceeds less Policy ACB can be paid out as Tax-Free Capital Dividends
Answer – the Capital Dividend Account
The CDA amount is the insurance proceeds that are in excess of the
Adjusted Cost Basis(ACB).
In our scenario, if the accumulated earnings that are transferred to
the policy are paid out tax-free to the estate of the deceased
shareholder using the Capital Dividend Account, then we have
achieved a Corporate Estate Transfer
Therefore the alternatives for holding non registered assets in
the corporation that earn investment income can be included
in two pools;
a pool of investments held within an exempt life insurance
policy growing without attracting tax,
or a pool of investments that earn income on a taxable basis.
Clearly, the preferable choice is offered by insurance.
Those looking for tax shelters or deferral mechanisms may wish to explore the significant benefits that may be derived from an ‘exempt’ life insurance policy… it is to be noted that a substantial portion of the income from such investment accumulates free of tax, that such income can be utilized before death, and that the proceeds are not subject to tax on death … such policies may be a powerful tool in the tax planning arsenal.”
Excerpt from: Coopers & Lybrand,Tax Planning Checklist, 1997-1998
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