A common estate planning technique is to structure a family trust which owns the shares of a small business corporation in such a way that allows each beneficiary (most commonly being members of the taxpayer’s immediate family – spouse and/or children) to participate in the sale or disposition of the business, thereby utilizing their life time capital gains exemption and potentially saving several hundred thousand dollars in taxes payable on the disposition of shares of the business by the trust. I note that the government proposals introduced in July 2017 on tax reform included a proposal to severally limit this planning opportunity but it now appears (for the moment) that the government has retracted this proposal.
This plan is not always executed at the time the taxpayer’s passing. The sale of business can take place anytime and often does, for instance at retirement.
There a number of matters to be wary of in such an arrangement, to avoid attribution of the sale proceeds back to the taxpayer for tax purposes, such as making sure that the funds are properly distributed to each beneficiary as directed by the trustee(s) and making sure each beneficiary reports their portion of the sale on their respective tax return. I always make the point that the allocated proceeds belong to each beneficiary and should be deposited to their respective bank accounts accordingly. Discussions and subsequent actions to be taken with regard to the ultimate use of funds should be dealt with separately.
A recent tax court case decision (Laplante c La Reine 2017 CCI 118) really highlights the need to complete such transactions to the end and exercise care in doing so.
In this case, the taxpayer’s family trust sold the shares it owned of a small business and the sale proceeds were distributed by check to 7 beneficiaries, all members the taxpayer’s family. However, all the checks were endorsed back to taxpayer who was a trustee and each beneficiary signed a gift certificate signifying a donation. Some of this but not all of it was documented in the corporate minutes of the company. Each beneficiary reported the sale on their respective tax return and claimed the small business capital gains exemption. Each beneficiary had some alternative minimum tax to pay, which the taxpayer looked after personally.
The Canada Revenue Agency (“CRA”) reviewed the transaction and determined that, based on the facts and evidence gathered that, the return of said funds to the owner operator was essentially a “simulation” (i.e. act of deception) The CRA essentially took the position that the beneficiaries were essentially nominees of the taxpayer and had a legal obligation to remit the amount received from the trust to the taxpayer, triggering in CRA’s opinion, the attribution rules. The CRA re-assessed the taxpayer for taxes on the full amount of the capital gain.
The taxpayer appealed the re-assessment and lost. There were some specific legal issues associated with these transactions which the taxpayer may have avoided and complicated his case further, but notably the court also relied on evidence from certain members of the family who admitted that the taxpayer had asked the beneficiaries to “give” their capital gains exemption on more than one occasion leading up to the sale. It appeared that the taxpayer was intent on keeping the money.
Bottom line, if you intend to distribute the wealth you created to your beneficiaries, follow thru on it completely, and then have the beneficiaries take advantage of the related tax savings and move on. Have that “what are you going to do with the money” discussion at a later date.