POST MORTEM PLANNING a primer and case study

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POST MORTEM PLANNING- a primer and case study -

• Joan E. Jung
• Minden Gross Grafstein Greenstein LLP,
• a member of MERITAS Law Firms Worldwide
• jjung_at_mindengross.com

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Introduction- a primer -

• Why is post mortem planning needed?
• Deemed disposition on death
• Double taxation
• integration inverted

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Simple Example
Jill

• Jill dies deemed disposition of Cashco shares
• Jack predeceased
• How do Jill Jr. and Jack Jr. extract the cash?

100 common
Cashco
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Simple Example
Peter

• Peter dies w/o spouse
• Deemed disposition on death
• Children (Bo Peep and Mary) wish to sell Opco
  shares

Wolf Holdings
Low ACB shares
Opco
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Estate Freeze?

• Reduces but does not eliminate double taxation

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Post Mortem Planning Tools

• Subsection 164(6)
• triggers capital loss
• 88(1)(d) Bump
• bump the cost of underlying assets
• Pipeline
• Extraction technique

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The Pipeline
Estate of Jill

• Distribution
• Easy example is cash

Pay promissory note
Sale for promissory note
Holdco
High ACB
Cashco
Dividend
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The Pipeline in Isolation

• Terminal period capital gain remains
• Extraction of corporate level assets with high
  ACB
• pre-existing ACB
• triggered ?

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Subsection 164(6)

• Effect
• replaces the terminal capital gain with a deemed
  dividend
• Capital gains rate vs dividend rate?
• November 23, 2005 Finance Release?

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Subsection 164(6) in Isolation
Estate of Peter

• Within first year of estate
• Trigger deemed dividend re shares of Wolf
  Holdings
• redeem shares
• wind up corporation

FMVACB 1M
PUC Nil
Wolf Holdings Inc.
Opco
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Subsection 164(6) in Isolation
Estate of Peter

• Deemed dividend
• 1M Nil 1M
• Capital loss
• Proceeds reduced by deemed dividend
• POD 1M - 1M Nil
• CL 1M
• Terminal period gain

FMVACB 1M
Wind up
PUC Nil
Wolf Holdings Inc.
Opco
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Subsection 164(6) in Isolation

• Deemed dividend vs terminal capital gain
• Overall tax efficiency where combined with
  corporate surplus accounts
• RDTOH
• CDA

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Subsection 164(6) in Isolation

• Use of CDA in conjunction with s.164(6)
• Stop-loss rule s.112(3.2)
• may grind capital loss
• effectively need taxable dividend equal to
  capital dividend

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Subsection 164(6) considerations

• Redemption or wind up?
• s.40(3.6) stop-loss rule
• use wind up instead
• New s.40(3.61)
• result s.40(3.6) not applicable to the extent
  of a s.164(6) election
• Can still be an issue in certain situations

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Paragraph 88(1)(d) Bump

• Mechanism to increase the ACB of corporate owned
  assets
• Non-depreciable capital property only
• E.g., land shares of corporation
• Future sale planning
• Rules are rather complex

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Use of Paragraph 88(1)(d) bump
Estate of Peter

• Subsequent sale of Opco shares?
• High ACB of Holdco shares from deemed disposition
• Bump ACB of Opco shares?

High ACB
Wolf Holdings Inc.
Low ACB
Opco
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The Bump
Estate of Peter

• s.85(1) roll of shares to Parentco
• Wind up Wolf Holdings into Parentco
• Bump ACB of Opco shares

s.85(1) high ACB
Parentco
High ACB
Wind up
Wolf Holdings Inc.
Low ACB
Opco
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Bump Limitations - glossed over

• 1 Capital property of the subsidiary at the time
  the parent last acquired control
• 2 Property thereafter owned by subsidiary w/o
  interruption until distributed to parent on the
  winding up
• 3 Only certain property
• ineligible property leads to bump denial

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Bump Limitations glossed over

• 4 Aggregate bump amount limited
• roughly, excess of external basis over internal
  basis
• 5 Bump to a particular property limited to FMV
  at time parent last acquired control of subsidiary

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Bump Limitation 1

• When did the parent last acquire control of the
  subsidiary?
• s. 88(1)(d.2) rules applicable where non-arms
  length share transfers
• s.88(1)(d.3) can override
• deems the date on which control was last acquired
  to be immediately following death

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Bump Denial Rule

• Series of transactions or events including the
  winding up
• Parent acquired control of subsidiary
• Property of subsidiary or substituted property
  acquired by certain restricted persons or group
• Generally not related persons

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Bump Denial Rule

• Worrisome because of broad wording
• Consequence
• bump denied on all property distributed to
  parent, not just the property acquired by the
  restricted person

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Case Study the facts

• Jack predeceased Jill in 1989
• Jacks Will provided for a testamentary spouse
  trust
• Jack had implemented an estate freeze through a
  holding company
• Operating business wound down years ago

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Case Study the facts

• Corporate owned assets now limited to investments
• Income trust units
• Interest bearing instruments
• Land previously used in the operating business
  and now rental

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Case Study the facts

• Common shares (post freeze) initially held by
  family trust
• Prior to 21st anniversary, distributed equally to
  adult children, Jill Jr. and Jack Jr.
• Voting control by spouse trust

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Case Study - Jill Dies
Estate Spouse Trust
Jill Jr.
Jack Jr.

• Limited RDTOH in Holdco
• Low ACB of investments in Holdco except bonds
  (300K)

100 common shares
2M voting freeze preferred shares Nominal
ACB Nominal PUC
Holdco
Investments
common shares Nominal ACB Nominal PUC
Landco
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Case Study - Do Nothing?

• Capital gain to Estate (2M)
• Distribution cost of extracting assets
• No recognition of tax paid at shareholder level
  upon corporate sale of assets
• DOUBLE TAXATION !!

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Case Study Pipeline?

• High ACB assets lt freeze value
• 300,000 2M
• Use of pipeline technique will permit extraction
  of 300,000 w/o additional shareholder level
  taxation
• Pipeline in isolation is not enough

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Case Study Bump?

• Bump the cost of investments owned by Holdco and
  land owned by Landco?
• If yes
• Will reduce future capital gains on corporate
  level asset sales
• Results in high ACB assets for pipeline use
• Cost - 2M capital gain remains

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Case Study Bump?

• Bump Limitation 1 - problematic
• capital property of the subsidiary at the time
  that the parent last acquired control of the
  subsidiary
• Capital property?
• land investments - should be OK

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Case Study Bump?

• at the time the parent last acquired control of
  the subsidiary
• Why relevant?
• can only bump capital property owned by
  subsidiary at that time
• FMV limitation in bump allocation

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Case Study Bump?

• at the time the parent last acquired control of
  the subsidiary
• Classic post mortem bump
• Estate transfers shares of subsidiary to Newco
  (parent)
• desired acquisition of control time is
  immediately after death to facilitate maximum bump

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Case Study Bump?

• Interaction of s.88(1)(d.2) and (d.3)
• (d.2) operates to deem the time an acquirer
  last acquired control of subsidiary where NAL
  transactions
• typically deemed back to the time vendor
  acquired control
• deemed back to the time deceased acquired
  control?

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Case Study Bump?

• 88(1)(d.3) a saving provision for post mortem
• If applicable, the time the parent last acquired
  control of the subsidiary effectively deemed to
  be immediately after death

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Case Study Bump?

• 88(1)(d.3) requires
• control of a corporation is last acquired by an
  acquirer because of an acquisition of shares of
  the corporation as a consequence of the death of
  an individual
• Spouse trust
• Does above apply upon death of surviving spouse?

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Case Study Bump?

• Was Jill the sole trustee of the spouse trust?
  External trustee?
• CRA Document no. 2004-0087761E5
• change of trustees acquisition of control
• Acquisition of control upon Jills death?

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Case Study Bump?

• Assume Jill was sole trustee and replaced by
  children
• Interpretation issues in corporate chain
  structure re s.88(1)(d.2) and (d.3)

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Case Study Bump?

• Limited bump utility if Jacks death is the time
  a person last acquired control of Holdco
• Were income trust units owned by Holdco at that
  time?
• if no - then no bump
• Can only allocate bump to FMV at that time
• FMV of land at Jacks death

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Case Study - Bump?
Estate Spouse Trust
Jill Jr.
Jack Jr.

• Land owned by Landco, not Holdco (the
  subsidiary)
• To bump ACB of land, amalgamate first and rely on
  s.88(4)

100 common shares
2M voting freeze preferred shares Nominal
ACB Nominal PUC
Holdco
Investments
common shares Nominal ACB Nominal PUC
Landco
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Case Study Bump?
Estate Spouse Trust
Estate Spouse Trust
(1) Transfer Holdco shares to Newco
Newco
(3) Wind up amalgamated Holdco/Landco into
Newco Elect to bump ACB of land
Newco
Holdco

• At best, limited bump to land

(2) Amalgamate Holdco and Landco
Landco
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Case Study so far .
Estate Spouse Trust
Jill Jr.
Jack Jr.

• 2M capital gain to Estate
• Elimination of double tax
• limited pipeline
• limited bump to land only

100 common shares
2M voting freeze preferred shares Nominal
ACB Nominal PUC
Holdco
Investments
common shares Nominal ACB Nominal PUC
Landco
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Case Study s.164(6)?

• within first taxation year of the estate
• not applicable to spouse trust
• Analogous procedure available
• trigger deemed dividend capital loss
• apply capital loss against capital gain

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Case Study Capital loss planning

• Technically spouse trust deemed to dispose of
  Holdco shares and realizes capital gain
• Capital loss planning requires spouse trust to
  continue after Jills death
• Jacks Will provides for lag prior to
  distribution?

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Case Study Capital loss planning

• Consider stop-loss rule s.40(3.6)
• new s.40(3.61) N/A applies only to extent of
  s.164(6) election
• s.40(3.6) stop loss if spouse trust affiliated
  with Holdco immediately after the disposition
  (redemption)

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Case Study Capital loss planning

• Extension of affiliated persons to trusts
• Holdco affiliated with spouse trust if affiliated
  with majority interest beneficiary
• assume Jack Jr. and Jill Jr. equally entitled
• no majority interest beneficiary
• Share redemption to trigger capital loss possible

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Case Study Capital Loss planning

• Procedure inherently trades deemed dividend for
  capital gain
• Tax efficient to the extent of available RDTOH
  and CDA
• Consider taxable transfer of investments by
  Holdco to new subsidiary

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Case Study Capital Loss planning

• Will create RDTOH and CDA at the cost of a
  corporate capital gain
• If transfer building, can refresh UCC at the cost
  of recapture and capital gain
• s.13(7)(e) applicable to NAL transfer
• Step up of capital cost limited to ½ of the gain

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Case Study Capital Loss planning

• RDTOH and CDA can be streamed up for utilization
  on the redemption of Holdco shares by spouse
  trust
• Be mindful of s.112(3.2)

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Case Study Capital Loss planning

• November 23, 2005 Finance Release
• eligible dividends
• more tax beneficial than capital gains (fully
  phased in and assuming provincial adoption)
• Redeem Holdco shares over next 3 years (carryback
  period) to stream eligible dividends?

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Case Study - Summary
Estate Spouse Trust
Jill Jr.
Jack Jr.

• s.88(1)(d) bump too complex for limited bump
• Transfer assets to subsidiary to achieve
  increased cost plus RDTOH/CDA

100 common shares
2M voting freeze preferred shares Nominal
ACB Nominal PUC
Holdco
Investments
common shares Nominal ACB Nominal PUC
Landco
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Case Study - Summary
Estate Spouse Trust
Jill Jr.
Jack Jr.

• Redeem Holdco preferred shares to trigger capital
  loss
• Wait for favorable rates for eligible dividends?

100 common shares
2M voting freeze preferred shares Nominal
ACB Nominal PUC
Holdco
Investments
common shares Nominal ACB Nominal PUC
Landco