Canada Archives

Capital Gains Tax Increase: Impact on Planning

The Canadian federal budget was tabled on 16 April 2024. It included, among other things, a proposal to increase the capital gains inclusion rate for the first time since 2001, from one half to two thirds, with the increase coming into effect for dispositions (or deemed dispositions) occurring on or after 25 June 2024 (and for individuals, the increase applies to capital gains over CAD 250,000 in any year, with capital gains below that amount remaining subject to the existing 50 percent inclusion rate).

Taxable capital gains (or losses) are realized when a Canadian resident sells a capital asset outside of a registered plan or qualifying insurance policy, and subject to some exemptions (e.g. lifetime capital gains exemption, principal residence exemption, reductions of inclusion rate on charitable donations). It is a common goal in Canadian tax planning to characterize as much personal and corporate income as possible as capital gains rather than other forms of income, because of the 50 percent inclusion rate (the other 50 percent being received tax free). Such planning will remain relevant as long as the capital gains inclusion rate is less than 100 percent; however, the increase to the inclusion rate will erode the benefit of doing so.

Examples of events or transactions which will be impacted by the increase include corporate surplus stripping transactions (which aim to extract corporate surplus as capital gains rather than dividends), estate freezes, taxes on death, and taxes on becoming non-resident of Canada. In addition, many professionals in Canada practice their profession through a professional corporation and accumulate and invest their savings in those corporations, virtually always pursuing a capital growth strategy because dividend income is taxed aggressively. The increase will impact the taxation of capital gains realized in those corporations.

Canadians may wish to consider deliberately triggering accrued capital gains prior to 25 June 2024 while the existing 50 percent inclusion rate is still applicable. This could entail crystalizing gains in investment accounts, carrying out an estate freeze, making lifetime gifts of capital property to family members or charities, or expediting plans to become non-resident of Canada (which triggers a deemed disposition of certain capital property upon exit).

Individuals with intentions to accumulate investment assets in private corporations and who would have otherwise planned to invest and grow their wealth in the corporation may now find that investing in corporate-owned life insurance is comparatively more attractive as well. Such policies and their in-policy growth continue to be tax-sheltered, and their comparatively conservative investment returns (versus unrestricted investment accounts) are less of a disadvantage in view of the higher capital gains inclusion rate.

Details of how the capital gains inclusion rate increase will be administered have not yet been released, particularly with respect to which transactions will be deemed to fall before and after 25 June 2024, and with respect to the inclusion rate for capital losses. It appears from the initial budget release that there will be an effort to match the inclusion rate for capital losses to capital gains at the same rate, likely to forestall triggering gains at the lower rate and losses at the higher rate on the same type of asset, such as public securities.

If you would like to pursue transactions to take advantage of the current 50 percent capital gains inclusion rate prior to 25 June 2024, or discuss becoming non-resident of Canada and related planning, please contact us and we will be glad to assist. ■

Planning for Canada’s Departure Tax

We have written previously about the importance of planning for the tax consequences of emigrating from Canada; see our previous inBrief here. In this inBrief, we will describe a number of more advanced planning options for Canadian residents who are considering giving up their Canadian residency. Bear in mind that not all of the approaches discussed in this inBrief will be right for any particular person, as each person’s individual circumstances will differ.

Upon becoming a non-resident, Canada imposes a departure tax in the form of deemed disposition of certain capital assets, causing any unrealized capital gains to be realized in the year of departure. It is common for high net-worth individuals in Canada to hold their public and private investments through holding companies (Holdcos), so one major source of capital gains upon emigration is the shares they own in their Holdcos. We will also touch upon foreign trust planning, Canadian real estate holdings, and charitable donations.

With respect to Holdco shares, much emigration planning focuses on how to minimize the departure tax by reducing the fair market value of those shares prior to exit. Some potential options to achieve this may include.

Strategic Dividends: Causing Holdco to pay out dividends to the maximum extent it can out of tax-preferential accounts maintained by it, which may include Holdco’s capital dividend account (CDA), eligible refundable dividend tax on hand (ERDTOH) and non-eligible refundable dividend tax on hand (NERDTOH). Dividends can be paid out of Holdco’s CDA tax-free, and dividends that are paid out of its ERDTOH and NERDTOH result in tax refunds to the company, making them somewhat more tax-efficient. In advance of doing this, it may be advisable for Holdco to sell some of its investments, thereby realizing capital gains and creating additional CDA that can be dividend out tax free. The payment of dividends in this manner will reduce the fair market value of Holdco’s shares, thereby reducing the amount of the deemed capital gain on such shares upon emigration.

The other reason you should be sure to dividend out all CDA in any Holdco prior to emigration is because such dividends lose their tax-free status when paid to a non-resident shareholder. Once you are a non-resident, Holdco will be required to apply a withholding tax to any dividends paid to you, and you will be taxed on such dividends personally under the laws of your new country of residence. If Holdco will continue to operate after you emigrate and will continue to have Canadian resident shareholders, it would be prudent to create separate classes of shares that allow for dividends out of CDA to be paid to Canadian shareholders (who can receive them tax-free), and other dividends to be paid to you (as you may very well be in a position to receive them much more tax-efficiently than a Canadian shareholder^[1]).

Life Insurance: Cause Holdco to acquire life insurance on your life, acquiring a policy that is maximum funded at the outset but with attributes that result in the policy having a low fair market value. This expenditure in exchange for an asset that is initially low-value (the life insurance policy) reduces the value of the Holdco shares. There are several other potential benefits to this approach that stem from the value of the insurance policy itself, because its value will increase after you have emigrated and can be leveraged as a valuable asset of Holdco going forward (i.e., front-end or back-end leveraging strategies to extract value from the policy during your life), in addition to the security of the death benefit.

If Holdco does leverage the life insurance policy by borrowing against it, Holdco will be able to use those funds for income-generating investments and will be permitted to deduct the interest on the loan. This can be an attractive arrangement.

You may wish to consider whether it makes sense to introduce a foreign ownership structure that is more forward-looking and supports your wealth and estate plans more broadly. For example, if you intend to establish a family trust structure in an offshore jurisdiction as part of your post-emigration planning, it may be prudent to transfer the shares of Holdco to the foreign trust at approximately the same time that you emigrate from Canada. You would do this after having taken any available steps to reduce the value of Holdco’s shares, as described above. If Holdco’s value is derived primarily from Canadian real estate holdings, this approach could be beneficial if you foresee a sale of Holdco in the future. In that case Holdco shares will be “taxable Canadian property” and will be taxed in Canada, and you can reduce the impact of that tax by reducing the value of Holdco’s shares through dividends after you are a non-resident (at the lower beneficial treaty rate).

There are special considerations with respect to Canadian real estate holdings. Canadian real estate is “taxable Canadian property” and is not subject to the deemed disposition upon emigration.^[2] How you can best structure your holding of Canadian real estate as a non-resident will depend on whether it is property for your personal use, or if it is a rental property. If it is for personal use, you will need to consider whether your ownership of it puts you at risk of being deemed to be Canadian resident for tax purposes even after your emigration.^[3] If it is a rental property, you will likely wish to transfer ownership of it to a Canadian holding company, otherwise the tenant will be required to withhold an amount in respect of tax from every rent payment they make to you as a non-resident owner.

Finally, an option that is not to be overlooked is simply making a charitable donation of assets that have significant accrued capital gains before you emigrate, which will have the effect of reducing both the value of your holdings as well as reducing your departure tax exposure. It will also generate a charitable tax credit which you may use to further reduce your tax burden on exit. If your charitable intentions are relatively large and you wish to maintain some ongoing involvement and control over the how the endowment is managed, you may wish to establish a charitable foundation instead of simply donating funds or assets to an existing charity. A charitable foundation that is registered as such with the Canada Revenue Agency will qualify as a registered charity and can issue charitable tax receipts, and can carry out activities and funding in line with its charitable purpose in Canada and overseas. The charitable options should, of course, only be considered where the primary objective is furthering the chosen charitable purpose with any tax incentives being secondary.

The strategies discussed in this inBrief are intended to illustrate that there may be effective pre-emigration planning that you can consider, aimed at reducing the impact of Canada’s departure tax. All such strategies are complex in their planning and application and professional advice is required to evaluate and execute them. If you are interested in exploring planning of this nature, please contact us and we will be delighted to assist. ■

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[1] The withholding tax that Holdco would be required to apply to dividends paid to you as a non-resident would be a default rate of 25% if you reside in a non-treaty country, or could be 5%, 10% or 15% if you reside in a treaty country. You may need to hold your shares through a company established in your new country of residency to access these reduced rates.

[2] You may elect to trigger a deemed disposition of taxable Canadian property if you prefer, in order to trigger gains or losses which you are able to offset against other losses or gains on exit, respectively.

[3] Very briefly, owning a residential property which is available for your personal use in Canada will cause you to be deemed tax resident in Canada, unless there are tie-breaker rules in the applicable treaty with your new country of residence. Ensuring that you will indeed be non-resident for tax purposes is a critical aspect of non-residency planning.

Family Governance in Trust Structures

When contemplating a family wealth structure that is intended to endure, such as a family trust or foundation, it is important to consider how the structure will be governed, particularly in the longer term after the founder’s lifetime. Governance mechanisms that are designed to encourage ongoing family involvement in the structure have proven to be effective at averting second, third and future generation conflicts that can undermine the structure. The most common family governance mechanisms are the family charter and the family council. This inBrief will provide an introduction to those mechanisms and explain why they can be useful for many families.

Trust Governance versus Family Governance

Most family trusts are fully discretionary, meaning the trustees are given very broad discretion to manage the trust assets and distributions. Such trusts are also normally made subject to some common governance and control mechanisms which set out either firm rules or soft guidance for the trustees. Those mechanisms typically consist of the terms of the trust deed, the appointment of a trust protector, and the issuance of a letter of wishes. These governance structures are discussed in more detail in our inBrief “A Matter of Some Discretion: Controlling Your Trust.”

The usual control mechanisms for a trust are a necessary starting point; however, if the trust is intended to survive through multiple generations and successfully serve the needs of the family, family governance becomes very important. When a family wealth structure fails over time, it is most often because of relationship breakdown among family members, no matter how well-drafted the trust deed was or how effective the tax planning. It would be rare, for instance, for a founder to be able to successfully lay out the detailed investment and distribution scheme for a trust beyond one or two generations into the future, after which that exercise becomes overly cumbersome and complex and will probably be incorrect.

The main purpose of a family governance structure is to enable long term harmony between family members; it achieves this by keeping all family members engaged with and informed about the trust, and by placing some important decision-making powers in their hands. When a grandchild or great-grandchild is a beneficiary of a trust, they will likely lack personal context around the ancestor (founder) who established it and why, and they may quite naturally view the trust through the lens of self-interest without any broader family context. They may not know or care about the ongoing future success of the structure. The natural outcome over time is conflict between family members or with the trustees or both.

Family governance mechanisms can be especially important when there is a family business that is owned by the trust, since trust ownership can lead to a lessening of family members’ emotional attachment to the business over time. There is also a natural divide between passive family member beneficiaries, and family members who are involved in the family business.

Good family governance seeks to remedy these disconnects and prevent that sort of conflict by ensuring each family beneficiary, over generations, is kept informed about the structure and has a voice along with other family members in decision-making for the trust.

Family Charter and Family Council

A family governance structure sets out how a family makes decisions in the context of a wealth structure like a family trust, how family members are kept informed, and how family governance integrates with other structures such as a trust or family business. Family governance usually consists of two main components: the family charter and the family council.

The Family Charter

The family charter is essentially the family’s constitution or code of conduct. Its contents are unique to the particular family’s needs and wishes and should retain some flexibility for amendments so it can adapt to future needs. It is a document that should have moral and ethical value to the family, while operationally it is intended to set out how family decisions will be made, when such decisions are required, and some principles or guidelines to inform those decisions. It has been aptly described as a bridge between family and business, or family and trust. Some of the topics typically addressed in a family charter include[1]: a preamble for important context; the family history; core values or goals of the family; adherence by family members; formation of a family council and its functions, decision making and voting rights; relationship with the family trust/business structure; family philanthropic/charity/education goals; conflict resolution; and procedures to amend the family charter.

Although family charters are generally not intended to be legally binding documents, that possibility is not ruled out. While it is not an area that has been sufficiently tested given the private nature of such documents, there is a growing belief that family charters can be legally binding (at least in part) if they are drafted and executed in a manner that indicates a clear intention to be bound. Even where a family charter is not legally binding, it can of course remain very morally persuasive. Importantly, it can carry tangible consequences by properly linking compliance with the terms of the family charter to one’s ongoing entitlement to benefits from a family wealth structure. That is, a family member might be given reduced or suspended entitlements to receive trust distributions in case of non-compliance with requirements set out in a family charter, and such consequences can be given effect by a family council using influence or control that it enjoys over the role of trust protector, for example.

The Family Council

If the family charter is the family constitution, then the family council is the parliament or board of directors, made up of representative members of the family. The family council is tasked with giving effect to the family charter, making decisions on behalf of the family as a whole, balancing competing interests, and communicating trust and company business to the other family members who otherwise would not have visibility into or involvement with the family wealth structures.

The family council can build harmony by communicating with the broader family and representing their interests at family council meetings thereby giving them a voice through representation, among other things. It can also advise on how and when to make distributions equitably across branches of the family and across generations, taking into account the purpose of the structure, individual needs, or current versus future needs. Sometimes the family council can also be a useful vehicle to track informal shared ownership arrangements in which one family member may be tasked with owning property for the broader benefit of other family members, in an arrangement that relies on family integrity rather than legally enforceable obligations. Such informal arrangements can be very beneficial because they do not generally trigger reporting, disclosure, registration, attribution, FATCA/CRS, tax, and other consequences that arise when formal trusts are created. This is a benefit of greater family strength, and is one way in which tangible value is produced by good family governance.

Integration of Family Governance

As noted above, family trusts are usually the sole creation of a founder with little or no input from family members (although that dictatorial approach seems to be softening these days). One way to promote the success of a family trust over multiple generations is to have the founder consult representatives of the family members during the trust planning process, and in particular in the family charter drafting process. The trust document may integrate the family charter and family council and include ways for the family representatives to select, remove and replace the trustees, or to act collectively as trust protector or trustee advisory committee. It could also include dispute resolution provisions to avoid future litigation among beneficiaries and trustees. Allowing for future members of a family council to exercise control over a trust, in the role of protector or otherwise, ensures that the trust’s operations remain flexible over time and are adapted to best serve the family through evolving needs and successive generations. Having room to adapt to changing family and legal environments is crucial to the long-term success of any wealth structure.

Vesting trust protector and advisor powers in a diffuse, multi-person committee can also be important from a tax planning point of view. Where only one person has effective control over the trust in the role of protector, there is a risk that trust income will be taxable in such person’s hands, or that the trust itself will be deemed tax resident in the place of such person’s residence.

This inBrief has focused on family governance in the context of a family trust. We would note that the same concepts apply to private foundations as well, and to family businesses through the terms of shareholders’ agreements, partnership agreements, or other comparable constitutional documents. In all cases, the goal is to provide for a vehicle through which family interests are represented and communicated, in an effort to achieve a fair and sustainable balance between family interests versus business interests, and immediate needs versus future needs.

Finally, although our focus as a firm is to ensure a robust legal and tax structure, we would be remiss if we did not acknowledge the fact that family governance structures can be valuable beyond the wealth management context, and we encourage families to capture their broader beliefs, values and goals and reflect them in their family charters.

Planning with trusts, foundations and business structures is complex, and particularly so in the cross-border context. It is critical to obtain legal and tax advice from experienced professionals before embarking on such planning. Please don’t hesitate to contact us and we will be delighted to discuss how we can assist.■

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[1] This is not an exhaustive list of topics that can be included in a family charter. For further information on the drafting and substance of family charters, please contact the author.

Invest in Start-ups in Canada: Qualify for Canadian Citizenship

Venture capital (investing in startups) has been a popular form of investment for many over the years. In recent years, Canada’s Start-up Visa Program has offered Canadian permanent residency (leading to Canadian citizenship upon qualification) to immigrant investors as well as immigrant entrepreneurs with the skills and potential to build businesses in Canada that are innovative; can create jobs for Canadians; and can compete on a global scale.

A qualifying immigrant investor can now invest a minimum of CAD115,000 in a qualifying Angel Fund and a qualifying startup (and an approved immigrant entrepreneur can manage and operate such start-up) in order to qualify for Canadian permanent residency. Based on past cases, it takes between two to two and a half years to process such application and to obtain Canadian residency if all proceeds in the ordinary course. Such investor and entrepreneur could further qualify for Canadian citizenship by remaining in Canada for three years (during a five year residency).

Under this program, designated organizations (certain venture capital funds, angel investor groups or business incubators) choose which startup investment business proposals to review and to invest in. The startup does not even have to be in Canada: it can be a foreign startup and then the immigrant entrepreneur can relocate with the start-up to Canada and become eligible for Canadian residency. Each designated organization has its own intake process for proposals and criteria used to assess the proposals. If a designated organization chooses to support the start-up business idea, it will give applicants a Letter of Support. For example, for an incubator, such Letter of Support will mean that the incubator is willing to accept the start-up into its program and help the business grow in Canada while providing guidance and expertise. As a result, the investor and entrepreneur are not alone in growing the start-up: they receive support and direction from the incubator, in addition to obtaining Canadian residency leading to Canadian citizenship upon qualification.

Finally, it is important to note that the ability to communicate and work in English, French or both languages will help a start-up succeed in Canada. As a result, applicants will have to take a language test from an approved agency. Applicants will also need to give proof that they have sufficient initial funds to support themselves and their dependents after arrival in Canada. For example, this requirement can be satisfied for a family of four if an applicant and family bring CAD25,000 to Canada. ■

Beneficial Ownership Registers for Ontario Corporations

As of 1 January 2023, all privately held corporations in Ontario must maintain a register of their beneficial owners, namely individuals who exercise “significant control” over these corporations. The changes were introduced as amendments to the Business Corporations Act (Ontario)[1] which were introduced in Bill 43 (Build Ontario Act, Budget Measures, 2021). In this note, we look at the implications of the new rules, both practically speaking and in the context of the global transparency movement.

Backdrop

Like other OECD countries, Canada is making efforts to tackle money laundering and abusive tax structures by enhancing the transparency of ownership and control of Canadian corporate entities. The relative ease of establishing corporations anonymously in Canada was highlighted by Transparency International in 2015. In 2019, federally registered private corporations were required to begin keeping a register of individuals with significant control, to be made available to certain tax and law enforcement authorities upon request. Several provinces have followed suit in respect of provincially incorporated entities, Ontario being most recent. Importantly, the registries are not available to the public. The focus on beneficial ownership transparency in Canada and worldwide is being driven by OECD anti-money laundering and tax avoidance initiatives in recent years.^[2] The establishment of beneficial ownership registers in particular reflects 2020 revisions and guidance to FATF Recommendations number 24 and number 25 (which relate to ensuring that accurate and up to date beneficial ownership information is available to appropriate authorities).

Ontario requirements

Under the new rules, a person with “significant control” is someone who is the registered or beneficial owner of, or who has direct or indirect control or direction over 25 per cent of the corporation’s shares by votes or value. It also includes any individual who has any direct or indirect influence that if exercised would result in de facto control of the corporation as well as an individual whose circumstances meet the definition as set out in the regulations (not yet established). What is “direct or indirect control or direction over” shares, or “control in fact” are not defined but further guidance may be set out in the regulations; however, it is clear that joint ownership arrangements, ownership by family members, voting agreements and shareholders’ agreements and any comparable contractual arrangements will qualify.

The register must include names, birthdates, tax jurisdiction and a description of how the individual meets the definition of significant control. The corporation must ensure the register is kept up to date by taking steps to refresh the information in the register at least once every financial year. There are penalties (monetary and potential imprisonment) for directors and officers who knowingly allow the corporation to fail to maintain correct records and for shareholders who knowingly fail to provide accurate information in response to requests for information from the corporation. That is, Ontario corporations are required to request such information from their shareholders, and the shareholders are required to respond.

The register must be kept at the corporation’s registered office and be made available to requests from tax authorities, regulatory bodies and law enforcement.

It should be noted that no such similar requirements have been introduced in respect of partnerships or limited partnerships in Ontario as of the date of writing.

Are public registries next?

Although the new Ontario rules place a greater burden on corporations to ensure that they hold accurate records about their beneficial owners, the fact that such information must be available to authorities upon request is not a particularly novel concept given the existing powers of such authorities to require disclosure from corporations. Pragmatically speaking, the new rules can be viewed as somewhat cosmetic. A far more dramatic and controversial issue is whether such records will be required to be made available to the public (and the press), but it seems unlikely for now that this will occur in Ontario (or other Canadian provinces, with the possible exception of Quebec) without substantial further debate and the allocation of significant funding from the federal and/or provincial budgets.

The federal government had previously announced a publicly accessible beneficial ownership registry of federally registered corporations to be established by end of 2023. However, it has yet to announce any details of when and how this will occur or to allocate the required budgeted funding. In the intervening years the controversy around making such beneficial ownership registers public has grown, as doing so raises potentially serious privacy concerns and questions about whether making such information public carries benefits that outweigh those concerns (particularly when such information is already available to relevant tax and law enforcement authorities). The UK was the first to implement such a public registry, which continues to operate now. On the other hand, a recent landmark ruling of the Court of Justice of the European Union^[3] invalidated a provision of the EU Anti-Money Laundering Directive guaranteeing public access to beneficial ownership information on the basis that such public access violated privacy rights. While it is far from certain, it may be that the Canadian government and many others around the world will reconsider the establishment of such a public registry for similar reasons.

The implementation of publicly accessible beneficial ownership registries in Canada remains controversial and, for now, not imminent in the near term.

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[1] Implemented in sections 140.2, 140.3, 140.4 and 258.1 of the Business Corporations Act (Ontario).

[2] In particular the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes (transparency focused); the Financial Action Task Force (FATF) (anti-money laundering focused); and, a third major work stream, known as the base erosion and profit shifting (BEPS) initiative, which is led by the OECD Committee on Fiscal Affairs (tax avoidance focused).

[3] The full ruling can be found here: https://curia.europa.eu/juris/document/document.jsf?text=&docid=268059&pageIndex=0&doclang=en&mode=lst&dir=&occ=first&part=1&cid=1291

Choosing the Right Offshore Jurisdiction

Wealth and estate planning that make use of so-called offshore trust structures are popular. Such structures are useful for many reasons, including to support individuals and families who are seeking a change in residency, and to offer longevity, predictability and security that is not always available in one’s home country. They can more readily adapt to beneficiaries in different and changing jurisdictions, and in the right circumstances they can offer tax efficiencies. If you have determined that an offshore structure is right for you, you will find that there are many offshore jurisdictions that could potentially be suitable for your needs. This inBrief looks at how to go about evaluating and selecting the right jurisdiction for your structure.

A brief summary of some of the factors you should take into account follows:

– A zero-tax environment. Many jurisdictions offer this.

– Reputability. This is really a colloquial catch-all for how well the jurisdiction adopts and implements FATF guidelines, OECD (and US) tax and reporting rules, transparency and level of cooperativeness of local government and courts, among other things. The international reputation is not a matter of perception, but much more importantly, it is a matter of how willing other professionals and financial service providers will be to deal with entities formed in that jurisdiction.

– Regulatory compliance. This is related to reputability. A jurisdiction that is compliance-focused will be more readily welcomed by banks, investment managers, insurers, land and asset registries, and others that will interact with the entity you establish. In this context, compliance refers essentially to thorough disclosure of beneficial ownership and processes to keep it up to date and verifiable, and accessible to legitimate government inquiry (not to the public, necessarily).

– Quality of service providers. Offshore structures such as trusts can only function properly if they are serviced by qualified, experienced, reliable service providers, in particular trust companies acting as trustees (others include accountants, lawyers, private bankers, investment managers, and insurance advisors). It is of great benefit to establish a trust in a jurisdiction with a mature market of well-established service providers.

– The legal environment. Offshore jurisdictions tend to have well-developed laws regulating their trust industry, and many have developed issue-specific specializations. Depending on your priorities and what you wish to achieve with your trust, you may be better served by one jurisdiction or another. For instance, the Cook Islands have a relatively strong position protecting Cook Islands trusts against foreign claims. The British Virgin Islands offer a special regime for so-called VISTA trusts[1], which have advantages when the trust acts as a holding vehicle for shares in an underlying company, especially where the underlying investments are relatively high risk. The Cayman Islands have a special regime for so-called STAR trusts, which allow for non-charitable purpose trusts, useful for creating “orphan” structures, for example. There are other examples, and many other uses for VISTA and STAR trusts[2].

– The courts. This is really part of the legal environment, but it deserves a separate mention. The track record of the courts in upholding the local laws, and their ability to address trust-related claims in a manner that is sophisticated and predictable is an important factor.

– Privacy. This is also part of the legal environment but deserves a separate mention too. Robust, modern privacy laws are important to ensure that your sensitive personal and financial information is not misused or disclosed to third parties or the public or potential bad actors. It is worth clarifying that “privacy” does not mean “secrecy”, and that any reputable jurisdiction will have detailed beneficial ownership disclosure requirements, and will have international reporting obligations and exchange-of-information treaties, including among tax authorities. The purpose of an offshore structure is not to conceal information from governmental authorities who have a legitimate interest. This was the case decades ago and is the source of negative stereotyping of offshore jurisdictions which continues in the media to this day, ignoring the enormous reforms in transparency, regulation and international disclosure that have occurred over the years.

– Political stability. A long track record of peace and good order and rule of law is critical. Trusts for wealth and estate planning purposes are often intended to last for many years, over multiple generations.

– Cost. The cost of establishing and ongoing maintenance of the trust or other structure is a legitimate focus, of course, but in our view is not the primary driver. The other factors listed above are more important, and, the cost tends to be relatively similar across the board, with limited exceptions.

In our view, among the factors listed above, by far the most important factors to focus on are the legal environment and the quality of trust service providers. The legal environment is important because the objectives for the trust may be better served by the laws of one jurisdiction or another. The quality of trust service providers is important not only for the reasons summarized above but also because a good service provider brings with it its own standards and safeguards around privacy (and the IT infrastructure and culture of compliance that goes with that), often at a level higher than that required by local laws.

A good service provider will also attract qualified personnel, will be responsive, service-oriented, and will be helpful and capable whenever new demands arise.

If you have identified jurisdictions that are reputable, and which have a legal environment that supports your needs, and which have quality service providers available, you can consider some of the softer tie-breaker considerations, such as time zone for ease of communication, and physical accessibility in the event you wish to personally visit from time to time to meet your trustees or other providers.

During the planning phase, it can be useful to weigh the pros and cons of different jurisdictions for a number of reasons. Good planning sometimes entails utilizing a structure with elements in multiple jurisdictions (a private investment company owned by a trust, each in different jurisdictions, for example); and, it can be helpful to consider an alternate jurisdiction in case you wish to re-domicile your trust (most offshore trusts are portable from one jurisdiction to another, if the trust deed allows for it).

The above is not intended to be a definitive list, and specific factual context must always be taken into account. The factors set out above should usually present a reasonable starting point.

If you are considering an offshore trust structure or have questions about whether it may be suitable for you, or which jurisdiction may suit your needs, please contact us and we will be happy to help. ■

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[1] Trusts created under the Virgin Islands Special Trust Act 2003 (as amended) (British Virgin Island)

[2] Trusts created under the Special Trusts (Alternative Regime) Law 1997 (Cayman Island)

Tax-Driven Changes in Residency for Canadians

For those with sufficient assets, tax-driven relocations and changes in residency have become commonplace. They began to occur in earnest in the 1990s and have increased in popularity ever since. In the past 1-2 years in particular, the popularity of residency changes for tax reasons has seen a marked rise. This has been driven by several factors, which include: the steady reduction in other viable international tax planning strategies as the OECD continues to press aggressive reform, more mobile lifestyles brought about by COVID-19, and the expectation of an increased tax burden especially for the wealthy (also brought about by COVID-19, at least in part). In short, more people have begun to enjoy more mobility, and the comparative tax advantages of relocating have never been greater. As we have stated in prior inBriefs, for Canadians, changing their country of tax residency is almost certainly going to be the single most effective tax planning strategy they can adopt, with both immediate and long-term benefits.

The opportunity to attract such mobile, wealthy people is also very appealing to potential recipient countries, who stand to gain economically from an influx of wealthy immigrants. Competition for economically beneficial immigrants is high. Many countries have established residency programs and tax incentives specifically intended to attract economic immigrants. Some of the most popular destinations in recent years have included the UAE, Portugal, Greece and Italy, among many others including some Caribbean nations. The models adopted by these countries typically require the applicant to make an investment in the country, often in real estate, in exchange for medium- or long-term residency (and sometimes a path to citizenship over time), and access to a favourable tax regime. The amount of the investment varies greatly from country to country (from EUR 200,000 to EUR 3,000,000).^[1] The favourable tax regime will be one of two models: the requirement for an annual lump-sum payment of tax irrespective of actual income each year (e.g., Italy, Switzerland), or, access to a low or no tax environment without the lump-sum in exchange for having made an initial investment (e.g., Portugal, Greece, UAE).

Deciding where to seek your new residency can be complex and should take into account many factors, not only taxation. There are publicly available resources which help you to evaluate potential destination countries according, breaking down some of the more relevant factors on a country-by-country basis, and even offering rankings of countries by popularity for their tax residency offerings.^[2]

The conditions of residency and favourable tax treatment usually do not require significant “days in country”, so extensive travel is permitted, but you would need to avoid spending so many days in another country that you are deemed tax resident there as well. The residency status granted normally gives you and your family the ability to live, study, and work in the destination country (and, for EU destinations, these rights would apply anywhere in the Schengen region).

From a tax planning perspective, it is crucial to carefully evaluate your assets and your expected sources of income before settling on a destination for tax residency, and to obtain professional advice as to how your specific assets and income will be taxed there. There are always exceptions to the favourable tax treatment offered by each jurisdiction. For instance, some may provide that only passive income from foreign sources will enjoy low/no tax, and only if there is a double taxation treaty in place with the foreign source country (in which case, income from assets located in offshore jurisdictions may not qualify, nor income you generate if you are working in your new country of residence). Also, assets located in the country you are moving away from may continue to impose tax on income and gains on those assets, despite your non-residency.

As such, the change of residency journey will almost always include a restructuring of your assets, and planning your sources of income, in order to achieve the desired tax-efficient result. As part of the planning, it can often be helpful to make use of trusts in low/no tax jurisdictions as a vehicle in which to hold appreciating or income-producing investments. Distributions from trusts can generally be structured in a manner which attracts little or no tax, depending on whether the distribution is out of trust income or trust capital. International planning using trusts can be complex and requires cooperation among advisors in your new country of residence, your country of origin, the country in which the trust is established, and every country in which there is a beneficiary of the trust. Trust distributions to a beneficiary will be treated differently depending on where each beneficiary resides. However, despite some complexity in the planning phase, trusts remain by far the most popular wealth planning vehicle for good reason, as the benefits of their use can be significant. For example:

– Tax efficient distributions: payments from a trust to its beneficiaries can be managed so as to attract less overall taxation, or no taxation, if the trust has been planned and structured properly. This can include tax-free distributions to Canadian resident beneficiaries, if properly planned.

– Wealth accumulation: trusts in low/no tax jurisdictions often have very long lifespans, or are permitted to exist indefinitely. As such, they can accumulate investment gains with little or no tax over a long period, and can effectively preserve and grow capital. As such, capital can effectively be sheltered in the offshore trust indefinitely, with distributions made to beneficiaries as and when desired so that only those distributions are subject to tax when received (assuming the recipient is subject to tax).

– Transition of wealth: for the above reasons, it is often very advantageous to structure an inheritance through an offshore trust, where the capital can be better preserved, grown and distributed much more efficiently than if the inheritance were given directly to beneficiaries.

– Creditor protection: trusts have long been a popular vehicle for asset protection. Since the trust legally owns the assets, the settlor’s creditors cannot seize them (subject to some exceptions where there are concerns around defrauding creditors). And, since beneficiaries usually only have discretionary interests which are not vested, the creditors of the beneficiaries have nothing to seize either. Trusts are also a useful tool to keep wealth outside of the net of “family property” or similar definitions which determine what a spouse is entitled to upon separation, divorce or death.

– Flexibility and control: trusts are flexible enough to allow you to transfer legal title to assets and grant beneficiaries economic benefits to or from the assets, without transferring control over the assets. This flexibility to retain control can be useful for many reasons, including in situations where beneficiaries may not be ready to responsibly manage the assets, or, in the context of a family business, where you may not yet know which child or children will be involved in the business upon succession. Often of most interest to settlors is the ability to continue to control the management of the trust’s investments, rather than handing over control to a trustee and institutional investment manager.

– Estate planning benefits: trusts have a great many benefits in the context of an estate plan, including all of those noted above in this list, along with additional benefits such as the ability to place trust assets outside of the scope of a forced heirship regime, and the fact that trust assets will not be made subject to probate and estate administration procedures which are complex, time-consuming and sometimes expensive.

Once you have selected a destination and have considered how to structure your assets and income in order to achieve a tax-efficient result, you may also need to carefully plan your emigration from your current place of residency. For Canadian residents, there are tax consequences of ceasing to be a resident and there may be planning opportunities to reduce the impact upon your exit. Advance planning is especially important if you own shares in one or more private companies.

In light of the above, it is important that you select an experienced advisor who not only has local expertise along with an international network and capabilities, but who can also mobilize other professionals in your country and your new country of residence (and a suitable trust jurisdiction) in order to provide you with cohesive and complete advice. It is typical to require legal counsel and tax accountants in at least two countries, along with valuation experts and professional trustees, in order to provide complete advice on a tax-driven relocation.

If you would like to explore a change in residency and the potential tax advantages, please do not hesitate to contact us. ■

[See also our earlier inBrief dated 4 October 2021, “Planning for Non-residency – Doing it Right”]

[1] There are other paths to residency aside from investment in some countries, such as through employment or establishing a business. In the UAE, for example, you may establish a company for significantly less cost than the cost of investing in real estate, and arrange for the company to sponsor your UAE residency.

[2] For example, see the popular Henley & Partners indices and reports which rank investment immigration programs, and perceived quality of different residencies and citizenships: https://www.henleyglobal.com/publications

A Matter of Some Discretion: Controlling your Trust

Two common reasons for the use of trusts in estate planning are to achieve tax efficiencies and to protect assets from potential creditors and claims. These are by no means the only reasons that trusts are utilized, but they are important benefits and are sometimes the primary focus of trust structure. Generally speaking, trusts that provide tax and asset protection benefits need to be structured so as to grant the trustees very wide discretion as to when distributions are to be made, to which beneficiaries, in what amounts, and in which circumstances. The language used in trust deeds usually gives trustees “absolute discretion” or “unfettered discretion” or similar. Consider the following two examples of why discretion is important:

Example A (tax efficiency): If a family trust is established with many family members as potential beneficiaries (e.g., “all of my issue”, which would include children, grandchildren, and you may include corporations owned by them, etc.), one of the goals of the trust is probably to take advantage of income splitting opportunities among the beneficiaries. The trustee needs to be able to assess the individual tax brackets of the beneficiaries so they can “income sprinkle” across the beneficiaries in a tax efficient manner. If the beneficiaries had fixed entitlements to a specified proportion of trust income or capital, the trustees could not achieve a tax efficient result. Thus, discretion is needed.

Example B (asset protection): Consider the same example again, but this time one of the beneficiaries has been successfully sued and his/her assets are subject to attachment by the judgment creditor. If the beneficiary has a fixed entitlement under the terms of the trust, the creditors will be able to attach that interest as well and that beneficiary’s interest is effectively lost. If the beneficiary’s entitlements are entirely subject to the trustee’s discretion, then the beneficiary has no vested interest at all unless and until the trustee declares each new distribution. The trustee can confirm before making a distribution whether any beneficiary is subject to creditor claims, and if so, it can exercise its discretion in favour of another beneficiary (or none at all), until the claims are dealt with, keeping the trust assets out of the creditor’s hands. Accordingly, discretion is again an essential component.[1]

With the necessity for a trustee to be granted such broad discretion, the question is often asked: how do you know the trustee is going to exercise its discretion in the manner you would have intended? There are essentially three approaches available: include terms in the trust instrument itself, issue a letter of wishes, and/or the appointment of trust “protectors”. We will briefly discuss each in turn.

(i) Terms of the Trust Deed

Some terms can be included in the trust deed itself without unduly constraining the trustee’s discretion. These may include directions to the trustee not to make distributions to beneficiaries whose assets are subject to attachment; or a term which excludes the trust property from any beneficiary’s net family property to help protect it from being included in equalization payments upon marriage breakdown; or even a direction that requires certain minimum payments or expenses to be paid out of the trust so that the broad discretion only applies to the funds remaining after that. A trust deed is a very flexible instrument and can be prepared with as many, or as few, specific constraints on a trustee as desired. However, for the most part, if tax and asset protection benefits are to be maintained, the hard constraints need to be kept to a minimum. It is more common to do the opposite; that is, explicitly oust duties that trustees would otherwise have as a matter of law that would potentially constrain them.

(ii) Letter of Wishes

A letter of wishes is separate from the trust deed and is just what its name suggests: a letter from the settlor to the trustee setting out guidance for the trustee as to how the settlor wishes the trustee to exercise its discretion. The trustee is not legally bound by the letter of wishes, but in practice trustees do give effect to them, and if a beneficiary challenges the trustee’s choices a court will take letters of wishes into account as relevant context. Letters of wishes are sometimes very brief and provide simply that the trustees should take into account the views of another person when exercising their discretion (and that person is sometimes the settlor). This is a potentially acceptable approach in the short term, but it has its drawbacks: a court may find that the settlor is the person who is “in fact” making trust decisions as a de facto trustee, a finding that would almost certainly have detrimental consequences for any plan for which the trust was needed; and, upon the settlor’s death (or to whomever the letter of wishes referred), the settlor obviously then loses whatever influence he/she had. Thoughtful, detailed, foresightful letters of wishes are strongly recommended. Note that the trust deed should oust any default duties that trustees must comply with as a matter of law which may prevent compliance with a letter of wishes (the obligation to treat all beneficiaries equally, for example, should be ousted in the trust deed, along with others).

(iii) Appointing a Protector

Finally, there is the role of the trust “protector”. A protector is someone (or multiple persons) who is granted a number of key powers in the trust deed, but who is not a trustee and, typically, has no fiduciary duties to beneficiaries.[2] They are supposed to provide oversight of trust administration and decision making from the perspective of someone close to the settlor who presumably knows what the settlor would have wanted. Protectors are often granted powers to approve certain decisions of the trustees, to veto certain decisions, to remove and replace the trustee, or to terminate the trust, among other key powers. The protector provides a significant check on trustee discretion. The choice of protector is therefore important: not only should the protector be someone close to you and who understands your wishes, they should be trustworthy and reliable, and without a conflict of interest (e.g., a beneficiary, or a spouse of a beneficiary). Care must be taken so as not to usurp the role of the trustees altogether, either in the trust deed or in practice, or there will be a risk that the protector will be found to be the de facto trustee, with potentially disastrous consequences.[3]

In addition to the above, where a trust is created as part of a plan intended to have specific tax consequences, it is common for trustees to obtain professional advice before making a distribution, to ensure that it is being made in a manner that will not upset the plan. This is not a limit on the discretion of the trustees, per se, but it does function as one. Sometimes, detailed tax-driven instructions are provided to the trustees by professional legal advisors when the trust is created, setting out guidelines for how distributions are to be made, when, and also to whom they must not be made. Such advice has similar status to a letter of wishes, but is arguably even more likely to be adhered to as the trustees will not wish to be responsible for triggering negative tax consequences in the face of having received such advice.

The above tools to control the discretion of a trustee are very useful, but they still leave some discretion to the trustee, which is unavoidable if the structure is to be robust enough to withstand a challenge by tax authorities or disgruntled beneficiaries.[4] On a practical level, these tools are quite effective as professional trustees are motivated to serve their clients (i.e., settlors) as best they can, and to avoid litigation that may arise from ignoring letters of wishes, or professional advice, or contravening a protector’s decision. ■

[1] For asset protection trusts, note that it is important that the beneficiary whose interest is being protected is not also the sole trustee (or ideally even one of multiple trustees), as a court may order the beneficiary/trustee to exercise its control over the trust to satisfy the creditor’s claim. The beneficiary must not have any control over trust decisions.

[2] The issue of whether a protector does have, or should have, fiduciary obligations to beneficiaries similar to the obligations of trustees is an unresolved issue in Canadian law. Care should be taken to specify the settlor’s intent in the trust deed as to the duties expected of a protector.

[3] Garron Family Trust v. Her Majesty the Queen (2012 SCC 14) is the leading case in Canada on trust residency. In that case, the courts “looked through” the exercise of powers by a protector, where the protector was in turn subject to replacement by the beneficiaries, and this was one of the reasons that court found that the beneficiaries were effectively functioning as the trust decision makers, with negative consequences for the trust in that case.

[4] This note focussed on trustee discretion with respect to distributions of trust income and capital. It is important to bear in mind that a trustee’s discretion with respect to managing the trust’s investments can be controlled as well, to a greater degree of certainty and detail than controlling discretion as to distributions.

International Estate Administration for Canadian Executors

The administration of an estate can be a complex and intimidating process at the best of times. If the estate in question has international components to it, the complexity increases and professional guidance will almost certainly be essential. This article will provide an overview of some of the issues that arise in the context of estate administration with international elements, from the perspective of a Canadian executor or a Canadian beneficiary.

There are a number of things that can make an estate administration “international”. These include: foreign assets that form part of the estate; the existence of foreign beneficiaries; the non-Canadian domicile^[1] of the deceased at the time of death or at the time of making his/her will; a foreign executor; or some combination of the foregoing. When an estate has one or more of these characteristics, there are certain questions that need to be addressed. The remainder of this article will be guided by these key questions and answers.

What laws apply to the estate?

As a starting point, movables in an estate are governed by the laws of domicile at the time of death, and immovables (real property and certain intangible assets) are governed by the laws of the place in which they are located. The practical application of this concept can be much more complex than it appears at first blush, particularly if there is a will that was executed during an earlier stage of life when the deceased may have been domiciled elsewhere, or if the will only addresses part of the estate assets (partial intestacy), or where outcomes based on the laws of one country must be enforced in another country which may have its own administrative or substantive requirements. The issue of which country’s laws apply is very important, as it determines the scheme of distribution (on intestacy) or how the will will be applied and how it may be challenged (if there is a will). This includes spousal or dependant relief claims and other challenges to a will or intestate distribution. For example, if the deceased was found to be domiciled outside of Canada at the time of death, the Canadian (provincial) laws that give preferential rights to spouses and dependents would not apply. The issue of domicile and determining whose laws apply is therefore central and must be considered as a first step. Note that a Canadian court may still agree to take jurisdiction and issue a grant of probate for the estate even if the deceased was not domiciled in Canada, but whether this would be appropriate is a case by case decision based largely on where the deceased’s assets are located (more on issues of probate and asset location below). The issue of which laws apply to which aspects of an international estate can be difficult and do not always have perfect solutions, particularly when the laws of multiple countries need to work together. The cooperative efforts of professional legal advisors in all relevant countries is usually a necessity in order to agree on how to achieve the best practical outcomes.

Where should you apply for probate?

Where to apply for the “original grant” of probate will be driven largely by which assets in the estate require probate in order to enable the executor to deal with them, and where those assets are located. Assets that require probate are usually assets that are subject to a third party’s control or consent, like bank accounts (the bank), land (land registry), public company shares (the company or the relevant exchange). As such, once an inventory of assets and their locations has been taken, inquiries should be made with the foreign third parties and authorities in order to confirm their particular requirements. Those requirements will be one of the following: a certified copy of the will; a fully attested copy of the will (possibly translated)^[2]; a grant of probate in the jurisdiction of domicile; or, the original grant of probate submitted to the local courts to obtain a local court endorsement to enable local parties to rely on it; a local ancillary grant of probate (i.e., a fresh probate application in the local courts). Which of these documents will be required in each instance will need to be confirmed with each relevant asset registry or authority. Note that assets that do not require probate in Canada may require it in other jurisdictions. If there is foreign real property to deal with, local probate will almost certainly be required (either re-sealing an original grant or issuing an ancillary grant locally). Probate fees may therefore apply in more than one jurisdiction as well.

In most cases, obtaining the original grant of probate in the place of the deceased’s domicile at the time of death is advisable as that is normally where the majority of matters requiring administration emanate from.

In general, even if probate is not strictly required, it is often advisable for an executor to obtain a grant of probate anyway as it offers protection against claims against the executor. In the context of an international estate administration this should be a material consideration for any executor.

Are there special tax issues with an international estate?

From the perspective of a Canadian executor that needs to distribute assets to foreign heirs, there are some additional tax compliance requirements. Most importantly there is an obligation on the executor to withhold what is known as Part XIII withholding tax (referring to Part XIII of the Income Tax Act) of 25 percent, or less if reduced by a tax treaty between Canada and the other country. If the distribution of assets consists of Canadian real property or amounts derived from it, the executor may also need to obtain a special clearance certificate from the CRA before making the distribution (a section 116 clearance certificate). Note this is different from the clearance certificate that the executor should obtain from the CRA to protect him/herself from liability for tax in respect of estate distributions in any event, even domestically^[3].

For assets located in other jurisdictions, local advice will be required as to whether any tax liabilities or filing obligations are applicable in respect of such assets, such as estate tax (as in the United States) or transfer taxes or stamp duties or similar.

For a Canadian beneficiary that receives distributions from a foreign estate, there are generally no tax consequences of the receipt itself. However, an information return may still need to be filed with the CRA^[4]. If the distribution results in the Canadian owning foreign assets worth CAD 100,000 or more, this will give rise to an additional filing requirement with the CRA^[5]. Note that if a Canadian resident owns (or acquires by inheritance) any foreign asset that generates income, that income will be taxable in Canada and will need to be declared going forward.

It is worth pointing out an opportunity for tax planning when a foreign benefactor wishes to leave an inheritance for a Canadian resident. If the foreign benefactor is not a Canadian resident, and has not been a Canadian resident for the past 18 months prior to death^[6], then they will be able to establish a trust in their will in a foreign jurisdiction (i.e., a low/no tax jurisdiction) using the inheritance. The Canadian beneficiary(ies) can receive distributions from the trust tax free, forever. The benefit of this structure is with respect to the income generated by the trust settlement, not the trust capital itself (which would not have been taxed in Canada in any event when transferred to the heirs). The income generated by the trust can be accumulated, capitalized, and paid out to Canadian beneficiaries as capital on an ongoing basis, attracting no tax.

What should you do to plan your international estate in advance?

Having a well-planned estate will make its administration much easier on your executors, and will help to ensure your wishes are in fact carried out in the way you intended and not thwarted by unforeseen legal or administrative obstacles. Some key elements of good planning that you may wish to consider are:

1. Keep your will(s) up to date as your assets grow or change in type, value or location, or your family (or other beneficiary) circumstances change, or as your country of residence changes. An out of date will can result in unnecessary and entirely avoidable difficulties and a distribution of your estate in a manner you did not intend.

2. Have multiple wills where appropriate on a country by country basis, or sometimes by asset type, so they can be probated and administered locally, or so that probate can be avoided for some assets. This can help to avoid the international attestation requirements, translation requirements, and international recognition or enforcement issues that can arise and which can be very time consuming. If multiple wills are used, be sure they are drafted in express contemplation of one another and do not operate to invalidate the other(s). Consider preparing an explanatory note to your executor regarding how the multiple wills are intended to operate, and what formalities are expected to be required to implement them so your executor does not need to struggle to work out your intentions.

3. Confirm whether you are subject to any forced heirship regime, as is the case for some EU nationals (e.g. Germany, France), and Middle Eastern nationals (e.g. Saudi Arabia, the UAE), and plan your estate with an awareness of which assets, if any, will be subject to the forced heirship regime. You can plan your will(s) accordingly so as to avoid a conflict between your wishes and what is required by law, or, you may be able to plan to effectively exclude some or all of your assets from the regime.

4. Keep a document that will be easily located by your heirs upon your death which sets out what documents you have prepared (i.e. your wills and any instructional memos) and where they can be located, and the best lawyers or other professionals who were involved in their preparation or other estate planning.

5. Consider establishing a trust during your lifetime which can hold some of your assets in order to avoid the probate and estate administration issues that would otherwise arise. Since ownership of the assets will have passed to the trust already, the only administration that is necessary is to provide the trustees with proof of death, whereupon the trustees will deal with the trust assets in whatever manner is provided in the trust deed. This provides ease of administration, avoidance of probate (and probate fees), and immediate access to assets for your heirs (or limited or delayed or conditional access, according to what you had provided in the trust deed). The use of trusts can dramatically ease the burden on your estate administrators.

International estate administration can be daunting. The support of professionals who are experienced in dealing with international issues and who are part of a strong network of professionals in other jurisdictions is essential. If you require assistance or have any questions about domestic or international estate administration issues, please do not hesitate to reach out to us. ■

^[1] The term “domicile” is not always the same as “residence”, although they usually are the same. Domicile requires a higher level of permanence, where one has their permanent home. For many people the answer is obvious, but for recent immigrants or emigrants of Canada, or for people with significant residential ties in multiple countries, the determination of domicile can require further analysis.

^[2] The attestation process typically consists of notarization in the place of origin, attestation by the Ministry of Foreign Affairs or equivalent, then finally attestation (or legalization) by the consulate or embassy of the country in which the document will be used. This can be an onerous process for those unaccustomed to it. Consideration should be given to the translation requirements in the local jurisdiction, which may include the necessity to use only licensed translators in that jurisdiction. It is usually more efficient to have the translation done in the foreign jurisdiction.

^[3] Such clearance certificates are required under section 159(2) of the Income Tax Act, as opposed to the section 116 clearance certificates for distributions of taxable Canadian property (mainly real property) to foreign beneficiaries.

^[4] Form T1142 (Information Return in Respect of Distributions from and Indebtedness to a Non-Resident Trust).

^[5] Form T1135 (Foreign Income Verification Statement).

^[6] Note the same tax-efficient offshore trust structure can be used during the life of the benefactor too, but they must have been non-resident for at least 5 years rather than 18 months.

Succession Planning for a Family Business

Planning for the succession of a family business is something that is too often delayed or addressed on an ad-hoc basis without a cohesive strategy. Considering that the business is likely the most valuable asset in a business owner’s estate, and probably the most complex, it is very much worth the time and effort to develop and implement a plan for succession before life circumstances take these decisions out of your hands. This article will provide an overview of some of the tools available for family business succession planning, with an emphasis on what is known as an estate freeze. This article does not address the advantages and disadvantages of providing for the succession using a will, and focusses only on lifetime succession plans.

This article will assume the business is incorporated. If it is not, it is possible to transfer an unincorporated business to a newly formed corporation on a tax-deferred basis, so achieving corporate form is not usually a major obstacle.

The simplest approach to succession is for the business owner to make a simple gift of some, or all shares in the company to the intended successors during his/her lifetime. The gift approach keeps the shares out of the transferor’s will and is simple and has virtually no cost associated with execution, but has little other benefit associated with it. It is the blunt instrument of wealth transfer. There are drawbacks to this approach, such as the fact that the gift will be treated as disposition at fair market value for tax purposes and tax will be payable on any capital gain that is deemed to have been realized. Also, the transferor would be giving up the value and control associated with the gifted shares, and there may be no way to backtrack once the gift is made.

Gifts can be made of only some of the shares, or new classes of shares can be created and issued to the successors in order to better customize their voting rights, participation in growth and entitlement to dividends. You may not wish to give your successors voting rights, or possibly even dividend entitlements, until you are prepared to exit from a leadership role in the company. In any scenario in which the company will have multiple shareholders, putting in place a shareholders’ agreement is strongly recommended in order to avoid conflict. A shareholders’ agreement should give clarity on matters of company governance, board participation, exit rights, what happens if the company is to be sold, what happens on death of a shareholder, how dividends will be dealt with, any expected contributions to the company from the shareholders, key issues for which unanimous or super-majority voting may be required, and how disputes will be managed (among many other things). In the family business context, a good shareholders’ agreement can act almost like a family constitution, and can be critical to both the business and family harmony.

One popular succession planning technique is the estate freeze. An estate freeze is a restructuring of a corporation in which a business owner exchanges his/her shares in the company for preference shares that have a fixed redemption value and certain other specific attributes required by the CRA. The fixed value is usually equal to the fair market value of the company at the time. At the same time, common shares are issued to the intended successors. The growth in the company from that point forward will accrue to the common shares only, not the preference shares, which remain at their fixed redemption value (and may or may not have dividend entitlements, as desired). As such, the value of the business owner’s interest (the preference shares) is said to have been “frozen” as of the time of the freeze. The share exchange is designed to occur on a rollover basis so that no taxable event is triggered, as the business owner has not actually extracted any remuneration from the corporation (just exchanged shares for shares).^[1] On death, or upon an earlier disposition of the preference shares, the business owner will realize a taxable capital gain on the value of the preference shares. The estate freeze has several important advantages, which include:

The value of the business owner’s interest is frozen, so his/her tax exposure on death or disposition is known and will not increase (so this can be predictably insured against with life insurance, for instance);
The future growth in value of the company is transferred to the successors, and this “transfer” occurs without tax because the value of the common shares issued to the successors is close to zero at the time of issue (the present value of future growth potential is not taxed, under current CRA practices);
The lifetime capital gains exemption can be effectively multiplied among the successors, assuming the corporation’s shares qualify for the exemption (meaning the corporation meets certain Canadian ownership and Canadian business and asset requirements, qualifying it as a “qualified small business corporation”);
Income splitting among the successors is possible if their shares are entitled to dividends (and if certain attribution rules are avoided);
The successors are directly and personally invested in the continued success and growth of the business; and/or
The business owner gets to enjoy witnessing the successors benefitting during his/her lifetime as opposed to dealing with the succession in a will.

An estate freeze is very often structured using a trust to hold the growth shares (common shares) for the benefit of the successor family members, rather than issuing the common shares to the family members directly. The trust then controls the shares subject to the terms of the trust instrument. This can be very useful as it allows the trust to act as a conduit through which the family members’ respective interests in the underlying common shares is divided, and the nature of the division can continually change as needed. For instance, the trust can distribute dividend income among the beneficiaries in a manner that is most tax efficient in view of the different income brackets of the beneficiaries (income splitting, but not during the lifetime of the settlor/freezor as the TOSI (tax on split income) rules would apply) and this can change from year to year, and can withhold benefits during periods when a beneficiary is subject to creditor claims (asset protection). The use of a trust also allows the settlor/freezor to retain more control over how the shares will ultimately be distributed to beneficiaries, if indeed a distribution is intended at all, and to help protect the shares from potential spousal claims. It may not be obvious at the time of the freeze which of the beneficiaries is the appropriate successor(s), which ones have an interest in the business, the aptitude for it, etc. A trust allows for deferral of such decisions without deferring the economic transfer and crystallization of the tax benefits. Essentially, the trust facilitates continued flexibility in decision making in ways that direct gifting or direct ownership does not. As of the date of writing, the lifetime capital gains exemption can still be multiplied among the beneficiaries even when the growth shares are held through a trust. A shareholders’ agreement should be put in place between the settlor/freezor and the trust.

There are many permutations on the estate freeze to accommodate a wide range of goals and circumstances. For instance, as part of the share exchange that occurs, a settlor/freezor may also choose to take back low value, super-voting shares along with the fixed value preference shares, so that he/she maintains voting control during his/her lifetime. These shares can be made to cease to carry such voting rights upon the settlor’s/freezor’s death so that control passes automatically to the family (or as provided in the shareholders’ agreement). Another permutation is that the freeze can be structured in such a manner that only some of the future growth is transferred to successors (say, up to the amount of the lifetime capital gains exemption for each beneficiary, and no more), and the settlor/freezor retains the rest. Or, the settlor/freezor can retain the ability to receive dividends or to take back some of the growth shares in what amounts to a partial unwinding of the freeze (aptly known as a “thaw”), if circumstances change. This can be achieved by making the settlor/freezor a discretionary beneficiary of the trust. It is also possible to execute a second freeze on an already frozen company, known as a refreeze, which may be advisable if the value of the company declines after the first freeze, or if the recipients of the growth shares themselves wish to freeze the value of those in favour yet further recipients (the next generation, for instance). There are several other named permutations which are need not be addressed here, the point having been made that the estate freeze is an adaptable structure.

When structuring an estate freeze, particularly when using a trust, it is important to be very careful to structure it in a manner that adheres to the CRA’s guidance on acceptable estate freezes, and does not trigger any of the so-called attribution rules in the Income Tax Act, and it is therefore important to execute a freeze only with the guidance of professionals who focus on trusts and have experience with estate freezes. The potential for inadvertent error is high, and the consequences of an error could be disastrous from a tax perspective (i.e., inadvertent attribution of all income and capital gains on trust property – being the common shares – back to the settlor/freezor, or the inadvertent application of the TOSI rules, or the inadvertent application of the corporate attribution rule). When executed correctly, the structure is safe and is not controversial from a CRA perspective; hence its popularity.

An estate freeze should be viewed as a flexible, customizable way of transferring ownership, control and economic benefits (as much or as little of each as is desired over time) in a family business to the next generation, in a tax efficient manner and with the added benefit of the continued flexibility offered by the use of a trust.

There are further permutations on the estate freeze that can benefit from the use of foreign trust and/or corporate structures established in low/no tax jurisdictions. For instance, foreign trusts can avoid being subject to the mandatory deemed disposition of all assets that applies to Canadian trusts every 21 years, and can therefore be made to last much longer than a Canadian trust, creating a much longer legacy. If the trust/corporation is established in a jurisdiction with which Canada has a tax treaty, there are potential additional benefits with respect to capital gains realized by the trust/corporation (e.g., Barbados and the United Arab Emirates). As always, planning with offshore trusts requires the assistance of professionals experienced in the area, as it is complex, but the advantages can be worth the additional planning in the right circumstances. It is worth noting that the media’s unfortunate portrayal of “offshore” structures as illegal or immoral is misleading. Such vehicles have always been, and they remain as of the date of the writing, entirely legitimate planning vehicles under Canadian law when used correctly.

The above presents a selective review of potential succession planning techniques relevant to a private or family business. Within each option, there is large scope for customization according to individual needs and goals and family composition. The terms of any shareholders’ agreement or trust instrument, or the rights attaching to any class of shares, can all be tailored to suit your specific circumstances. While there are tried and true structures that provide good basic starting points, succession planning for a business is not a cookie cutter process and always benefits from bespoke professional guidance.

If you have any questions or wish to discuss any issues around family business succession, please do not hesitate to contact us. ■

[1] If a business owner does wish to extract cash from the company, a tax liability will be incurred on the payment of such amount. It is often possible to extract such amount in the form of a capital gain.

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Tag: Canada