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Written by the Mackenzie Tax and Estate Team
What can your client do if they want to retire from their business but no one in their family is interested in taking it over, and they cannot find a buyer? In that situation, your client may have to wind down their business to support their retirement expenses. Winding down the corporation typically involves selling business assets, paying off liabilities and personally extracting after-tax corporate funds. There are many ways for your client to wind down their corporation, and in this article, I explore some tax-efficient options for them to consider.
Sale of assets
When your client sells their business assets, they will typically realize a capital gain, if the assets have appreciated in value. Under the current tax rules, 66.67%ꝉ of these capital gains would be taxable in your client’s corporation, and the non-taxable portion would get added to the corporation’s notional Capital Dividend Account (“CDA”). The balance in the CDA can be used to pay tax-free capital dividends to shareholders of a private corporation. This could be one way for your client to receive tax-free capital dividends from their corporation to support their retirement. Any funds that cannot be paid as tax-free capital dividends may be paid using one or more of the options below.
Keep in mind, if your client sells any depreciable assets in their corporation, and the sale proceeds are greater than the undepreciated capital cost (“UCC”) of the asset, then previously deducted depreciation expense may be brought into the
corporation’s taxable income in the year the asset is sold. This is referred to as “recapture of capital cost allowance” and 100% of this amount would be included in the corporation’s taxable income.
Charitable donations
If your client has philanthropic goals, they may consider making in-kind donations using corporate assets for a two-fold benefit. The first benefit arises from the tax deduction available to your client’s corporation, based on the fair market value of the in-kind donation. This will help your client lower the corporate tax liability in the year the tax deduction is used.
The second benefit arises where eligible capital property — such as shares of public corporations or mutual funds — are donated. These donations would be eligible for a zero capital gains inclusion rate, so no taxable income arises from the donation. In addition, the non-taxable capital gain (that is, 100% of accrued capital gains, in the case of a donation) would be added to the corporation’s CDA. This would allow your client to receive additional corporate assets tax-free, as a
capital dividend.
Shareholder loans
Your client’s corporation can use after-tax corporate dollars to pay outstanding liabilities. This includes any existing shareholder loans owed by the corporation. If your client previously loaned money to their corporation as start-up capital, the corporation
can pay off the loan to your client using corporate funds on a tax-free basis.
Retiring allowances
Your client may qualify to receive a retiring allowance (also known as severance pay) from their own corporation when they
retire. These payments can help your client extract corporate funds and transfer them directly to their RRSP for continued tax deferred growth until withdrawal. The “eligible portion” of the retiring allowance can be transferred directly to your client’s RRSP under paragraph 60(j.1) of the Income Tax Act, for the years prior to 1996 that your client was considered an officer or employee of the corporation. The remaining “non-eligible portion” would require existing RRSP contribution room for tax deferral treatment.
These payments from the corporation are not subject to CPP or EI withholdings, however income tax withholdings would apply to the “non-eligible portion” of the retiring allowance that is not transferred directly to your client’s RRSP.
Taxable dividends
If your client has exhausted the options above, extracting funds from the corporation would typically be treated as taxable dividends on your client’s personal tax return. If the corporation has a balance in its Refundable Dividend Tax On Hand (“RDTOH”) account, issuing taxable dividends would also trigger a tax refund for the corporation, allowing it to recover
previously paid “refundable taxes” on investment income earned within the corporation.
Depending on your client’s personal tax bracket, they may benefit from receiving taxable dividends over several years, rather than winding down the corporation and extracting all after-tax corporate dollars in one year. Distributing the taxable income
over several years would allow your client to access a lower tax bracket and minimize total tax liability. If your client’s spouse or common-law partner is in a lower tax bracket, your client may be able to further reduce the total tax liability by splitting dividend income with them, over several years. They should work with a tax advisor to ensure any dividend payments to their spouse or common-law partner are not subject to the highest marginal tax rate under the expanded Tax on Split Income (“TOSI”) rules that came into effect on January 1, 2018.
These are some options that you can use to initiate a discussion with your client and help them prepare a detailed plan for their retirement, that minimizes taxes and allows your client to keep as much of their hard-earned corporate wealth as possible.
ꝉ The 2024 Federal Budget announced an increase in the capital gains inclusion rate, effective June 25, 2024, from one half to two thirds for corporations, and trusts, and from one half to two thirds on the portion of capital gains realized in the year that exceed $250,000 for individuals, graduated rate estates (GREs) and qualified disability trusts (QDTs). A Notice of Ways and Means Motion (NWMM) to introduce this change was tabled on June 10, 2024. Additional technical amendments are expected to be released in July 2024.
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