April 2006

Planning For The Future
what are your goals for business succession?

Succession planning and estate planning share some of the same fundamental goals: wealth preservation, wealth creation, intergenerational transfer of wealth, and the transfer of ownership or the eventual sale of your business. Estate planning should be considered within the framework of succession planning. Both need to encompass the needs of your business and your family. As a business owner, you need to ask yourself the following:

• What are your intentions and objectives for the future?
• Do you have children who are active in the business? Are they capable of running it in the future?
• Do you have children that are not active in the business who need to be provided for?
• What is the composition of your family wealth? Is it all within the business, or do you have investments outside?
• Is the value of the business the most signifi cant portion of you family's worth?

ESTATE FREEZE

An estate freeze is a method of planning that allows for the transfer of future growth to the next generation. It is a key planning technique for family owned businesses, which essentially freezes the owner's tax liability at today's values. This is typically done by having the owner exchange his/her common shares for special shares that have a fi xed value. The children end up owning common shares of the corporation that initially have a nominal value. The current fair market value of the company is frozen in the preferred shares. Any future income or growth generated from the new common shares accrues to the benefi t of the children.

Determining when to implement an estate freeze can be a diffi cult decision. It is as much a psychological decision as it is a fi nancial decision. From a tax perspective, the earlier the freeze is implemented the better, as it provides a greater tax deferral. On the other hand, by waiting until a later date, you are more certain as to who your beneficiaries will be and whom you want to run the company in the future. Before implementing the freeze, it is important to keep in mind that once the assets are frozen, it is diffi cult to unfreeze them. Also, by freezing the assets, you will have a limited share in the future growth of the company. As someone who has built up the company, you may not be ready to pass on control just yet. Accordingly, prudent planning should ensure that control is maintained.

From a financial perspective, it is important to ensure that you are able to sustain your current lifestyle from the frozen assets, especially after considering the effect of infl ation. You should also give consideration for what happens when the company unexpectedly takes off and becomes far more profi table after the owner has frozen his/her assets.

DISCRETIONARY FAMILY TRUST

Adding flexibility in the planning through the use of a discretionary family trust can circumvent some of the issues addressed above. Instead of having the children hold the common shares directly, you can set up a discretionary family trust to subscribe for the common shares and designate the children as beneficiaries. As the trustee or as owner of the voting shares, you retain control of the company. Being a fully discretionary trust allows the flexibility to allocate income and/or capital to the beneficiaries as you see fit, which allows you to account for the competing and changing needs of the beneficiaries.

The use of a discretionary trust also allows for some income splitting among family members. Take a typical scenario of an adult child who is currently attending university and does not have an income. The flexibility of the trust allows you to allocate dividends of up to approximately $32,000 to this child without him/her incurring income tax. Income can be left in the trust rather than distributed, but it will be taxed at the highest marginal tax rate.

Another advantage of holding the shares through a trust is that the shares held by the trust are not subject to the claims of the beneficiary's creditors. As the trustee has full discretion to allocate income and capital, it is diffi cult to determine a value for a beneficiary's interest in the trust. This may also provide a level of protection for children in the event they go through a marital breakdown. This is an area that we recommend seeking legal advice for.

Some additional points to note: Assets held within the trust would not be affected by probate fees. A discretionary trust also allows each beneficiary to utilize their $500,000 capital gains exemption in the event that the company is sold. For practical purposes, you will have to distribute the assets in the trust to the beneficiaries within 21 years.

TESTAMENTARY TRUST

A testamentary trust is a trust that is setup by the will of a deceased individual and can also be fully discretionary. The main advantage of a testamentary trust is that, unlike an intervivos trust, which is taxed at the highest marginal rates, a testamentary trust benefits from it?s own graduated tax rates. The use of a testamentary trust can result in annual tax savings of as much as $16,000. If there is more than one beneficiary, a separate trust can be setup for each beneficiary to take advantage of multiple sets of graduated rates.

A spousal testamentary trust is a trust that is setup to ensure that an owner?s spouse is entitled to receive all of the income of the trust while he/she is alive. The benefit of such a trust is that tax is deferred on the transfer of assets to the trust. Upon the spouse?s death, there is a deemed disposition of the assets and the remaining capital can be distributed to the beneficiaries.

Although we want to ensure that our family members are treated equitably upon our death, it can be difficult to determine how to do so when implementing an estate plan. How do you reward a child who has been active in your business, yet also provide for a child who is not active in the business? By ensuring there is flexibility in the planning, you will ensure that your plan will adapt to your families changing needs.

Rob Steven MAcc, CA, CPA (Delaware),
Rob Steven MAcc, CA, CPA (Delaware), is a tax associate with the firm of Crawford, Smith & Swallow, Chartered Accountants LLP, specializing in the field of taxation, and provides services for personal and corporate clients in Canada and the U.S. from for all offices in the Niagara Region.

Readers are urged to consult their professional advisors prior to acting on the basis of material in this newsletter. If you have any questions regarding the content of this newsletter, please contact Crawford, Smith & Swallow. Copies of the newsletter in PDF format are available on our website.