Purification - Your Start to Saving Taxes? If you operate your business through a corporation, you may have heard the term purification. You may even have wondered aloud: I thought that only mattered if I was going to sell my shares... Im never going to sell my business, so why should I worry about that?; or I can only sell the assets of the company, so I dont care about qualifying for the lifetime capital gains exemption (CGE), so who really cares if the company is pure? Purification Making sure the company is pure is one of the first steps that can potentially save you taxes. In an income tax context, purifying a company means taking the assets not used or needed in the active operations of your business out of the corporation. A pure company is one that: a) is using all or substantially all (somewhere around 90%) of the fair market value (FMV) of its assets in active operations at the time the shares are disposed of by way of sale, transfer or deemed disposition; and b) has used at least 50% of the FMV of its assets in the active operations of the business over the last 24 months. When you meet these criteria (and other more specific criteria which I have intentionally left out in order to make this example straightforward), you may be able to use your CGE to shelter all or a portion of the gain on the share disposition. With approximately $184,000 of tax savings per $800,000 of available CGE, the upfront planning done can result in significant tax savings. Inactive assets Depending on the nature of the corporations inactive assets, ongoing purification may be as simple as removing excess cash by paying down trade payables or debt, or by issuing cash dividends to shareholders. Other inactive assets can include some of the following items: marketable securities; rental property; and/or an investment made in the shares of your childs company for his or her venture of the moment. Commonly, these other inactive assets are removed from the operating company by a method known as a related person butterfly, which is a series of transactions undertaken to move assets, with accrued gains, from one company to another without triggering income tax. Although the process of purification is simple in concept, in practice there are a number of tax provisions (such as income tax, HST and PST) and facts particular to each situation that need to be dealt with (example: whether to pay a cash dividend to shareholders). If not, the purification may not be on a tax-deferred basis, and may result in double or triple tax. So you need to do it right. To that end, getting expert assistance is highly recommended. A little planning up front can save you a lot of money down the road. Common unexpected situations when you want a pure company 1. A big player in the industry wants to buy out your company and is willing to purchase your shares. 2. A competitor is willing to buy a portion of your customer list that you no longer wish to service. The competitor wants a cheaper price, while you want to take the money personally rather than extracting it out of the company later. You negotiate a hybrid transaction wherein you sell shares but the purchaser gets the client list they want. 3. You are getting divorced, and your spouse wants a large payout. Using corporate dollars or financing (and using the CGE to get the money out without paying personal tax on up to $800,000) could be cheaper than funding the payout personally. 4. Your business partner wants to retire and travel the world, and is willing to sell you her shares of the company. 5. Youve been in a tragic accident. Now your estate is dealing with the tax bill on the deemed disposition of your shares on death. If you encounter these situations without having a pure company, its likely too late to do any significant restructuring to fix the problem areas. So, plan ahead. Purifying a company may be a little more time-consuming and a lot more costly if the assets have accrued capital gains. (Because of the costs involved, it is often prudent to consider your retirement and succession-planning objectives at the same time.) Questions? Contact me! I do more then just real estate ;)
Posted on: Mon, 15 Dec 2014 05:24:03 +0000
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