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If you are in business and have your own corporation, you probably know about corporate structures. After all, you chose a corporate structure when you set up your corporation. So once you have your business in a corporation, why would you need to undertake reorganization? There are some very good reasons.
When a corporation is initially set up, it will often have only one shareholder, usually the primary operator of the business. If the operator’s spouse is included as a shareholder for income splitting purposes, the share ownership may not have been set up on a 50/50 basis. As the business becomes successful, the advantage of splitting income with a spouse becomes more attractive.
Income splitting can be done by paying a salary, but there are restrictions. For example, a salary has to be for services rendered, and has to be reasonable under the circumstances. Simply issuing new or additional shares to a spouse is also a problem. A successful business will have grown in value, and issuing shares for nominal consideration should not be done without a corporate reorganization that meets certain tax rules.
Income splitting can also be done with children. A corporate reorganization can be undertaken, often involving the use of a discretionary family trust that allows dividends to be paid to children via the family trust, for a more tax-effective method of splitting income.
Another reason for a corporate reorganization is to allow the corporation to qualify for the capital gains exemption, particularly if a future sale is being considered. Current tax rules provide for a capital gains exemption to an individual, of up to $750,000 on the sale of certain qualified assets, including the sale of shares of a qualified small business corporation.
However, a corporation may have built up passive assets, such as investments, that would cause the shares to not qualify for the exemption. Sometimes the corporation will own its business premises, which may not necessarily be part of an eventual sale. Those are assets that need to be removed without incurring tax.
That is not as simple as it sounds. The rules for what qualifies for a tax-free reorganization are complex, and it can take years to ensure that the particular assets are removed without tax, and to arrange the ownership within the family to allow for other family members, such as a spouse and children, to be able to use the exemption on an eventual sale.
When the principals are ready to retire and want to pass on the business, who will step in and take over? Will the business be retained in the family and passed on to the next generation? Will it be sold to employees or to an outside party? Or will it simply be closed down?
These factors have to be considered and, depending on what is going to happen to the business, a corporate reorganization may often be necessary. For example, if the business is to stay in the family, the appropriate transition of ownership is one key consideration. If the business is to be sold, keeping taxes to a minimum will often require tax planning and reorganization.
Corporate tax reorganizations are not something to be done on the back of a paper napkin. Proper planning is essential and should not be left to the last minute. There are ways to undertake a reorganization, but there are also traps in taxation that need to be carefully navigated. That can be done, but often has to be done well in advance. As each business and family is different, seeking the advice of a tax specialist will ensure your planning is tailored to your unique needs.
Alladin Versi, CPA, FCMA, CFP, is a Taxation Specialist with MNP LLP. For more information, contact Alladin at 250.753.8251 or firstname.lastname@example.org
Please consult your local MNP tax advisor for advice about how the above information should be applied.
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