Tax Considerations for Difficult and Uncertain Times

March 16, 2020

The world is in unprecedented territory with the COVID-19 virus spreading around the globe. Undoubtedly, your primary focus is the safety of your family and community. There are proactive steps to take to manage your financial well-being, which includes managing the tax you pay now or in the future.

Managing the downturn in the financial markets

You may have seen the value of your investment portfolio fall dramatically over the past few weeks due to the uncertainty in the business community and financial markets. Whether to sell or hold certain of your equity positions should be discussed with your financial advisor. If you do decide to sell and realize a loss on your investment, you should consider the tax consequences of realizing this loss. Review the following factors:

  • How can I apply my capital losses?

    Capital losses must first be applied against any capital gains in the current year. They can then be carried forward to future years, or they can be carried back and applied against any capital gains you realized in the three previous taxation years. Therefore, if you realize capital losses in 2020, you can carry back these losses against any capital gains on which you paid tax in 2017, 2018, or 2019 or carried forward to future years.

  • Are there any rules restricting the deductibility of capital losses?

    The superficial loss rules prevent you from triggering a capital loss on an investment for tax purposes and then repurchasing that investment within 30 days, either by yourself or by an affiliated person (such as your spouse, or a corporation you control). Any losses you incur that are not deductible under these rules are added to the tax cost of the new investment you make.

  • I have borrowed money to make my investments. Can I continue to deduct the interest on my loan once I sell my investment?

    When you have borrowed to purchase an investment, you can continue to deduct the interest paid on the loan even if that investment is sold for a loss. To maintain full interest deductibility, you must reinvest the proceeds you receive in a new investment if the proceeds are not used to repay your investment loan.

  • My investments are owned in a corporation. Does this give rise to any special considerations?

    You should speak to your BDO Tax advisor before triggering any capital losses in a corporation to determine if your company has a Capital Dividend Account (CDA). A CDA is a complex calculation based on the history of the corporation and its activities. The CDA can be paid out to you as a tax-free dividend if the proper tax elections are filed. There may be a reduction of the CDA balance for your company based on realized capital losses and therefore it usually is prudent to pay out any CDA as a capital dividend before triggering any capital losses.

    If your corporation has capital losses that it cannot use, it may also be possible to transfer an asset to your company that has an accrued capital gain. This would allow for the use of those losses against this gain. Alternatively, you could merge your corporation with another company that has capital gains that it will realize. Please talk to your BDO Tax advisor about these possible opportunities.

Tax planning when the business value has declined

Tax planning involves managing the taxes that you, your family, and your business pay throughout your lifetimes and the life of your business. One key planning technique that private businesses and their owners usually undertake at some point in the business life cycle is an estate freeze. If you find that the value of your business has declined because of the current economic turmoil, it might be an ideal time to consider this planning idea. If you have already done an estate freeze in the past when your business had a higher value, it is an ideal time to revisit this plan to see if it needs to change.

An estate freeze is a process where you take steps to ensure that the future growth of your estate accumulates in the hands of your intended beneficiaries in a tax effective manner. By freezing the value of your estate, you will effectively lock-in the tax that will arise on your death (subject to changes in future tax rates). An effective estate freeze will allow you to pre-determine the taxes that will arise on your death so that you can ensure that cash will be available to pay that tax (for example, by taking out sufficient life insurance). An estate freeze completed when the value of the business is depressed will minimize the tax that will arise on the death of the business owner, with future increases in value accumulating in the hands of your beneficiaries.

A holding company freeze can also provide additional benefits that are well suited for a depressed economic environment. If your business corporation has funds that are not currently needed in the business, these funds can be paid by the business corporation to a holding company on a tax-free basis. This will help ensure the funds will be isolated from future business risks that may arise in the business corporation without a tax cost. It may even be possible to take this planning one step further by borrowing to pay a larger dividend to the holding company and loaning the funds back to the business corporation on a secured basis to pay off this loan.

If you have already undertaken an estate freeze, but the value of your business has declined in the current environment, it is worth considering whether the freeze could be “undone” and you should “re-freeze” your business at the current value of your business. This could make sense if the value of your business is less than its value at the time the original freeze was undertaken, and therefore the fixed value shares you took back on the original freeze is more than the value of the business. A re-freeze would allow you to reset the freeze at the value of your business today and further reduce the amount of taxes your estate would have to pay on your death.

You may also decide that you want to undo an estate freeze done in the past due to the decline in value. Known as an estate “thaw,” this would be possible if you and/or your spouse are beneficiaries of the family trust that own the common shares of your business. Implementing a thaw would mean that you would transfer the common shares out of the trust to you and/or your spouse. Whether this makes sense depends on your own situation, and the interests of the other intended beneficiaries.

Summary

There are many things to think about. The uncertainty in the world today is likely creating challenging times for you, your family, and your business. You can still effectively manage your taxes by being proactive. Your BDO Tax advisor is ready to help.


The information in this publication is current as of March 16, 2020.

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.

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