Advocis Banff School 2007 The New Dividend Tax Rules’ Impact on Corporate-Owned Life Insurance Strategies Florence Marino, B.A., LL.B., TEP AVP Tax & Estate Planning Group, Manulife Financial

We've provided written material with this oral presentation to make it easier for you to take notes. Do not rely on the written material on its own because it may be incomplete or inaccurate without the additional context and information provided by the oral presentation. Because of this, and also because the presentation is of a technical nature designed for insurance professionals, the written material should not be redistributed. We have provided client-friendly material about many of our products and concepts on our advisor website at This presentation is for educational purposes only. It should not be construed as legal, tax or accounting advice. This presentation doesn't bind Manulife to provide, or to continue to provide, any of the concepts or products described in the presentation. It also doesn't limit Manulife's ability to change any of the procedures that may be described in the presentation. If this presentation contains competitive information, we've made every effort to ensure its accuracy as of the date of the original oral presentation. We can't, however, guarantee the accuracy and, if you have any questions regarding this information, you should contact the competitor directly. Important Information

Agenda l New dividend tax rules - background l A word about Provincial variation l Corporate client profiles l Overview of general implications of new dividend rules l General impacts on Corporate Owned Life insurance planning l Understanding impact on Buy Sell and Business Succession - Case Studies l Conclusion – Lots of opportunity

New Dividend Rules: Background l The Old Days: Total tax on dividends paid out of high rate corporate income from Canadian companies = 56% (maximum) n Effective double tax to shareholders Maximum tax on income from income trusts =46% (for individual)

New Dividend Rules: Background l New dividend regime introduced to “level” playing field Applies to dividends paid after 2005 Canadian companies n Public n CCPC’s taxed at general federal tax rate  Not income taxed at small business rate  Not investment income that has generated RDTOH

Eligible dividends – CCPC’s l Distributions paid after 2005 From active income subject to high corporate tax rate (post 2000) or From “eligible dividends” received after 2005 Received by a person resident in Canada l General Rate Income Pool (GRIP) Tracks amount available to pay out eligible dividends Dividends can be paid 1 st from GRIP pool

New dividend rules – Public Companies l Most dividends received from public companies will be eligible dividends – i.e. portfolio dividends l Must track “LRIP” (Low Rate Income Pool) LRIP will include n Taxable income that has benefited from SBD (might have occurred while a CCPC) n Non-eligible dividends received Must pay non-eligible dividends (out of LRIP) first

A word about Provincial variation dividend tax rates Not with the program *14.55% by 2009 **22.37% by 2010

CCPC Client Profiles Opcos l Earning active business income in excess of small business threshold l In Ontario, probably non M&P above claw back range $1.1 million+ l Procorps in active phase

CCPC Client profile Holdcos l Funnelled eligible dividends from Opco l Opco sold off assets now Holdco l Procorp after professional dies l Investco receiving public company dividends

Overview of general implications l Sale of business Old norm: buyer wants assets; seller wants to sell shares Shift – seller more likely to sell assets – difference between post asset sale wind up dividend (if sufficient GRIP) and realizing capital gain not significant

Overview of general implications l Income splitting Stream eligible dividends to higher rate taxpayers l Alberta trusts continue to thrive l Holdcos Generally still a bad idea to “incorporate” investment portfolio Eligible dividends can be used to recover RDTOH

Overview of general implications l More likely for companies not to “bonus down” to small business thresholds Leaves more “trapped surplus” at the corporate level More deferred capital gains tax on CCPC shares? n Increased use of wasting freeze?

Overview of general implications l Eligible dividends generally cheaper than or close to capital gains tax rates Preference shift to dividend producing strategies vs. capital gains producing strategies n Post-mortem planning use of 164(6) loss carry- back to eliminate capital gain and be taxed on dividend (with or without insurance)

General impacts on corporate life insurance planning l Are RCA’s for owner mangers (and therefore insurance funding of them) dead? l Life insurance for increased corporate retentions Increased capital gains exposure Tax efficient investing l Generally, eligible dividends preferred to capital gains Changes to buy-sell and succession planning

Impact on buy-sell planning – Case study Facts: Stephen, 45 Jim, 50 50/50 shareholders of Opco ACB/PUC = 0; FMV $2 million Currently receiving 500,000 bonus/yr each Buy sell agreement on death requires “most tax effective” method of buy-out 1 million corporate-owned life insurance on each

Buy-sell planning Opco $2 million FMV StephenJim 50

When Stephen dies…. What is most tax effective?

Options under the old rules l Sale to Jim – promissory note method (All capital gain): Stephen pays 1,000,000 x 23% = 230,000 Stephen’s estate net cash of 770,000 Jim has 1,000,000 ACB – future capital gains tax liability of 1,000,000 x 23% - 230,00 No CDA remaining

Options under the old rules l Redemption 100% capital dividend (Half capital gain): Stephen pays 500,000 x 23% = 115,000 Stephen’s estate receives 885,000 Jim has 0 ACB and future capital gains tax liability of 2,000,000 x 23% No CDA remaining

Options under old rules l Redemption 50% capital dividend (Half taxable dividend) Stephen’s estate pays 500,000 x 31% = 155,000 Stephen’s estate receives 845,000 Jim has 0 ACB and future capital gains tax liability of 2,000,000 x 23% = 460, ,000 CDA credit remaining

Tax Recap Old rules

Tax Recap with eligible dividends

Tax recap including grandfathered shares or spousal rollover

No insurance redemption for full eligible dividend or capital gain vs. with insurance new normal

Buy-sell planning conclusions l Insurance funding always better than no funding l 50% solution even more efficient now l Implications for drafting buy-sell agreements: address GRIP/eligible dividends Flexibility Perspective l hybrid agreement?

Impact on succession planning – Case study Facts: Dad, age 65, owns $1 million pref shares in Opco with nominal ACB, PUC Active kids hold common shares (Dad has done a freeze) GRIP balance = $1 million Contemplating options for Dad with and without insurance

What if Dad dies tomorrow l Capital gain on Dad’s death Proceeds of disposition$1,000,000 - ACB 0 Capital gain to Dad$1,000,000 23%* $230,000 *BC 21.85%, Alta 19.5%, Sask 22%

What if Dad dies tomorrow l If pref are redeemed within first year of estate can get eligible dividend treatment: Deemed dividend1,000,000 Capital dividend 0 Taxable dividend (eligible)1,000,000 Dividend 22%* 220,000 *BC 18.47%, Alta 17.45% going to 14.55%, Sask 20.35% Capital gain on death 0 (Loss carry back wipes out gain)

Comparison of options l Redeem pref with corporate funds, no insurance l Redeem pref with corporate funds and insurance proceeds, purchase $181,000 corporate-owned insurance to fund dividend tax l Purchase $1million corporate-owned insurance to redeem pref and use 50% of the CDA (50% solution, full funding) l Purchase $500,000 of corporate-owned insurance, redeem pref at death with insurance and corporate funds and use all the CDA generated by insurance (50% solution)

Summary of options Undfunded redemptio n 1,000,00000 Insure for tax 181,000 50% Sol’n – full funding 01,000,000500,000 50% Sol’n – 50% funding 500,000 Strategy Corp Funds Insurance Capital Div

Dad’s total tax under various options *500,000 CDA remaining in corp for kids

Cost compare of options for funding redemption

Conclusion New rules create opportunity! l Most clients (and many professional advisors) aren’t aware of the implications of the new rules Revise existing buy-sell agreements? Consider options for business succession planning lDiscuss the planning opportunity Is there sufficient funding? New rules as a door opener Advanced planning needed!

Advocis Banff School 2007 The New Dividend Tax Rules’ Impact on Corporate-Owned Life Insurance Strategies Florence Marino, B.A., LL.B., TEP AVP Tax & Estate Planning Group, Manulife Financial