Unique Philanthropic Opportunities for Your Business

The year a business owner sells their business is most likely the year that they will pay the most income taxes compared to any other year.  Many people start a business with a zero-cost base and if they sell it for $ 5 million – after the Small Business Capital Gains Deduction – you are still looking at taxes on the Capital Gains of approximately $1,000,000. Rather than simply pay this amount of tax, there are strategies that can be deployed that can eliminate or drastically reduce the tax bill of $1,000,000 by using the generous tax rules we have in Canada relating to philanthropy and life insurance.

Consider this strategy. Donate $2 million to your favourite local charity, which will result in a charitable tax receipt of $2 million.  This will offset the income tax due of $1 million.  The net amount left of the $5 million sale price of the business is $3 million versus $4 million if you simply paid the tax.  Now stay with me, there is more to come with this strategy.

To restore the donated funds to the family, a $2 million joint life and last to die life insurance policy is put into place using what is called an IFA strategy (Immediate Financing Arrangement). Using this strategy, a financial institution would finance the premiums of the life insurance policy so the client’s money could continue to be used for investment purposes. The client pays the interest only on the loan, which is fully tax deductible. When both parents die, the family will receive the $2 million (or more) death benefit tax-free and the IFA borrowings will be repaid.

Wealthy Business Owners often have large sums in registered accounts, money they don’t need to pay bills. RRSP and RRIF funds are taxed at over 50% in Ontario.  A $2 million RRSP/RRIF is worth only $960,000 to heirs. Consider donating all or part of your RRSP/RRIF to your favourite charity and nothing to the tax department (CRA)

Here is how it could work. Withdrawals (or disposition at death) are taxed at 53.53%. Donations to charities generate 50% tax savings. Net out-of-pocket cost to donate a $2 million RRSP is 3.5%.

Normally, withdrawals of registered fund are subject to withholding tax of 30%. However, it can be arranged with CRA to waive the withholding taxes at source. The financial institution transferred the entire $2 million to charity. The charity now has $2 million.

A joint life and last to die 10-Pay Life Insurance Policy is set up to be owned by the charity. A premium of $100,000 per year for 10 years would be paid by the charity from the $2 million donation from the RRSP/RRIF. The death benefit at life expectancy of age 85 is $3.5 million.

The business owner in this example converted $2 million of taxable RRSP funds (worth only $940,000 to his or her family), creating a family legacy of $4.5 million ($1 million from the RRSP and $3.5 million from the life insurance).