COVER

CONFRONTING THE TAX MAN

FAMILY FORTUNES ARE AT RISK

TOM FENNELL November 5 1990
COVER

CONFRONTING THE TAX MAN

FAMILY FORTUNES ARE AT RISK

TOM FENNELL November 5 1990

CONFRONTING THE TAX MAN

FAMILY FORTUNES ARE AT RISK

COVER

It is an enormous problem for some wealthy Canadians—and one that attracts little sympathy from the public at large. Across Canada, financial planners, tax lawyers and business people are racing to shelter family and corporate fortunes, held in trust, from a looming tax deadline. In 1972, when the federal government replaced inheritance taxes with a capital gains tax, it built in an escape hatch that allowed individuals and companies a 21-year tax deferment for gains on assets placed in trust by that year. The tax holiday expires on Jan. 1,1993. Then, if estate planners did not make other arrangements, the total tax bill due could reach billions of dollars. For family fortunes and businesses held in trust that are unable to take advantage of other shelters, the results could be devastating. According to David Gallagher, managing director of the Ontario branch of the Canadian Association of Family Enterprise, a Toronto-based business lobby group, the end of 1992 will bring “the big bang for Canadian business.”

Rush: The situation arose as a result of a clause in the Income Tax Act, known as the 21-Year Deemed Disposition Rule. It essentially treats trusts in the same way as individuals, whose estates have to pay capital gains on assets at the time of death. Under the rule, trusts, in a sense, die every 21 years—and have to pay capital gains taxes at that time. The rush to avoid the looming deadline has created a boom in the financial planning industry, as tax experts engineer the movement of assets out of the trusts ahead of the deadline. The job of those professionals is to shepherd as much of the assets as they can out of the reach of the tax man—and preserve it for a younger generation of inheritors. And the stakes are enormously high. Gallagher estimates that a third of the value of some companies will have to be paid in taxes if the regulations cannot be avoided. Said Gallagher: “They may even have to sell the company to pay for the taxes.”

At the same time, wealthy Canadians face another threat—the possible return of inheritance taxes. Since the capital gains tax went

into force in 1972, all provinces have phased out their own estate taxes because they decided that having both was unfair. Quebec was the last, dropping its succession duty in 1980. But while hundreds of lawyers and accountants are busy trying to move family businesses and inheritances in trust out of Revenue Canada’s grasp, Ontario’s New Democratic Party gov-

ernment is proposing to bring back inheritance taxes on the basis that the capital gains tax has too many loopholes. Premier Bob Rae says that an inheritance tax affecting large estates would raise $190 million annually for the province. Added the premier: “Because of [capital gains] exemptions there is a lot of money that is not being counted as income.”

Federal NDP tax critic William Blaikie said that inheritance taxes are fair because they act against the further concentration of wealth. He

rejected arguments that an inheritance tax in Ontario alone would cause the companies and estates located there to leave. Said the Winnipeg MP: “Where are they going to move to— Saskatchewan?” For its part, the United States, where taxes are generally lower than those in Canada, imposes a tax rate of 37 per cent on estates worth more than $600,000 and 55 per cent on estates worth more than $3 million.

The new Ontario government has not yet drawn up a proposal for an inheritance tax. But government spokesmen say that one is necessary because there are several ways for estates and companies to shelter assets as they move out of trusts. Wolfe Goodman, one of Canada’s top estate planning lawyers, said that while some trusts are unable to do so, the simplest way for others to sidestep the tax is to collapse the trust before the 1993 deadline, and distribute the assets, which in many cases consist of shares of family companies, to the beneficiaries. By doing so, the trust avoids the tax and the assets stay in the family. At the same time, such a process allows parents to stay in control of a family business by retaining voting shares in the company, while children receive dividends on their common shares. As well, analysts say that in very rare cases extremely rich Canadians can avoid taxes by creating trusts in foreign tax havens, as long as the income generated in the trusts is not returned to Canada.

Collapse: Some efforts to move holdings out of trusts before the deadline are hampered by arrangements made in 1972. In some cases, the terms of the trust specified that money and assets could not be distributed to children until they reached a certain age, which may happen after Jan. 1, 1993. As a result, some families have gone to court to try to convince the Offical Guardian of the Province, who has legal responsibility to protect minors and future beneficiaries, that an earlier collapse of the trust would not be detrimental.

Meanwhile, Gallagher’s organiza5 tion is lobbying the federal govem| ment to reduce the capital gains tax. It g argues that the capital gains tax is g particularly unfair when it is applied to g the value of businesses, because much " of the apparent growth is due simply to inflation. A firm that was valued at $1 million when it went into a trust in 1972 could be worth 10 times as much now, leaving it vulnerable to a devastating tax bill of more than $3 million in 1993. As the deadline to protect billions of dollars in assets from the tax collector looms, the children of Canada’s wealthier citizens face the prospect of sharing their legacies with both the federal and Ontario governments.

TOM FENNELL with ANN WALMSLEY in Toronto

ANN WALMSLEY