Tis the Season to Capital Gains Strip
Posted on December 16, 2021
This Article Covers a Tax Strategy to Consider for 2022. Tis the Season to ‘Capital Gains Strip’
With the holiday season looming, many of us are looking forward to that lovely festive dinner. Each year, my mother-in-law spends five to six hours prepping and cooking the turkey. With attention to details spent like that, I can assure you the final result is well worth it.
This, however, is not the attention most of us spend when it comes to proper tax planning. We draw from our companies whenever we are hungry, not realizing that there is a much more tax effective way of doing so. Let me share with you a tax strategy that can help you maximize your ‘holiday meal’.
The Capital Gains Strip is a tax strategy for those who have built up cash in their company or want to extract some of its value. Typically, the only way to withdraw funds from a company is by paying yourself a dividend or a salary. However, with a marginal tax rate at 53%, any excessive withdraws is surely to make CRA very happy. Many owners find their hard-earned equity essentially ‘locked in’, unless they either sell their company, or payout a large dividend and incur the accompanying tax bill.
The Capital Gain Strip, however, allows you to covert taxable dividends to taxable capital gains. It is accomplished by ‘smart’ structuring and uses ‘tools’ such as tax deferred rollovers that are available in the Income Tax Act.
By doing so, capital gains are taxed only at ½ the tax rate. It is a powerful method for accessing company funds, without the heavy tax burden. Especially during Covid-19 uncertainties, such withdrawals can help to fund living expenses, repay large debts, make personal investments.
New concepts are always best explained with an example – Here is a case study of one of our clients who implemented this strategy:
- Company ABC had excess cash in the company, and the owner wished to withdraw $400,000 for immediate needs
- If he simply withdrew it as a dividend, the personal tax on such a withdraw is $152,668 (despite this being his only source of income)
- Instead, Company ABC implemented the capital gains strip:
- A reorganization of share structure was undertaken by his lawyers (and overseen by us as his tax advisors) to set up a proper series of share transfers
- A second holding company was set up and utilized to be able to transfer value into a separate vehicle
- Elections were taken under the income tax act to sell specific shares at $400,100, resulting in $400,000 of capital gains to the owner
- In total, there were about 7 steps that were planned and overseen by us
- The result was $400,000 tapped into in the most tax effective manner, with total tax savings of $81,944.
Not all Capital Gains Strip structuring strategies are created equal, therefore it is important to work with an accountant who is knowledgeable and experienced in this area.
Pursuing such strategies also requires a tolerance for out-of-the box income tax solutions. This strategy has been tested under audit at the highest CRA level (GAAR and Audit HQ) and been accepted for a $900,000 corporate distribution.
There is implementation cost involved with working with tax specialists and lawyers. However, the opportunity cost of not pursuing this strategy far outweighs any implementation costs.
Even if you may not need the money right away, this strategy could still be worthwhile pursuing now in case of future changes in tax law.
In summary, the capital gain strip is a tax strategy that reduces tax rate for high income earners. It is the opportunity for any incorporated owner-manager who requires $300,000 or more.
Happy holidays, and we hope you enjoyed this ‘food’ for thought.