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INVESTMENT, AND LIFESTYLE PERSPECTIVES FROM RBC WEALTH SERVICES Investment holding Tax implications of investing through a

Earning investment income through a corporation can be complex as you have to consider the payable in the corporation as well as the taxes payable on withdrawing the funds from the corporation. This article outlines the major advantages and disadvantages of using an investment holding for investments, and identifies situations where the use of an investment may be beneficial. This article outlines several strategies, not all of which will apply to your particular financial circumstances. The information in this article is not intended to provide legal or tax advice. To ensure that your own circumstances have been properly considered and that action is taken based on the latest information available, you should obtain professional advice from a qualified Please contact us tax advisor before acting on any of the information in this article. for more information about the topics Investing through a holding corporation, the total corporate and personal tax payable should be discussed in this company An investment holding company is approximately the same amount as article. not a defined term in the Income what the would have Tax Act. It is a term used to describe paid if the investment income was a corporation that holds passive earned directly by the shareholder. assets, such as shares of another Accordingly, there should be no company. Typically, you would not material tax deferral opportunity be running an active inside and/or taxes payable on passive a holding company. income earned in a corporation. This is the concept of integration, The Canadian tax system is designed which of course does not always to be neutral between investment work perfectly. In fact, in almost all income earned personally and provinces, the integrated tax rate for investment income earned through investment income earned through a corporation. What this means a corporation is slightly higher than is that after the corporation pays the personal tax rate for investment tax on its investment income and income. So why would anyone the shareholder pays personal tax consider having a holding company? on received from the 2 | RBC Wealth Management

Advantages of using an property to an investment holding investment holding company company and one of the main The following are some of the major purposes of the transfer or loan is to advantages of having an investment benefit a spouse or a related minor holding company. child (which includes a grandchild, niece or nephew) who owns 10% or Estate freezes more of any class of shares in the An investment holding company investment holding company. If One of the purposes of can be used to implement an corporate attribution applies, then an estate freeze is to estate freeze. One of the purposes the individual who transferred or “freeze” a company’s of an estate freeze is to “freeze” a lent the property to the corporation share value for the company’s share value for the original is deemed to have received interest original shareholders and pass on the future income in the year equal to the CRA and pass on the growth of the corporation to the prescribed rate of interest for the period on the outstanding amount of future growth of the next generation or to other desired the transferred property or loan. This corporation to the next individuals. This way, the capital gains triggered on the deemed disposition annual deemed interest benefit is generation or to other reduced by the following: desired individuals. of the shares upon death and probate taxes for the original owner of the ●● Any actual interest received in the company may be minimized. Where year by the individual in respect of an estate freeze is done to benefit a the transfer or loan; spouse and/or minor children, the

corporate attribution and “kiddie” ●● Grossed-up taxable dividends tax rules discussed in the next section received by the individual in should be considered. the year on shares that were received from the corporation as Another use of an estate freeze consideration for the transfer; and is to crystallize the capital gains

exemption on the transfer of ●● Income subject to kiddie tax qualifying small business corporation (discussed below) reported by the shares. You may want to do so if related minor child. currently, your shares qualify for the capital gains exemption and you Another rule that restricts the ability expect that they will not qualify for to split income with minor children is the exemption in the future. It should known as the split income rule (also be noted that holding companies that known as kiddie tax). Under this rule, are used only to hold an investment a minor child who receives certain portfolio do not qualify for the capital payments from a Canadian gains exemption. corporation whose stock is not listed on a designated stock exchange (e.g. As estate freezes are quite complex a ) is taxed on transactions, they should only be the grossed-up value of the dividend undertaken with the assistance of a received at the highest personal qualified tax advisor. marginal tax rate. The parent is also jointly and severally liable with the Income splitting child for the taxes payable on the Certain income tax rules are designed split income. to discourage income splitting with spouses and related minor children Both the corporate attribution through the use of an investment and split income rules do not holding company. One such rule apply where the shareholders of is corporate attribution. Corporate the holding company are adult attribution generally applies when children. Therefore, it is possible an individual transfers or lends to split income with adult children RBC Wealth Management | 3

through the use of an investment a holding company. This may protect holding company without triggering those earnings from creditors of your the above mentioned adverse tax operating company. If the operating consequences. You may incorporate company needs , a holding company and the adult your holding company can lend children can subscribe for the shares that money back to your operating of the company. It may also be company on a secured basis to possible to transfer certain assets maintain the potential protection to the holding company on a tax- from creditors. It is essential that you deferred basis to benefit your adult speak with a qualified legal advisor children. Income earned in the regarding any asset protection corporation can be paid as dividends options available to you. You may to the adult children and taxed in also wish to speak to a qualified tax their hands. advisor about the tax implications of Holding U.S. investments moving the funds from your holding There are also more sophisticated company to your operating company. in a Canadian corporation ways of structuring a holding may minimize or eliminate company that avoid the application U.S. estate taxes the Canadian shareholder’s of the corporate attribution rules with Holding U.S. investments in exposure to U.S. estate tax. respect to a spouse or minor children. a Canadian corporation may However, these structures are beyond minimize or eliminate the Canadian the scope of this article. In any shareholder’s exposure to U.S. estate case, as this area of taxation is quite tax. For more information on this topic, complex, it is strongly recommended speak with your qualified tax advisor. that you discuss these issues with a qualified tax advisor prior to Probate taxes implementing any strategies. In certain provinces, you may be able to reduce your exposure to Inter-corporate tax-free dividends probate taxes on death by using A common corporate structure a multiple Wills strategy. You may involves a holding company owning have a “Primary” Will dealing with shares of an operating company. assets that require probate to Incorporating a holding company transfer ownership, such as a bank into an existing corporate structure account or investment portfolio. A may be advantageous if you want “Secondary” Will may be used to to assets or funds out of the transfer assets that do not require operating company but do not probate such as artwork or private necessarily want to pay personal tax company shares. Under provincial on the assets or funds. corporate statutes, it may be possible to transfer share ownership on death In certain circumstances, it may without probate. Using an investment be possible to move these assets or holding company in conjunction funds from the operating company with a secondary Will may therefore to the holding company as an inter- minimize probate taxes on death. corporate tax free dividend. Speak to Note that the probate taxes may your qualified tax advisor for more not be significant enough to justify information about the tax implications establishing an investment holding of moving assets between an operating company. The avoidance of probate and holding company. taxes should be viewed as a secondary Creditor protection benefit of using an investment holding company. If you have excess earnings in your operating company each year, you There may also be circumstances may want to move the excess funds to where the secondary Will needs to be 4 | RBC Wealth Management

probated. For example, if your Will Disadvantages of using an contemplates that the shares or the investment holding company assets of the company be transferred While there are a number of to a set up in your Will, probate advantages to having an investment may be required by a financial holding company, there are also institution to open the investment disadvantages. You should consider account for the trust. Furthermore, the following disadvantages if you are some financial institutions may If investments in a loss planning to set up or currently have a require that the secondary Will be holding company. position are sold by a probated as a matter of policy. shareholder to their Capital losses and the superficial/ holding company that More information on probate taxes is stop-loss rules available from your qualified tax/legal is controlled by them or If investments in a loss position are advisor. their spouse, and the sold by a shareholder to their holding holding company holds Control of amount and timing of company that is controlled by them these investments for income or their spouse, and the holding company holds these investments at least 30 days, any Some federal non-refundable tax for at least 30 days, any capital losses capital losses arising credits and benefits, such as the age arising from the transaction cannot from the transaction amount (a non-refundable tax credit) be claimed by the shareholder on cannot be claimed by and Old Age Security (OAS) benefits their personal income tax return. the shareholder on are reduced or eliminated when your The shareholder’s capital loss will their personal income net income exceeds certain thresholds. be denied, and the cost base of the If investment income is earned and tax return. transferred property, now owned retained in an investment holding by the holding company, will be company, you may be able to manage increased by the amount of the your personal income to keep it denied capital loss. This means that below those thresholds. Keep in mind the cost base of the shareholder’s however that keeping investment investment rolls over to become the income in an investment holding cost base of the investment now held company may effectively result in a within the holding company. When prepayment of taxes. The prepayment the holding company subsequently of taxes works as a deterrent to those sells the investment to a third party, who attempt to defer income tax if the investment is still in a loss on investment income by using a position, the capital loss may then be corporation. A portion of the prepaid recognized by the holding company. taxes is refundable only upon payment of taxable dividends to the On the other hand, if a holding shareholder. To reduce the amount company disposes of a security at of prepaid taxes, you may consider a loss, and that same security is investing in tax-efficient investments acquired by a controlling shareholder (e.g. securities that offer deferred or anyone affiliated with them (i.e. capital growth). your spouse, a company controlled by you and/or your spouse, or a trust Also, as previously discussed, the in which you and/or your spouse combined corporate and shareholder are a majority interest beneficiary) taxes paid on investment income at any time within 30 days before or earned through an investment after the disposition by the holding holding company may be slightly company, then the holding company greater than personal income taxes will be unable to recognize the loss paid on such income. until the controlling shareholder or the affiliated person disposes of the security to a third party. The ability to RBC Wealth Management | 5

claim the loss at a point in the future the corporation but also its liabilities. stays with the investment holding Therefore, it may be necessary to company. The loss cannot be claimed reorganize the holding company and by the controlling shareholder or the the target operating company in order affiliated person in this situation. to access the capital gains exemption. The reorganization process is beyond Losses trapped the scope of this article and you may Losses that arise in a corporation want to discuss this matter with your can only offset earnings in that qualified tax advisor. corporation. Losses incurred in a Losses that arise in a corporation cannot be transferred to and compliance costs corporation can only its shareholders. Alternatively, if you Incorporation and other legal fees offset earnings in that own investments personally, you can may be incurred when establishing corporation. utilize the losses, depending on their an investment holding company. In nature to reduce your taxable income addition, there are on-going costs in the current year or carry them to and administrative requirements the future years. associated with corporate ownership. For example, you will need to ensure Capital gains exemption company minutes are kept up to You may qualify for the capital gains date. Shareholder agreements may exemption if you dispose of shares be required and annual financial of a small business corporation if statements and tax returns must be certain conditions are met. One of the prepared and filed on a timely basis. conditions is that the small business corporation is a Canadian-controlled Estate Planning private corporation. It must use When engaging in any estate all or substantially all of the fair planning, you should consider how market value of its assets in an active your interest in your investment business carried on primarily in holding company and the company’s Canada. Since an investment holding assets will be dealt with on your company derives most of its income death. You should also consider what from passive investments, it generally steps your executor may need to take does not qualify as a small business to transfer your shares o r corporate corporation and the capital gains assets to your beneficiaries. exemption is not available when its shares are sold. do not cease to exist on the death of a shareholder. A There are circumstances where corporation is its own legal entity, you may qualify for the capital separate from its owners. On your gains exemption when you sell an death, your investment holding investment holding company such company will remain in existence and as where all or substantially all of may continue to operate as a holding the investment holding company’s company. If you are the sole officer and holdings are in an underlying director of your company, you may Canadian small business corporation. want to consider appointing additional If this is the case, the sale of officers and directors prior to your investment holding company shares death. These individuals can continue may qualify for the capital gains to provide direction with respect to exemption if it satisfies the other your corporate assets after your death. conditions. However, a purchaser may Otherwise, your executor may need not be interested in purchasing the to take certain steps and incur fees in shares of a holding company because order to deal with your investment they will acquire not only the assets of holding company after death. 6 | RBC Wealth Management

On your death, the shares of your this double taxation. For example, investment holding company will in general, when a corporation is form part of your estate and be wound up by the shareholder’s estate, distributed in accordance with it will result in a deemed dividend your Will, or if you have no Will, and capital loss to the estate. If the the governing provincial/territorial corporation is wound up in the intestacy laws. When drafting your first taxation year of the estate, the Will, you should consider whether estate may be able to carry back the you want the shares to pass outright capital loss realized to the deceased to your named beneficiaries or shareholder’s final taxation year and the company to be wound up. You offset the capital gain realized on the may also want to consider the tax shares. The double tax issue may be implications of these different options eliminated with the loss carry back Individuals owning shares in (discussed in more detail below) because the net result is that the holding companies at death to your estate and beneficiaries. To estate only pays dividends tax. For may be subject to double ensure you have properly addressed more information on strategies that all estate planning issues with respect may mitigate this double tax exposure, taxation. to your investment holding company, talk to your qualified tax advisor. speak with your qualified legal and tax advisor. Transactions between you and your holding company Taxes at death Certain tax rules govern transactions Individuals owning shares in holding between a shareholder and their companies at death may be subject to company. These rules are designed double taxation. First, the deceased to prevent the tax-free distribution is taxed on the gain arising from the of the accumulated surplus of the deemed disposition of the shares of company to the shareholder while the the holding company at death. The company continues to operate. One amount of the capital gain is based on of these rules relates to shareholder the fair market value of the shares of benefits. Shareholder benefits are the holding company, which in turn construed very broadly to include any derive their value from the fair market benefits or advantages conferred on a value of the investments and assets in shareholder by the holding company the holding company. Then, when the and, subject to some exceptions, holding company is wound up and include any transfer of corporate distributes its assets to its shareholder assets to the shareholder for less than (i.e., the deceased’s estate), a second fair market value consideration in level of tax is triggered. Alternatively, return. The amount of the benefit a redemption of the shares by the must be reported by the shareholder estate or the beneficiaries may result as income in the year that the benefit in a taxable dividend. Therefore, the is received. For example, if the value of the investment in the holding holding company transfers a security company may be taxed twice, once as with a fair market value of $100 to a a capital gain to the deceased and the shareholder in exchange for $50 cash, second as a dividend to the estate/ the holding company is deemed to beneficiaries. have disposed of the security for $100, and the shareholder may be required It is possible to defer this potential to include the $50 difference as double tax by transferring the shares income on their personal tax return. of the holding company to a surviving If the security is of capital nature to spouse or qualifying spousal trust the shareholder, the amount of the on a tax-deferred basis. There are benefit is added to the adjusted cost also other post-mortem planning base of the security. alternatives that may eliminate RBC Wealth Management | 7

Another rule that is directed at Conclusion preventing shareholder appropriation Although there may no longer be of corporate assets relates to a tax benefit to investing through shareholder loans. It would be a holding company, the use of an possible, if not for this rule, for a investment holding company may shareholder to escape tax on the serve various other purposes, such distribution of corporate surplus as creditor protection. Consider by simply borrowing the funds the advantages and disadvantages of the holding company with the if you are thinking of setting up an shareholder never repaying the funds. investment holding company. Subject to certain exceptions, this rule requires that, the shareholder or If you have an existing holding a person who is connected with the company, there may be other reasons Although there may shareholder include in income the why you should keep it open. You no longer be a tax principal amount of all loans received may not wish to up your benefit to investing from the holding company during the company where the dissolution may through a holding year. Subsequent repayment of the result in the realization of previous loan will generate a tax deduction in company, the use tax deferrals and existing unrealized the year that the repayment is made, capital gains. of an investment unless the repayment is considered holding company may as part of a series of loans and You should consult with a qualified tax serve various other repayments. The income inclusion advisor to determine if you can benefit purposes, such as rule would not apply if the entire loan from an investment holding company creditor protection. is repaid within one year after the end or whether an existing holding of the taxation year of the corporation. company should be wound up. 8 | RBC Wealth Management

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This document has been prepared for use by the RBC Wealth Management member companies, RBC Dominion Securities Inc. (RBC DS)*, RBC Phillips, Hager & North Investment Counsel Inc. (RBC PH&N IC), RBC Global Inc. (RBC GAM), Royal Trust Corporation of Canada and The Royal Trust Company (collectively, the “Companies”) and their affiliates, RBC Direct Investing Inc. (RBC DI) *, RBC Wealth Management Inc. (RBC WMFS) and Royal Mutual Funds Inc. (RMFI). *Member-Canadian Investor Protection Fund. Each of the Companies, their affiliates and the Royal Bank of Canada are separate corporate entities which are affiliated. “RBC advisor” refers to Private Bankers who are employees of Royal Bank of Canada and mutual fund representatives of RMFI, Investment Counsellors who are employees of RBC PH&N IC, Senior Trust Advisors and Trust Officers who are employees of The Royal Trust Company or Royal Trust Corporation of Canada, or Investment Advisors who are employees of RBC DS. In Quebec, financial planning services are provided by RMFI or RBC WMFS and each is licensed as a financial services firm in that province. In the rest of Canada, financial planning services are available through RMFI, Royal Trust Corporation of Canada, The Royal Trust Company, or RBC DS. Estate & Trust Services are provided by Royal Trust Corporation of Canada and The Royal Trust Company. If specific products or services are not offered by one of the Companies or RMFI, clients may request a referral to another RBC partner. products are offered through RBC Wealth Management Financial Services Inc., a of RBC Dominion Securities Inc. When providing life insurance products in all provinces except Quebec, Investment Advisors are acting as Insurance Representatives of RBC Wealth Management Financial Services Inc. In Quebec, Investment Advisors are acting as Financial Security Advisors of RBC Wealth Management Financial Services Inc. RBC Wealth Management Financial Services Inc. is licensed as a financial services firm in the province of Quebec. The strategies, advice and technical content in this publication are provided for the general guidance and benefit of our clients, based on information believed to be accurate and complete, but we cannot guarantee its accuracy or completeness. This publication is not intended as nor does it constitute tax or legal advice. Readers should consult a qualified legal, tax or other professional advisor when planning to implement a strategy. This will ensure that their individual circumstances have been considered properly and that action is taken on the latest available information. Interest rates, market conditions, tax rules, and other investment factors are subject to change. This information is not investment advice and should only be used in conjunction with a discussion with your RBC advisor. None of the Companies, RMFI, RBC WMFS, RBC DI, Royal Bank of Canada or any of its affiliates or any other person accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. ® Registered trademarks of Royal Bank of Canada. Used under licence. © 2017 Royal Bank of Canada. All rights reserved. NAV0069 (06/17)