What is a pipeline and how you can use it to save taxes
Article co-written by Claudius du Plooy
How to Plan Your Legacy with Certainty
If you pass away while you own shares in a corporation, your loved ones can face serious tax consequences and obligations.
Yes, even death has its own taxes.
In this article, we discuss how you can protect your nest egg using a post-mortem pipeline.
What is a post-mortem pipeline?
Having a post-mortem pipeline can help to reduce your tax liability.
For instance, if the deceased person’s assets are not appropriately managed, their beneficiaries may face double taxation. Double taxation happens when the deceased person’s estate and the beneficiaries both have to pay tax on the same shares.
A pipeline transaction is a common way to avoid this problem. While the strategy was once considered to be “aggressive tax planning”, Canada Revenue Agency affirmed in 2019 that pipelines are valid tax mechanisms for avoiding double taxation.
The Double Taxation Issue
Double taxation means your beneficiaries get less of their inheritance, while Canada Revenue Agency gets a whole lot more.
When the owner of a private corporation passes away, subsection 70(5), “deems capital property of a deceased person to be disposed of immediately before death for proceeds equal to the fair market value at that time”.
This usually leads to a capital gain in the final income tax return of the deceased person’s estate. The capital gain payable is based on the difference between the buying and selling price of the private corporation’s shares.
Afterwards, the estate’s beneficiaries become shareholders of the corporation. If those shareholders wind down the business, sell their shares, or collect dividends, they are taxed on any amount received.
Thankfully, there’s a common way to address this problem – the post-mortem pipeline.
Pipeline Step by Step
In the following example, we’ll walk through how a post-mortem pipeline can help protect your financial legacy:
- When the owner of a privately-held corporation, let’s say OriginalCo, passes away, they are deemed to have disposed of the shares at fair market value of, for example, $1 million.
- The owner’s estate incorporates a new entity, PipelineCo, then transfers the OriginalCo shares to PipelineCo in consideration for a promissory note of $1 million.
- If the $1 million dollar promissory note from PipelineCo does not exceed the adjusted cost base of the shares when the transfer occurs, there should be no adverse tax consequences. PipelineCo and OriginalCo both operate their businesses for at least one year.
- After one year, PipelineCo and the private corporation can either amalgamate, or the private corporation, OriginalCo, can be wound up into PipelineCo on a tax-deferred basis.
- Amalgamations and wind ups can sometimes help to prevent adverse tax events.
- PipelineCo can then “pipeline” funds to the estate as tax-free repayments on the outstanding promissory note. The post-mortem pipeline allows the $1 million to flow to the estate while avoiding dividend payments that come with a second layer of taxation.
- PipelineCo is wound up once the all of the funds are transferred to the estate.
Requirements of a Successful Pipeline Plan:
– PipelineCo and OriginalCo must be separate entities for at least one year
– OriginalCo’s assets must not be distributed for at least one year
– OriginalCo must continue to carry on business during its existence
It is never too early to start planning the legacy you’ll leave for your loved ones.
If you’re interested in streamlining the future for your beneficiaries, contact Du Plooy Law and ask about designing a smooth succession plan.
The CRA has reaffirmed the use of pipeline transactions in post-mortem tax planning.
As of the date of publication, the contents of this article are believed to be accurate and reliable; however, tax laws are complex and subject to change at least on an annual basis. Before implementing any tax or succession plan, you should always consult professional legal and accounting advice. This article is to inform only and is not to be construed as legal advice. Du Plooy Law does not accept any liability for the tax consequences that may result from actions made based on the contents of this article.