Bumps and Pipelines

When someone dies owning private company shares, there is a risk of double or even triple taxation.

• A deceased individual’s estate owning private corporation’s shares may be taxed because of the deemed disposition at death of those shares (capital gains tax).
• There may be tax payable by the corporation when it sells assets to fund distributions to the deceased person’s estate (capital gains tax).
• There may also be taxes payable when the corporation distributes proceeds to the estate (dividend tax).

This post describes the “bump” and “pipeline” tax planning strategy and highlights which professionals to consult when undertaking planning to manage post mortem tax risk .

The Bump

When Canadians die owning shares in a private corporation, they are deemed to have disposed of those shares immediately before death at their Fair Market Value. The deceased’s estate is therefore deemed to acquire the capital property at Fair Market Value. This is the “bump”. Whereas the cost base of those shares might be nominal, the Fair Market Value may be much higher.

The Pipeline

A pipeline tax planning strategy uses the “bump” to the estate’s advantage. This is done by amalgamating the former corporation into a new one in exchange for a promissory note equal to the corporation’s Fair Market Value.

The promissory note becomes the “pipeline” for capital to flow back to the estate’s beneficiaries. So, instead of the corporation paying a dividend (and therefore triggering more tax) the corporation pays back the promissory note.

Rules a Pipeline Must Follow

CRA requires the following conditions to be met for a pipeline transaction to be allowed:

• The estate transfers its private corporation shares to the new corporation in consideration for a promissory note issued to the estate.
• The two companies remain separate legal entities and continue their business activities for a period of at least a year.
• After the period of at least a year, the companies are amalgamated with, or wound-up into, the new corporation.
• Following the amalgamation or wind-up, the new corporation progressively repays the promissory note.
• The old corporation liquidates and dissolves into the estate and benefits are distributed to the heirs of the deceased.

Who should you consult?

The best place to start when making estate plans that involve a private corporation is to discuss your situation with an estate planning lawyer. This person can advise you on how to structure the ownership of your private company to plan for various scenarios. A good estates lawyer can also help you setup the ownership of your assets in a way that anticipates how your estate will be distributed and dealt with. An estate lawyer can draft your will to reflect the nature of your corporate holdings and may be able to refer you to other lawyers that can provide tax advice or execute corporate re-structuring.

It is also important to work with your accountant to consider the tax aspects of your estate planning. A good accountant who deals with wealthy investors & entrepreneurs with holdcos and other medium sized private businesses will see situations like yours on a regular basis and so they will be able to give you their experience.

Your family office is useful when making estate plans too. Oftentimes, tax planning choices are not clear cut. There are often situations where risk and rewards need to be considered. There is seldom “one clear answer”, instead just many shades of grey. A good family office will bring together other professionals (lawyers, accountants, insurance advisors, investment advisors) to provide you with advice when required. When making and reviewing your estate plans, your family office should be your sounding board. Then, once a decision has been made, your family office should co-ordinate the documentation required to undertake those plans. Lastly, your family office should store or co-ordinate storage of corporate documents (articles, bylaws, tax docs, etc) and your wills & trust deeds so they are accessible to the right people when required.