Episode 98: Why Your Holding Company Will Be Double-Taxed in Canada (And How to Fix It) [Secret Sauce Ep17]

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Are you unknowingly setting yourself up to lose over 70% of the wealth you built up through capital gains in your Canadian holding company?

Many incorporated business owners are unaware of a significant tax trap lurking in their corporate structures, especially those with holding companies in Canada. Without proper tax planning, your estate could face double taxation—meaning you pay taxes on the capital gain of your assets inside the company, and then your estate pays tax again on the transfer of shares to your heirs upon your death. This could result in more than double the taxes you’d pay if you held these assets in your personal name.

In this episode, we break down the double-tax problem many Canadian business owners face and explore how recent government policies have made it harder for Canadians with holding companies to protect their wealth from excessive taxation. We’ll also reveal a tool that not only solves this problem but can also help you grow your net worth while you’re alive and leave a better legacy for your heirs.

What you’ll learn:

1. Understand how double taxation could impact your estate and what it means for your holding company assets.
2. Discover why traditional tax minimization strategies may no longer work and what solutions we still have access to.
3. Learn how a properly designed corporate-owned life insurance policy is an important tool to not only preserve your wealth, but also supercharge your net worth inside your Canadian holding company.

Listen to this episode now to learn how to protect your assets from double taxation and set your family up for long-term financial success.

Resources:

• Understand the double-tax problem that faces Canadians with holding companies [Globe and Mail]
• Like this short, “Wealth Secret Sauce” Episode? Tell us in your rating and review on Apple Podcasts. 
• Dig into our Ultimate Investment Book List
• Book a Discovery Call with Kyle to review your corporate (or personal) wealth strategy to help you take the next step in your Canadian Wealth Building Journey!
• Follow/Connect with us on social media for daily posts and conversations about business, finance, and investment on LinkedIn, Instagram, Facebook [Kyle’s Profile, Our Business Page], TikTok and TwitterX. 

Calling All Canadian Incorporated Business Owners & Investors:

Consider reaching out to Kyle if you’ve been…

• …taking a salary with a goal of stuffing RRSPs;
• …investing inside your corporation without a passive income tax minimization strategy;
• …letting a large sum of liquid assets sit in low interest earning savings accounts;
• …investing corporate dollars into GICs, dividend stocks/funds, or other investments attracting corporate passive income taxes at greater than 50%; or,
• …wondering whether your current corporate wealth management strategy is optimal for your specific situation.

This episode helps Canadian incorporated entrepreneurs, business owners and investors to determine what they should be doing to avoid the double-tax issue owners of Canadian holding corporations face when it comes to passing on their assets to their heirs. The Canadian Income Tax Act has made it hard on incorporated business owners to know what to do with their retained earnings and in many cases, sending funds to a Canadian holding company is the most sensible move. However, without the proper participating whole life insurance policy designed to help mitigate the tax consequences, some estates will be left with a tax bill that may tax up to 70% of the capital gains of corporate held assets. 

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Transcript:

Hey there, Canadian Wealth secret seekers.

It’s Kyle here with another secret sauce episode, and today I’m gonna keep it quick or at least do my best to do so. We’re gonna be talking about double tax.

I’ve had a lot of conversations lately with clients who have gone and done some wealth planning, maybe estate planning, and they have come to recognize that they might be paying, or their estate might be paying somewhere north of 70% in taxes upon death. That might sound like completely fictional in your mind, right? You’re going like, “That is impossible.” But there are actually some cases where this can happen, and it’s more common than you might expect.

Who knows, maybe you listening may be either already on this path or maybe you’re getting ready to potentially set yourself up on this path. While I’m going to talk about this specific scenario, I don’t want you to be scared of this specific scenario, this specific structure. What you need to know is how it works so that you can structure yourself in a way to avoid the double taxation.

What actually sparked this was some client calls, but then also Matt Bigley. You remember Matt? He’s our real estate partner, our business partner, and a realtor with the Real Group here in Windsor, Essex County. He sent this article over; he’s an avid Globe and Mail reader. There’s a new article that just came out yesterday, and it says, “Understand the double tax problem that faces Canadians with…” And here’s the key part… holding companies.

A lot of listeners of this show have holding companies, those who are incorporated business owners. If you have a successful business, especially if it’s an active business, typically you will eventually open up a holding company to send any retained earnings to. So any money that you don’t take out to pay yourself as salary or dividends, you typically will send up to a holding company to hold that capital and then typically try to create investments inside there.

Now, the government recently has put us in a position where they make it hard for you to do so and almost dare you to take it out because they want you to get taxed personally on this money. So there’s passive income tax inside of a corporate structure that’s at north of 50%. On any interest, income, or dividends that aren’t Canadian publicly traded companies, you’re going to be paying 50% on that.

An easy example is a GIC—50% tax on the interest. Now, here’s the problem though. Let’s say it’s a million dollars. We have a million dollars in there, we throw it into a GIC, and it earns, you know, 5%. So what do you get? You’re going to get $50,000, but the government’s going to take half. So they’re going to take $25,000. You just lost half your return because it’s passive income.

What else do people do? Then they go, well, you know what, yeah, I’m not gonna let them tax me with passive income. I’m going to buy appreciating assets. So anything that appreciates is going to trigger a capital gain.

Now, currently, I know in the US they’re talking about actually taking capital gains and actually taxing capital gains every year, even without selling the asset, which is incredibly crazy. Like the fact, if you actually think about that, if that goes through, like, oh my gosh, I have no clue what would happen, but my goodness, it would be insane. Um, so not a good move. I don’t anticipate it’ll happen.

But typically a capital gain is only paid after a sale or after a deemed disposition, meaning somebody maybe passes away, they assume the sale, and they charge the tax.

Now, inside of a corporate structure, like in a holding company, you can actually do that capital gain. And up until June 25th of this year, this is being recorded in 2024, there wasn’t really a difference. Like, you were actually better off to buy that capital gain, or sort of appreciating asset, inside the structure so you didn’t have to take it out and take personal tax and then reinvest it.

Well, now the government’s daring you even more. ‘Cause now they’re saying, listen, if you get any sort of capital gain inside a corporate structure, they’re going to tax you on two thirds of the upside and only one third is tax-free. Whereas if you own it personally, you will pay 50%, or pay tax on 50% of the gain, or only one half of it, and you’ll get one half tax-free.

So now they’re kind of daring you to say again, it’s like a little better, but that’s only on capital gains of less than $250,000. So we’re in a bit of a pickle here.

The government’s putting us in a scenario where they’re trying to essentially make up for all the spending that’s been going on, and how do we do it? Through taxation, right? So they do it in a lot of sneaky ways. Inflation is like an invisible tax.

But in this particular case, those with holding companies are now starting to wonder what is gonna happen. But here’s the problem that’s been lurking that you may not have even recognized initially, is the fact that inside your holding company, you can buy these appreciating assets that are going to eventually trigger capital gains.

But the problem is that unless you are structuring yourself appropriately, you can actually pay double the tax. Meaning you’re gonna pay a capital gain on the gain inside the company and your estate is going to pay a capital gain on the share transfer upon death.

So imagine this: I own a million-dollar asset inside my company. It grows to $2 million over my lifetime. It doesn’t matter what the time period is, right? It could have been one year, it could have been one day, it could have been, you know, five decades. It doesn’t matter. But we’re gonna assume there’s a million-dollar capital gain.

If I have it inside a holding company and I pass away, what will happen is my corporation is going to essentially be paying a capital gain on the asset inside the corporation, which is going to trigger capital gain tax, right? And it’s gonna be at a two-thirds inclusion rate, which is just north of 30% of that gain. So over $300,000.

And the actual shares of the holding company are going to transfer from me, who is now no longer here. I’ve now passed on, and they’re gonna transfer to whomever I’m passing these shares onto. Maybe it’s a child, maybe it’s someone else, but there’s going to be a gain on that. There’s gonna be tax on the actual growth of the shares because those shares may have only been worth a million dollars.

As I mentioned, there was a million-dollar asset in there, and then it grew to 2 million. So those shares over time have also grown in value. And if we don’t do anything about it ahead of our succession plan—meaning when I move on—if I don’t do anything to prepare for this, I could actually have tax on both ends.

So in simplest terms, a capital gain of $1 million, if I’m personally holding it, is going to trigger about $310,000 of tax, while inside the corporation it could actually trigger over $680,000 of tax, which of course is more than double that $310,000 that I might have to pay personally.

Now, when I say I might have to pay, again, I’m going to be moving on, I’m passing on, but there are still taxes that are triggered. So let’s talk about this.

The shareholder of the corporation, that’s me. I’m the shareholder who owns the shares in this holding company. When I pass on, I’m going to pay north of $310,000 due on the $1 million capital gain that was triggered on the disposition of the shares that I’m holding.

And there’s gonna be another $370,000 or so to be paid that’s split between the corporate tax and the personal taxes when the after-tax proceeds are paid out of the company to the heirs. So this is more than double the tax here.

Now, I’m no math major—actually, I’m just kidding. I am a math major. I hold a math degree in Computer Science. And, you know, a tax bill of over $680,000 on a $1 million capital gain is over 68% tax being paid on this capital gain.

So, of course, I’m sure you would agree that if this is your definition of your fair share of taxes, as the government has been touting lately, paying over 68% of your capital gain to the government is the way to go, then I would argue that this show is not for you. Unsubscribe and, you know, be on your way.

But if you’re still sticking around, then obviously you’re gonna want to figure out what to do instead. Because here’s the thing: even if you want to buy real estate, a lot of people will automatically open up a company to hold real estate.

Now, people don’t think of it this way when they start a company, but real estate is a passive income asset, right? It is deemed passive income even though we know it’s not passive. Like anyone who’s owned a rental property, even if you have property management in your back pocket—you’re paying a property manager—there’s still a lot of managing to be done. But it doesn’t matter, the government and the CRA do not see it as active income.

So, you’re going to earn, or you’re going to pay, passive income tax because they look at this like a holding company-type asset. So people often say a “real estate holding company.” All they’re saying is it’s a holding company for primarily real estate.

And you’ll notice that usually investors are trying to limit the actual income they show on paper because they don’t want to give half away in passive income tax. But the problem is that these assets are going to appreciate over time, right? I can leverage against these properties and I can, you know, access capital that way for reinvestment or doing all kinds of things with, but the problem is it’s still happening inside the holding company.

And down the road, when we sell those properties—whether it’s through our own doing or whether it’s through death, when the deemed disposition takes over—there are going to be capital gains. And again, if it’s you holding the shares of this holding company and you haven’t done anything about it…

You’re gonna have a problem.

Now, luckily for all of us, there is a tool. Because let’s be honest, the well is getting dry in terms of strategies and tax minimization and all of these things. Those who have tried capital gain strips in the past, you probably noticed that’s not a thing anymore. People who have done things in the past—slowly and surely, there are fewer and fewer, we’ll call them, easy strategies that you can put in place.

Now, are there things we can do to sort of, you know, slow the bleeding a little bit? Sure, we can get our own children to become shareholders—maybe non-voting shareholders—of our holding companies. We can do this along the way. We can consider family trusts, right? Sometimes it makes sense to do that, but the problem is there are still capital gains that are going to be triggered.

And for those who have explored estate freezes, you’ve got 21 years to sort of freeze the asset, to freeze the value of those shares. But then there’s this “capital gain” that has to be dealt with at the end of those 21 years. So none of these strategies are perfect, but there is one tool that can actually help us.

When designed appropriately and used within a comprehensive plan, we can not only solve the double tax problem, but we can also supercharge your net worth, both while you’re living and after you pass on.

Now, the only tool that can allow us to do that currently—and I don’t see any new tools coming in over time that allows you to continue accumulating assets while also dealing with the future capital gains tax burden without interrupting your current lifestyle or cash flow needs—is a corporate-owned permanent life insurance policy.

Alright? Now, if we just slap any old policy in there, it’s better than nothing. But when we design it appropriately and we design it to be as flexible and helpful as possible, so that it’s optimized to meet your personal and your corporate financial situation, that’s critical to ensure that we’re able to maximize your personal cash flow while you’re alive, continuing to grow your net worth along the way.

And then of course, being able to not only take care of the capital gains upon death, but ultimately and usually being able to leave your estate in a better situation than it was the day before you passed on.

Now, a lot of people think this can’t be done because, of course, when you do estate planning, when we look at the old-school approach to designing permanent life insurance policies, it was for a very specific purpose: just cover the taxes.

So what were we doing? We would take money, we would dump a certain amount of it in there, and that was like lost opportunity cost in order to buy this insurance policy.

But when we do this, and we do it well, we can do this so that there’s an early high cash value. So, those who are like infinite bankers, or those people who are, you know, sort of intrigued by this idea of being able to leverage their policy, we’re going to design a very similar style policy that’s going to continue to be funded each year. It’s going to grow tax-free, and it’s going to have a large tax-free death benefit.

But the key is that because we have a high early cash value, the owner of the holding company now has the opportunity to leverage those assets. They can leverage the cash value for additional asset accumulation and growth outside of the holding company, while the insurance contract remains as an asset inside the corporation.

Now, while high cash value life insurance policies will appear as an asset growing each year on the balance sheet of the holding company, when the insured person dies, the death benefit pays out to the holding company tax-free. And the net death benefit amount is credited to the corporation’s capital dividend account, or CDA.

By properly incorporating corporate-owned life insurance into your holistic corporate wealth management strategy, you not only solve the double tax issue described in the article in the Globe and Mail, but you also pave a tax-free path for the corporate retained earnings and its growth via a tax-free dividend to shareholders.

So, the secret sauce for this episode today is thinking about your situation—whether you have a holding company or other assets sitting in other places. We have to be thinking not only in the now for how much tax we’re paying currently, but also how much tax we’re going to pay over the long run and, in particular, when we move on.

In this case, we’re giving another example of how a properly structured permanent whole life insurance policy can help us not only deal with this double tax issue, but also put you in a better spot from a net worth perspective, both now and after you move on to the next world.

If you are ready to get serious about solving the double tax issue caused by holding assets inside your corporate structure, grab a date and time to reach out to me so I can go through your specific situation and help you find the best solution for you and those you love the most.

You can head to canadianwealthsecrets.com/discovery and book a free strategy call for us to go through your scenario. We’ll get a better sense of where you are, what sort of taxation you’re dealing with now, what taxation you might not even recognize you’re dealing with inside your corporate structure or personally, and finally, what sort of taxes you’ll be up against down the road when you go to pass on some of these assets to others in your life.

Head on over to canadianwealthsecrets.com/discovery, and I look forward to chatting with you soon.

Canadian Wealth Secrets is an informative podcast that digs into the intricacies of building a robust portfolio, maximizing dividend returns, the nuances of real estate investment, and the complexities of business finance, while offering expert advice on wealth management, navigating capital gains tax, and understanding the role of financial institutions in personal finance.

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