The Ultimate Strategy to Transfer Corporate Assets to Beneficiaries Tax-Free

As a business owner, you’ve worked hard to build wealth within your corporation. But how can you ensure a tax-efficient transfer of these assets to your family? One of the most effective tools available to Canadian-controlled private corporations (CCPCs) is the Capital Dividend Account (CDA). This strategy minimizes tax liabilities when passing corporate assets to beneficiaries, preserving your hard-earned wealth.

What is a Capital Dividend Account (CDA)?

The Capital Dividend Account is a notional account within a private corporation that tracks tax-free amounts. It allows business owners to distribute tax-free dividends to shareholders, making it a crucial part of estate and tax planning.

Tax-Free Distribution on Death

For many business owners, shares in their family corporation form a significant portion of their estate. Without proper planning, these shares could trigger substantial tax liabilities upon death.

When an individual holds corporate shares until passing, there is a deemed disposition at fair market value, leading to potential capital gains taxes. However, utilizing a corporate-owned life insurance policy can significantly reduce this tax burden. The death benefit from such a policy—less its adjusted cost basis (ACB)—is credited to the corporation’s CDA, allowing for tax-free distribution of funds to beneficiaries.

Case Study: Protecting the Williams Family Wealth

Jacob and Jessica Williams, both 65 years old, each own 50% of the shares in their holding company. Originally established as an operating business, the company sold its assets several years ago, generating proceeds of $2.5 million. These proceeds were used to build an investment portfolio consisting of fixed-income and equity investments.

Tax Implications Upon Death

If John passes away first and his will designates Jessica as the beneficiary of the corporation's shares, the assets would transfer to her at their adjusted cost base. Under this scenario, there would be no immediate tax consequences for either John or Jessica due to the spousal rollover provision under subsection 70(6) of the Income Tax Act. At the time of John’s passing, the company’s investment portfolio had appreciated to a fair market value of $5.6 million.

(Note: This example assumes that the holding company has no other assets and that an estate freeze has not been implemented. Additionally, dividends are distributed annually to recover refundable dividend tax on hand.)

The real tax challenge arises when Jessica passes away. At that point, their children inherit the shares at their fair market value, not at the adjusted cost base. This results in a deemed disposition of the shares, triggering capital gains tax. Additionally, there’s potential for double taxation—once at the personal level on the deemed disposition of shares, again at the corporate level on investment sales, and finally, a dividend tax if the children choose to withdraw funds by liquidating investments. The combined tax burden on the $5.6 million investment portfolio could reach up to 61%.

(Note: Proper post-mortem planning, including redemption, loss carry-back, and pipeline planning, can help mitigate double taxation. With appropriate structuring, the tax liability on the children could be reduced to approximately 35% instead of 61%.)

A Strategic Solution: Corporate-Owned Insurance

To ensure that their children receive the full value of their company’s assets, John and Jessica opted for a $5.6 million joint last-to-die, permanent insurance policy. This strategy made sense for several reasons:

• The tax burden occurs upon the death of the last surviving spouse, making a last-to-die policy the most cost-effective solution.

• Premiums are lower because the payout occurs only when both spouses pass away.

• The policy remains stable, with both the coverage amount and premium payments fixed for life.

A $5.6 million last-to-die policy would cost approximately $100,000 annually for life. However, to avoid prolonged payments if one spouse lived into their 90s, the Williams opted for a guaranteed limited payment plan (either five or ten years). If they were in good health and qualified for coverage, they could secure the full $5.6 million policy for a total premium of $2 million.

Since the premiums were funded by their holding company, the Williams effectively shifted taxable corporate funds into a tax-exempt insurance structure. Once approved for coverage, they transferred $400,000 annually from the corporation into the policy for five years, at which point the plan was fully paid, and no further premiums were required. The corporation remained both the owner and beneficiary of the policy to prevent taxable shareholder benefits.

Results

By implementing this strategy, the Williams achieved multiple benefits:

• Immediate Increase in Estate Value: Their net worth grew as the insurance policy was in place from day one.

• Reduced Future Tax Burden: Corporate assets were shifted into a tax-exempt structure, lowering future taxable income.

• Tax-Free Death Benefit: Upon the second spouse’s passing, the $5.6 million death benefit would be paid tax-free to the corporation.

• Efficient Wealth Transfer: The corporation credits the capital dividend account (CDA) with the death benefit, allowing tax-free distributions to beneficiaries.

If the surviving spouse passes away at age 85, the corporation can distribute a tax-free dividend of $4,690,024 through the CDA, leaving the remaining assets inside the corporation. The taxable portion ($1,153,985) can be withdrawn later when it is most tax-efficient. If the children withdraw the entire adjusted cost base amount, they would pay a non-eligible dividend tax of $488,251 (based on a 42.31% tax rate in Alberta), leaving them with $665,734 in net proceeds.

If either spouse lives to age 93, the entire $5.6 million death benefit could be distributed tax-free via the CDA. To achieve the same result with traditional investments, the Williams would have needed a guaranteed 5.23% after-tax return—an unlikely scenario in today’s low-interest environment without taking on substantial investment risk.

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Why Act Now?

Corporate-owned life insurance is a powerful tool to convert taxable corporate surplus into tax-free wealth for your heirs. However, tax laws are evolving. In 2017, the government reduced the amount of life insurance proceeds that can be credited to a corporation’s CDA, and further restrictions may follow. Securing coverage while in good health ensures access to this strategy before future legislative changes.

Conclusion

For business owners looking to preserve their wealth and minimize taxes, a corporate-owned life insurance strategy is invaluable. It enhances estate value, facilitates tax-efficient wealth transfer, and ensures beneficiaries receive their intended inheritance without excessive tax burdens.

At AJ Wealth Management, we specialize in helping business owners implement tax-efficient estate planning strategies. Contact us to discuss how we can help secure your financial legacy for future generations.