Preferred Shares of a Private Corp.
Case Study: Philanthropic Tax Strategy for Business Sale – James and Shiela's Story
Background
James and Shiela, owners of a successful manufacturing business in Western Canada, built their company from the ground up over a 30-year period. Ten years prior to selling their business, they undertook an estate freeze, valuing their preferred shares at $3 million. Now, with their business valued at approximately $5.7 million, they faced significant capital gains taxes as they prepared to sell the company to their two sons.
Challenge
As they approached the sale of their business, James and Shiela were concerned about the millions of dollars in capital gains taxes they would incur. They also had a strong desire to incorporate philanthropy into their wealth transfer strategy. They sought advice from their Financial Advisor (FA), tax lawyer, and tax accountant to explore ways to manage the capital gains impact while fulfilling their charitable aspirations.
Solution
James and Shiela’s Financial Advisor recommended consulting with GiveWise Foundation Canada, a philanthropic organization that could potentially accept a donation of the preferred shares in their corporation. This strategy would allow them to bypass applicable capital gains taxes on the donated shares.
The proposed solution involved structuring the sale of the business as a phased purchase by their sons, while simultaneously donating portions of the preferred shares to GiveWise. This method offered the following key benefits:
1. Donation of Preferred Shares:
James and Shiela decided to donate $400,000 worth of preferred shares in the first year, followed by two additional donations of $200,000 each in the subsequent years. This totaled an $800,000 donation of preferred shares over three years. Their sons would purchase the preferred shares from GiveWise at no additional cost to them than if they were purchasing direct from the business owners.
2. Capital Gains Bypass:
By donating the preferred shares, they could bypass capital gains taxes that would have otherwise been triggered upon the redemption of the shares. Given the 50% inclusion rate for capital gains, $400,000 of the $800,000 redemption would have been taxable.
3. Tax Savings:
If the capital gains taxes had been applied, James and Shiela would have faced over $200,000 in taxes. By executing the share donation strategy, they not only avoided this tax burden but also received $800,000 in donation tax receipts. This provided them with approximately $400,000 in additional tax savings (due to their tax bracket).
4. Cost of Donation:
After all considerations, the net cost of their $800,000 donation was approximately $200,000, yielding significant tax savings and maximizing the effectiveness of their charitable giving.
5. Establishing a Giving Fund:
The $800,000 worth of shares was placed into a Giving Fund with GiveWise Foundation, which James and Shiela could distribute to charities on a flexible timeline that suited their personal and philanthropic goals.
Outcome
The strategic donation of preferred shares allowed James and Shiela to reduce their capital gains taxes, avoid approximately $600,000 in potential tax liabilities, and establish a charitable giving fund with $800,000. By working closely with their financial, legal, and tax advisors, they effectively merged their desire for philanthropy with a tax-efficient exit strategy for their business.
Through the collaboration of professionals and charitable organizations like GiveWise, James and Shiela achieved:
Significant tax savings on the sale of their business
The ability to contribute meaningfully to causes they care about
A smooth and tax-efficient transition of their business to their sons
Greater flexibility in managing and distributing their charitable contributions
over time
This case illustrates how careful planning and philanthropic strategies can enhance wealth transfers, minimize tax burdens, and fulfill personal charitable goals for business owners.
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