Gift of Private Company Shares
Several years ago, I put together a planned gift for a business owner. The client, a gentleman in his mid-fifties, was considering his eventual retirement. He was married with five children, two of whom worked with him in the business. That business was a Canadian-controlled private corporation and he owned all the common shares.
Although he owned other assets, such as securities and real estate, his business, which was valued at $1.5 million, comprised the bulk of his net worth. He wanted to pass the business on to the two children that worked with him, but he did not want to unfairly deprive his other children. He also wanted to protect his main asset during his retirement.
I was meeting with the client initially because he felt that he had too much life insurance. He already had a combined total of $1.1 million in several personally-owned life insurance policies. I suggested that he assign ownership of those policies over to the company and that the company take out an additional $0.4 million coverage as a way of funding the redemption by the company of his shares upon his death. He agreed.
I left to prepare an estate plan for the client. However, when I returned to discuss it, the client mentioned that he was soon heading out on a visit with his church group to a country that could be dangerous for people of his faith. I asked him if he would want me to revise my original plan to include a gift to his church. I suggested leaving shares worth $0.4 million (the additional amount of insurance), and he was very appreciative of the suggestion.
Here is how the plan works:
(1) An estate freeze: The client exchanged all his common shares for voting, cumulative preferred shares worth $1.5 million, and the two children purchased new common shares at nominal cost. The preferred shares, with voting privileges, would allow the client to retain a controlling interest in the company and to receive preferred dividends during his retirement. Although the client retained the value of the business at the time of the estate freeze, any future growth would accrue to the common shareholders (his two children). I suggested that the shares be both redeemable at the company’s option and retractable at the preferred shareholder’s option to protect the client’s stake in the business.
(2) A shareholder agreement: Upon the client’s death, the company would be obliged to buy back all preferred shares, and this would be funded by the corporate-owned life insurance.
(3) A revised Will: All the preferred shares would form part of the estate. Of this, shares worth $1.1 million would become part of the residual and shares worth $0.4 million would be donated in kind to the church.
(4) Dividends: After the donation of shares to the church has been fulfilled, the company would redeem all the preferred shares. This would trigger a deemed dividend of $1.1 million to the estate and a deemed dividend of $0.4 million to the church.
(5) Capital dividends: Since the redemption is funded by life insurance proceeds, the company is entitled to create a capital dividend account equal to $1.5 million and to elect to pay tax-free capital dividends out of that account to shareholders. In this case, the company would declare a tax-free capital dividend of $1.1 million to the estate. However, since the charity is a tax-exempt entity, the company would pay an ordinary taxable dividend of $0.4 million to them. This leaves $0.4 million remaining in the capital dividend account, which can be paid out tax-free to the surviving common shareholders (his two children).
To the client: During his retirement, he would receive preferred dividend income and his voting shares would give him a controlling interest.
To the church: They would eventually receive shares worth $0.4 million which would be redeemed by the company for cash.
To the estate: It would receive a donation receipt for $0.4 million.
To the estate beneficiaries: Each would receive their share of the $1.1 million from the redemption of the preferred shares.
To the two children who, together, own all of the common shares of the business: They would receive a tax-free capital dividend of $0.4 million. However, it should be noted that they received no more than the other three children. They only received what they had put into the business; i.e. their original investment in new common shares, plus the company’s growth past the date of the estate freeze which was all due to their hard work. The tax-free capital dividend was merely payback for the premiums paid by the company for the life insurance policy that made all this possible, and which indirectly cost them personally in reduced net earnings (and, thus, reduced common share dividends).
To the financial advisor: He received a commission on the sale of additional $0.4 million life insurance to a male client in his mid-fifties, as well as the retention of existing business. He also received the gratitude of a satisfied client.
EVERYBODY IS A WINNER!