By – Sankalp (Sunny) Jaggi, CPA, CA, MTax, CFF

The death of a business owner is a difficult time for any family. The last thing they need is a surprise, multi-layered tax bill that can cripple the business they inherited and evaporate decades of hard work. As highlighted in our video, without proper planning, the combined tax liability can approach an astonishing 80% of your company’s value.

This isn’t an exaggeration; it’s a painful reality rooted in the interaction between personal and corporate tax law in Canada. Let’s break down how this happens and, more importantly, explore the powerful, legal strategies tax professionals use to prevent it.

The Three Layers of Tax at Death

Imagine you own a corporation worth $1 million, which you built from the ground up. Upon your death, the Income Tax Act triggers a series of events that result in up to three distinct layers of taxation on that same value.

1. Tax Layer 1: Personal Capital Gains Tax Upon death, you are deemed to have disposed of all your capital property, including the shares of your corporation, at their fair market value (FMV). If your shares are worth $1 million and your adjusted cost base (ACB) is nominal, your terminal T1 tax return will report a $1 million capital gain. At a top marginal tax rate of approximately 27% (depending on the province), this results in an immediate tax liability of $270,000.

2. Tax Layer 2: Personal Dividend Tax Your estate now owns the shares, which have a new ACB of $1 million. However, the cash and assets are still inside the corporation. To get that value out, the corporation must pay a dividend to the estate. If the full $1 million is paid out, it is taxed as a dividend in the hands of the estate. At a top marginal rate of nearly 48%, this creates a second tax bill of $477,400.

3. Tax Layer 3: Corporate Tax What if the corporation doesn’t have $1 million in cash? In our video example, the company held investments worth $400,000 that had a $300,000 accrued gain. To fund the payout to the estate, the corporation must sell those investments, triggering corporate tax on the capital gain. At a corporate tax rate of roughly 25% on investment income, this adds another $75,000 to the total tax bill.

Adding it all up: $270,000 + $477,400 + $75,000 = $822,400. Your family is left with less than 20% of the value you created. This is the consequence of double and triple taxation.

The Solution: Post-Mortem Tax Planning

Fortunately, the Income Tax Act contains specific provisions that, when used correctly, can unwind this double taxation. These strategies are complex and require expert guidance but are essential tools for protecting your legacy.

Strategy 1: The Subsection 164(6) Loss Carryback

This strategy directly targets the first layer of tax: the capital gain on your terminal return.

• How it Works: Within its first taxation year, your estate can redeem the shares of your corporation. The redemption proceeds are deemed to be a dividend. This treatment allows the estate to realize a capital loss equal to the difference between its ACB in the shares (the $1 million FMV at death) and the proceeds of disposition (which are reduced to nil because of the dividend). This $1 million capital loss can then be carried back and applied against the $1 million capital gain on your final personal tax return.
• The Result: The capital gains tax of $270,000 is effectively eliminated. This strategy converts the capital gain into a dividend, which is still taxable, but it is the first step in integrating the tax system and avoiding double taxation.

Strategy 2: The “Pipeline” Transaction

The pipeline is a sophisticated strategy designed to eliminate the second layer of tax—the dividend tax—by allowing your estate to extract the corporate assets as a tax-free return of capital instead of a taxable dividend.

• How it Works:
  
  1. Your estate incorporates a new company (“Holdco”).
  2. The estate sells the shares of your original company (“Opco”) to Holdco in exchange for a promissory note equal to the shares’ FMV ($1 million). This sale is tax-free for the estate because its ACB in the Opco shares is equal to the sale price.
  3. Opco is then wound up into Holdco or the two companies are amalgamated.
  4. The assets of Opco can now be used by the new combined entity to repay the $1 million promissory note to the estate, tax-free. The estate can then distribute this cash to your beneficiaries.
• The Result: The $1 million in value is “piped” out of the corporate structure without triggering the high personal dividend tax. This is a well-accepted strategy by the CRA, but it must be executed with precision to comply with anti-avoidance rules.

Strategy 3: The Subsection 88(1) “Bump”

This strategy is often used in conjunction with a pipeline to address the third layer of tax: the corporate tax on accrued gains inside the company.

• How it Works: When Opco is wound up into Holdco (as part of the pipeline), subsection 88(1) of the Act allows Holdco to “bump” the tax cost (ACB) of certain non-depreciable capital property it acquired from Opco (like the investment portfolio in our example) up to its FMV.
• The Result: The ACB of the investment portfolio is increased from its original $100,000 to its current FMV of $400,000. If Holdco then sells the portfolio, there is no capital gain to tax. The corporate tax of $75,000 is eliminated.

Conclusion: Planning is Not Optional

By combining these strategies, a skilled tax planner can dismantle the layers of double and triple taxation. The result is that the entire $1 million in value is subject to only a single layer of tax, typically at capital gains rates—reducing a potential $820,000 tax bill to approximately $270,000.

This is not a loophole; it is a series of legislative provisions designed to ensure fairness in the tax system. However, they are not automatic. Without a knowledgeable executor and a proactive plan, your family and your business could face devastating financial consequences. The time to act is now.

Checklist: 5 Critical Questions for Your Tax Advisor

If you are a Canadian business owner, your estate plan is incomplete without a clear strategy to address the significant tax liability that arises on death. Use these three questions to start a crucial conversation with a tax planner who specializes in post-mortem and estate planning. An advisor’s ability to answer these clearly and confidently is a strong indicator of their expertise.

Question 1: What is my estimated tax liability on death?

The first step is to understand the scale of the problem. A generic answer is not enough; you need a detailed, personalized projection.

Ask your advisor to:

• Provide a comprehensive calculation of the total tax bill your estate and corporation would face if you passed away today.
• Break down the projection into the three potential layers of tax:
  
  • Personal capital gains tax on the deemed disposition of your shares.
  • Personal dividend tax on the extraction of funds by your estate.
  • Corporate tax on the sale of assets held within the company.
• Clearly state the assumptions used in the calculation, particularly the Fair Market Value (FMV) of your business and the Adjusted Cost Base (ACB) of your shares and corporate assets.

Question 2: How can we eliminate the double or triple tax?

Once the potential liability is clear, the conversation must shift to the solution. Your advisor should be able to articulate a clear and customized plan.

Ask your advisor to:

• Identify which specific post-mortem strategies are most suitable for your situation (e.g., Subsection 164(6) loss carryback, a pipeline transaction, a subsection 88(1) bump, or a combination).
• Explain, in plain language, how each recommended strategy works to reduce or eliminate a specific layer of tax.
• Discuss the pros, cons, and potential risks associated with each strategy, including the CRA’s administrative positions and relevant anti-avoidance rules.

Question 3: What is the execution plan?

A strategy is only effective if it can be executed flawlessly. This requires a detailed roadmap for both before and after death.

Ask your advisor to:

• Outline the step-by-step process your executor would need to follow to implement the post-mortem plan.
• Identify any preparatory steps that should be taken now, such as updating your will to include specific powers for your executor, creating trusts, or reorganizing corporate structures.
• Detail the team of professionals (e.g., tax accountant, corporate lawyer, valuator) required for execution and clarify each person’s role.
• Provide an estimate of the professional fees and timelines involved in both the planning and implementation phases.

From Knowledge to Action

The strategies outlined above – the 164(6) loss carryback, the pipeline, and the 88(1) bump are not theoretical loopholes. They are practical, legal, and CRA-accepted tools designed to ensure fairness in the tax system. However, understanding them is only the first step. Flawless execution by a specialist is what separates a plan that saves your family hundreds of thousands of dollars from one that fails completely.

This is not a task for a general accountant; it requires a dedicated tax planner who lives in the world of complex estate structures and post-mortem reorganizations.

At Cedar Group, this is precisely what we do. Led by Sunny Jaggi, an Advanced Tax Planner with CPA, CA, MTax, and CFF designations, our team specializes in designing and implementing the very post-mortem plans discussed here. We work with business owners to build a fortress around their legacy, ensuring the value they created passes to their family, not to the CRA.

The government has a default plan for your estate that can result in an 80% tax bill. We can help you create a better one.

Don’t leave your life’s work to chance. If you are a Canadian business owner, the time to act is now. Contact us at cedargroup.ca to schedule a confidential consultation and take the first step toward securing what you’ve built for generations to come.