Post-mortem planning for private company shares

Many baby boomers transitioning to retirement are considering their retirement and estate plans to ensure maximum value for beneficiaries. Among the retiring group are business owners, 76% of whom plan to exit their businesses within the next decade, according to the Canadian Federation of Independent Businesses.

Owners of private corporations should be mindful of double taxation at death. Among the strategies used to reduce this potential outcome is the 164(6) loss carryback technique. While it has been available for some time, draft legislation released in August 2024 proposed to increase flexibility for executors and beneficiaries who use this strategy.

An example

Ashley is widowed with an adult child, Olivia. At retirement, she sold her business assets for $2 million and retained her corporation as a holding company investing in passive assets. Throughout her retirement, Ashley supplemented her income with dividends from the company.

Ashley has a will that names Olivia beneficiary of her estate, and upon her passing the holding company shares are to transfer to Olivia via the estate. Not much thought was given to tax implications on Ashley’s death.

Ashley passed away a few months ago. At the time of her death, the adjusted cost base (ACB) and paid-up capital (PUC) of the corporate shares were nominal. The fair market value (FMV) of the shares was $5 million due to the value of the passive assets within the corporation. Inside the corporation, the ACB of the assets was $2 million (the price paid for the investments on sale of the company’s business assets) and FMV of the assets was $5 million.

As per subsection 70(5) of the federal Income Tax Act (ITA), when an individual dies, they are deemed to have sold their capital property just before death. Because Ashley’s company shares were considered capital property, they were deemed sold just before death, resulting in a capital gain of $5 million (FMV minus ACB) reportable on her terminal tax return for the year.

Since Ashley’s marginal tax rate was 50% at the time of death, capital gains tax of approximately $1.3 million was the result. The corporation’s investment assets were not impacted by the deemed disposition that occurred on Ashley’s death.

Personal tax — Ashley’s terminal return
FMV of shares	$5,000,000
Less ACB of shares	$0
Capital gain	$5,000,000
Taxable capital gain (50% of gain)	$2,500,000
Personal taxes payable (at 50%)	$1,250,000

Ashely’s estate then received the company shares with an ACB of $5 million, the amount the shares were deemed sold for. As per Ashely’s will, her executor transferred the shares to Olivia (with an ACB of $5 million), who then chose to sell the corporate investments and wind up the corporation, which resulted in a redemption of shares.

With a 50% corporate tax rate and a 45% personal tax rate on non-eligible dividends, taxes payable by the corporation and Olivia on windup was approximately $1.7 million ($290,000+$1,444,500), calculated as follows:

Corporate tax — Sale of investments
FMV of investments	$5,000,000
Less ACB of investments	$2,000,000
Capital gain	$3,000,000
Taxable capital gain (50% of gain)	$1,500,000
Corporate tax (at 50%)	$750,000
Less refundable tax when dividends paid	$460,000
Taxes payable	$290,000

The corporation receives a partial refund of taxes paid when dividends are paid to shareholders. In this case the figure was $460,000.

Personal tax — Olivia on redemption of shares
FMV of investments	$5,000,000
Less corporate tax on sale of investments	$290,000
Dividend available to Olivia	$4,710,000
Less PUC	$0
Deemed dividend on redemption of shares	$4,710,000
Less capital dividend	$1,500,000
Taxable dividend	$3,210,000
Taxes on dividend (at 45%)	$1,444,500

A capital dividend is a tax-free amount paid to shareholders from a corporation’s notional capital dividend account (CDA). In this case, the figure is $1.5 million. Among other transactions, the non-taxable portion of realized capital gains are added to a private company’s CDA.

The deemed disposition that occurred on Ashley’s death required taxes to be paid on the increase in value of the company. Then, once the shares were transferred to Olivia, the sale of the investments and wind up of the company resulted in tax again, resulting in double tax on the same economic gain. In the absence of advance planning, total taxes payable were approximately $3 million, or 60% of the value of the inheritance.

Summary — No post-mortem planning
Personal tax – Ashley’s terminal return	$1,250,000
Corporate tax – Sale of investments	$290,000
Personal tax (Olivia) on redemption of shares	$1,444,500
Total taxes payable	$2,984,500
Taxes as a percent of FMV	60%

Given that capital gains tax rates across Canada are approximately 25%, this double tax scenario is difficult to accept. Fortunately, post-mortem planning can reduce taxes payable.

The loss carryback strategy

Instead of leaving her company shares to her daughter, let’s assume that, with guidance from her financial, legal and tax advisors, Ashley instructs her executor to wind up the company in her estate before distributing the proceeds to Olivia.

Provided the windup occurs within a year of Ashley’s death, subsection 164(6) of the ITA allows a capital loss triggered in Ashley’s estate to be carried back to her terminal return, where it can be applied against the capital gain realized on her death.

Ashley would include a provision in her will allowing her executor to claim beneficial tax elections on her behalf (a standard provision included in many lawyer-drafted wills). Assuming ACB, PUC and FMV amounts are the same as above, tax implications on Ashley’s death would be as follows:

Personal tax — Ashley’s terminal return
FMV of shares	$5,000,000
Less ACB of shares	$0
Capital gain	$5,000,000
Less capital loss carryback (details below)	$5,000,000
Taxable capital gain	$0
Personal taxes payable (at 50%)	$0

Following her deemed disposition at death, Ashley’s estate would receive her company shares with an ACB of $5 million, the amount Ashley is deemed to have sold the shares for just prior to death. At that point, as per her will, Ashley’s executor would wind up the company, resulting in a buyback or redemption of shares from the estate.

The buyback would provide cash to Ashley’s estate for distribution to Olivia. Assuming the corporation sells the investments as part of the windup and redeems the shares with cash, corporate tax would be payable in addition to personal taxes by Ashley’s estate.

As a part of this process, however, a capital loss to Ashley’s estate would result, allowing for a carryback of the loss to her terminal return, reducing total taxes payable.

Like the case where little-to-no planning was done, the sale of the company’s investments would create corporate taxes of $290,000.

Corporate tax — Sale of investments
FMV of investments	$5,000,000
Less ACB of investments	$2,000,000
Capital gain	$3,000,000
Taxable capital gain	$1,500,000
Corporate tax (at 50%)	$750,000
Less refundable tax when dividends are paid	$460,000
Taxes payable (at 50%)	$290,000

Following corporate tax, the redemption of shares would create a deemed dividend to Ashley’s estate for amounts that exceed the company’s paid-up capital. The dividend may be taxable or non-taxable depending on the characteristics of the company and credits to its capital dividend account. In this example, the result would be:

Personal tax — Ashley’s estate
FMV of investments	$5,000,000
Less corporate tax	$290,000
Dividend available to Ashley’s estate	$4,710,000
Less PUC	$0
Deemed dividend	$4,710,000
Less capital dividend	$1,500,000
Taxable dividend	$3,210,000
Dividend tax (at 45%)	$1,444,500

So far, not much different from the above scenario, where little-to-no planning was done. However, with this alternative, the redemption causes a disposition of shares by Ashley’s estate (as opposed to Olivia), resulting in a capital loss carryback which can be applied to Ashley’s terminal return.

Capital loss on windup — Ashley’s estate
Amount received on redemption of shares (i.e., proceeds of disposition)	$4,710,000
Less deemed dividend	$4,710,000
Adjusted proceeds of disposition	$0
ACB of shares (estate)	$5,000,000
Capital loss on windup/loss carryback	$5,000,000

This assumes no other realized capital gains in the estate against which this loss would be applied.

While Ashley’s estate receives $4.7 million on redemption of her company shares, for capital gain/loss purposes this amount is reduced to nil (adjusted proceeds of disposition).  When the ACB of the shares, $5 million, is subtracted from the adjusted proceeds, the result is a $5 million capital loss to the estate.

Subsection 164(6) of the ITA then allows for the capital loss to be carried back to Ashley’s terminal return, offsetting tax from her deemed disposition at death. Ashley’s executor can request a 164(6) election by requesting an amendment to Ashley’s terminal return.

Using the loss carryback strategy, Olivia can receive the post-windup, after-tax value of Ashley’s holding company from her estate. Total taxes payable for the family would be $1.7 million, representing a $1.3 million tax savings when compared to the above alternative.

Summary — With post-mortem planning
Personal tax – Ashley’s terminal return	$0
Corporate tax – Sale of investments	$290,000
Personal tax – Ashley’s estate	$1,444,500
Total taxes payable	$1,734,500
Tax as a percentage of FMV	35%

Is more flexibility on the way?

In draft legislation released in August 2024, the Department of Finance proposed to increase flexibility in post-mortem planning when using the 164(6) election. Specifically, the legislation proposed to extend the period during which realized capital losses in a graduated rate estate can be carried back and applied to the terminal return of the deceased.

Under current rules, the capital loss must be realized within one year of the deceased’s death. The draft legislation proposed to increase this period to three years, giving executors more time to carry out the strategy and to align the treatment of capital losses realized after death with net capital losses realized by other taxpayers (which generally allow for a three-year carryback period). Such a period also aligns with the 36-month lifespan of a graduated rate estate.

When the government prorogued in January 2025, this draft legislation terminated and did not become law. With a newly reelected government, time will tell if this legislation will be retabled and eventually passed, granting additional flexibility in post-mortem planning.

Bump and pipeline transactions

Estate planning can ensure inheritances are maximized and assets are distributed as intended. Planning for a 164(6) election can be an important part of this process and life insurance can be used to enhance benefits. Other strategies, such as bump or pipeline transactions, can also be considered.

Bump transactions allow a corporation to increase the tax cost of some non-depreciable capital property. A pipeline transaction can reduce the double taxation by converting the gain into a tax-free capital repayment. Advisors who are familiar with these strategies are well-positioned to further demonstrate value when working with clients who have corporations.