Understanding Share Structures in Canada for Small Corporations: A Guide for Tax and Estate Planning

When starting a business in Canada, one crucial consideration is the share structure. The right share structure can significantly impact your tax planning, estate planning, and overall business strategy. The share structure is indicated in your articles of incorporation. This article explores various share structures and how they can benefit businesses in Canada so that you can future-proof your share structure on your articles of incorporation:

What is a Share Structure?

A share structure defines the classification of shares a corporation can issue. Each class of shares may have different rights, privileges, restrictions, and conditions. Common share classes include:

• Common Shares: Typically provide voting rights and dividends.
• Preferred Shares: Often have preferential treatment for dividends and asset distribution upon liquidation but may have limited or no voting rights.
• Non-Voting Shares: Do not offer voting rights but may provide other benefits like dividends.
• Redeemable Shares: Can be bought back by the corporation at a future date.
• Convertible Shares: Can be converted into another class of shares.

Tax Planning Benefits

1. Income Splitting

   • Example: John, the owner of a small business, issues different classes of shares to family members. His spouse and adult children receive non-voting shares. This allows John to pay dividends to his family members, effectively distributing income among them. As a result, the family's overall tax burden is reduced because the dividends are taxed at lower individual rates. There are some rules in Canada that recently have limited the benefit of this rule by imposing requirements to avoid additional taxes, known as Taxes on Split Income (TOSI). More information on TOSI rules here: https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/income-sprinkling/guidance-split-income-rules-adults.html 

2. Capital Gains Exemption

   • Example: Sarah owns a corporation that qualifies as a Canadian-Controlled Private Corporation (CCPC). By setting up a share structure that allows for a family trust to hold shares, she can allocate capital gains to multiple beneficiaries. This maximizes the use of the lifetime capital gains exemption, potentially shielding a significant amount of capital gains from taxation when the business is sold.

3. Dividend Sprinkling

   • Example: Michael's corporation issues different classes of shares to himself and his spouse. By declaring dividends on specific classes of shares, he can control the amount of income each family member receives. This flexibility helps in minimizing the overall family tax liability. Keep in mind Taxes on Split Income (TOSI) restrictions.

Estate Planning Benefits

1. Succession Planning

   • Example: Emily wants to pass her business to her children while retaining control. She issues voting shares to herself and non-voting shares to her children. Upon her death, the non-voting shares can be transferred to her children without losing control of the business during her lifetime. This ensures a smooth transition and continued business operation.

2. Estate Freezing

   • Example: David owns a growing business and wants to lock in its current value for estate tax purposes. He performs an estate freeze by exchanging his common shares for preferred shares, which have a fixed value. His children receive new common shares, which will appreciate over time. This strategy freezes the value of David's estate at the current level, potentially reducing future estate taxes.

3. Use of Family Trusts

   • Example: Linda establishes a family trust and issues common shares of her corporation to the trust. Her children and grandchildren are beneficiaries of the trust. This allows Linda to control the distribution of income and capital gains, providing financial security for her family and potentially reducing estate taxes.

Setting Up the Right Share Structure

Setting up the right share structure requires careful planning and consideration of your business goals, tax implications, and family dynamics. Here are some steps to consider:

1. Consult with Professionals

   • Work with accountants, tax advisors, and lawyers to understand the legal and tax implications of different share structures.

2. Define Your Objectives

   • Clearly outline your goals, whether they are related to tax savings, estate planning, or business succession.

3. Choose the Appropriate Share Classes

   • Select share classes that align with your objectives. For example, if income splitting is a priority, consider issuing non-voting shares to family members.

4. Implement and Monitor

   • Once the share structure is set up, ensure proper documentation and keep it updated. Regularly review the structure with your advisors to adapt to any changes in your business or tax laws.

Conclusion

A well-designed share structure can offer significant advantages in tax planning and estate planning for Canadian businesses. By understanding the various share classes and their benefits, business owners can create a strategy that maximizes tax efficiency and ensures a smooth transition of ownership. Consulting with professionals before incorporating is highly advisable so that you are future-proofing your corporate share structure with your goals in mind. Regularly reviewing your share structure is essential in maintaining an effective plan that adapts to evolving circumstances. If you need more help or have any questions, schedule a free consultation.