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Unit 13: Valuation of Preference Shares

Notes
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Caselet The Philanthropist: Gifts of Preference Shares from a
Private Company

obert is in his late 40’s and has built a successful business now worth approximately
$20 million. He was recently asked to join the Board of a local charitable foundation
Rand would like to demonstrate his leadership and support by making a large gift.
Unfortunately most of his wealth is tied up in the value of his shares and he does not
want to significantly reduce his current cash flow, which is being used to support his high
standard of living.
His insurance advisor suggested that Robert explore converting some of his common
shares in his company (say $750,000) on a tax deferred basis into redeemable preference
shares with a fixed dividend rate. As part of this transaction Robert would use the capital
gains exemption to increase the cost base of those shares to equal their fair market value
of $750,000. Robert’s company would then acquire a $750,000 insurance policy on Robert’s
life, which would be used to redeem the preference shares on Robert’s death.

As a next step, Robert would donate the preference shares to the charitable foundation
and receive a charitable donation receipt for $750,000. This donation receipt can be used to
offset taxes in the current year and/or carried forward for up to 5 years to offset his taxable
income. Assuming Robert is in a 45% tax bracket, this gift would generate tax savings in
the range of $225,000.
While Robert is alive the charitable foundation will receive dividends on the preference
shares, which can be used to fund its charitable activities. On Robert’s death the shares will
be redeemed with the life insurance proceeds, so the foundation will have $750,000 in cash
for charitable endeavours.
There is another benefit of this strategy. The insurance proceeds received by Robert’s
corporation on his death will create a credit to the its “capital dividend account”. Tax-free
dividends can be paid from the capital dividend account to the surviving shareholders
in the company. This will generate an additional tax savings to Robert’s beneficiaries in
the range of $150,000- 225,000 (depending on the dividend tax credit available on the
dividend)
To summarise the benefits of this strategy:
1. Robert can make an immediate gift without impacting his cash flow, and benefit
from a significant charitable tax credit.
2. The Charity will annually receive income from the shares, and on Robert’s death will
realise a large cash infusion from the redemption of the shares.
3. The share redemption is funded through corporate owned life insurance, which
also creates a credit to the capital dividend account and future tax savings to the
beneficiaries of Robert’s estate.

The strategy will work provided the super capital gains exemption is available to the
operating company worth $20 million. Below is the criterion for using the super capital
gains exemption. According to the CRA Guide Capital Gains, all of the following conditions
must be satisfied:

zz They are common shares issued by the corporation to you;
zz The issuing corporation is an eligible small business corporation;
Contd...

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