September 2006: by Darrell Nordstrom

More asset protection strategies

As business owners many of us are so subjected to the busy day-to-day hands on operation of our businesses that we don't devote enough time to protecting our assets.

In the previous articles my two colleagues, Dale Berg and Jim Nellis, discussed asset protection methods including the purchase of keyman life insurance, buy-sell life insurance, disability coverage, and other insurance products. There are other significant risks that owner/operators will want to address.

It is common to see a successful business accumulate cash, real estate, and other investments that are not related to the direct operation of the business. This situation has at least three "RISKS" that should be considered.

First, to the extent that these assets are not involved in regular operations the tax rate has historically been at very high levels (50% +) and does not enjoy the small business rate of 18%. The result is that the asset goes "unprotected" to the extent that the tax erodes value. (The recent federal budget proposals may add some relief to these tax rates. However, it is still necessary to reduce these "costs" to add value to the business.")

A second issue is more direct because there is no creditor protection of these assets if the business was "attacked" and the entire proceeds, not just the taxable portion, would be at risk. Some businesses have more exposure to lawsuits by their very nature because of environmental risks, dangerous goods, or similar operations. This doesn't eliminate this risk for others though, as lawsuits can result from incidents such as car accidents. The problem is not always fully covered by liability policies, although the insurance usually helps.

The third risk occurs because of a loss of the ability to utilize the capital gains exemption at the time of sale if the passive assets exceed 10% of the total value of the business. The business must use 90% of its assets "actively" to allow the shareholder to claim the capital gains exemption.

Fortunately, there is a relatively straight forward solution to these three problems.

Most tax accountants and lawyers will be quick to point out the advantages of structuring an operating company (OPCO) and a holding company (HOLDCO). The HOLDCO should retain your investments such as excess cash, real estate, and all non-operating assets. The OPCO should contain what it says - operating assets.

The results are straightforward and dramatic. The assets - often cash – can be moved to the HOLDCO and thereby creditor protected. If the cash is needed in the OPCO it can be loaned back to the OPCO from the HOLDCO and the loan must be securitized.

The assets moved to HOLDCO will not attract lower tax rates and therefore should be invested in tax-deferred vehicles such as real estate or low trading securities. This addresses the tax risk to the extent it defers paying tax as the rate on capital gains is only one half the regular rate.

The third problem of losing the capital gains exemption is also solved as the OPCO shares can now be purchased by a new owner and the exemption would be allowed because of the purification of the OPCO. (This also offers a practical "winwin" solution to the succession issue of the business because the real estate can be retained in the HOLDCO and leased back to the new purchaser as part of the sales agreement. This lowers the purchase price for the new owners, making the business easier to buy and provides monthly cash flow to the vendor.)

These re-organizational stages often include even more sophisticated planning concepts that could include more than one holding company and family trusts. At the end of the day each step is designed to protect assets from the taxman, from creditors, from whatever has potential to compromise efficiency.

At the same time, the other typical advantages of strategies such as IPPs (individual pension plans), RRSPs, RAs (retiring allowances), health and welfare trusts, and many more are still effective. The pensions and RRSPs can easily provide creditor protection by naming a preferred beneficiary, often the spouse of the owners.

Successful owner/operators spend a lifetime accumulating significant assets. The more successful the business owner, the more demand for effective and efficient planning from all perspectives.

Devoting appropriate time and funds to this task with your tax accountants, lawyers, and financial planners produces the required results.

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About the author
Darrell Nordstrom, CFP, RFP, CLU, CHFC, is a Senior Financial Advisor with Assante Financial Management Ltd. He can be reached at 1-877-837-3377 or 306-665-3377, or click to email Darrell Nordstrom.

Disclaimer
Please contact a professional advisor to discuss your particular circumstances prior to acting on the information above. The opinions expressed are those of the author and not necessarily those of Assante Financial Management Ltd.

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