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If you’re like many business owners who’ve been navigating this year of change and challenge, you’re likely wondering what you should do next. While the government has introduced several measures intended to provide immediate and significant relief for business owners, the new realities of COVID-19 mean you are now tasked with navigating complex legal systems, making significant financial decisions, and putting together a strategy for surviving and thriving into the next normal.
Below are some considerations we believe are important when customizing your plan into action:
One of the most pressing issues faced by employers is how to get laid-off-employees back to work. Employees receiving the Canada Economic Response Benefit (CERB) may be reluctant or unable to return to work for reasons ranging from lack of childcare, ill or vulnerable family members, or health and safety concerns that have not been adequately addressed.
Employers should be cognizant of the potential for “constructive dismissal” allegations and litigation in the event the terms of employment are unilaterally altered. As well, employers should ensure the decisions they make with respect to which employees are being brought back or let go or seeing hours or pay reduced, are not in breach of the provincial human rights codes. There is an expectation that employment disputes will rise dramatically in the coming months so employers would be well advised to seek legal advice before making important staffing and employee decisions.
Many small business owners have inadequate employment contracts in place. If you fall into this category, now is an ideal time to work with your legal professional to review the terms of your agreements and update (or create) documents as needed.
If there are concerns about ongoing tenancy, landlords and tenants should review their commercial leases and seek appropriate legal advice to get a clear understanding of their rights and obligations. As tenants may continue to struggle with rent payments, and rules continue to evolve with respect to access and ongoing protective requirements, it’s important that you have an accurate picture of your options. While some leases may contain clauses allowing for a reduction of rent and other payments in certain circumstances, any failure to comply with the lease may expose the parties to eviction and/or a claim for damages. These are costly conflicts that can have a significant impact on cashflow and are best avoided if possible.
Regardless of whether you’re a sole proprietor or operate your business through a corporate structure, you may have personally guaranteed certain financial obligations. Generally speaking, small business banking loans of less than $1 million will require a personal guarantee. Even if the business operates through a corporation, obligations that have been personally guaranteed will not be “creditor protected” in the event the corporation cannot meet its obligations. In assessing options moving forward, business owners should review both their business and personal obligations and determine where there is flexibility and prioritize accordingly.
Financing and debt considerations, available government and industry support, adjusted revenue expectations and tax minimization are all key elements of cash flow planning. Businesses have been given the opportunity to defer income tax and GST/HST payments through the end of August. Deferring payments frees up funds for immediate cash flow needs but making the decision of what to use those funds for while ensuring the funds are available to pay the tax obligation come September will require careful consideration.
Cash reserves will need to be called into play for most businesses right now, with investments or deposits that can be converted to cash quickly and at no cost being first to go (GICs for example). There is, of course, the opportunity cost of interest foregone, but this will likely be far less costly than any other method of financing operations.
Financing Options May Be Challenging
Do not assume the financing options that were previously available will continue. Many financing arrangements are dependent upon a demonstrated ability to service the loan. With respect to personal loans, many institutions have already changed income verification policies. Whereas the norm was previously a 60-day confirmation, institutions are now asking for paystubs no more than 14 days old. Similarly, if you’re looking to refinance rental properties, lenders are paying close attention on the ability to demonstrate cash flow.
Understand How Much Cash is Needed and Available
This is an opportune time to take steps to better understand how much cash is needed and for how long. Reducing variable costs, like putting in place a hiring or wage freeze or temporarily restricting continuing education reimbursements, may be the quickest way to immediately reduce outflows. Encouraging employees to take vacation time as it accrues is another way to maintain control over costs – if an employee were to leave their employment with outstanding vacation balances that need to be paid out, this could result in a cash payment being required at an inopportune time. And of course, negotiating with partners such as suppliers to reduce costs and clients to increase certainty of payment should be actively pursued.
Those businesses operating in corporate structures should also consult with their Edward Jones advisor and tax professionals about whether any capital dividends may be available to take out of the corporation tax-free. It’s particularly important to ensure the capital dividend account balance has been considered before any corporately-held investments are sold at a loss, which may reduce or eliminate amounts that could have been paid out tax-free.
Business owners should ensure they have up-to-date documents in place to allow an authorized individual or individuals the ability to act on their behalf with respect to their financial and business dealings, in the event they are incapacitated due to illness.
These past few months have brought into sharp relief the risk of unexpected illness or death. If a business owner becomes incapacitated, substitute decision-making documents (such as Powers of Attorney for Property) may be needed to authorize someone else to access property or accounts, be able to negotiate any contracts and even apply for available government benefit programs. While it’s generally best practice that those named as primary or alternate attorney for property live relatively nearby, the recent provincial and border “lock downs” have demonstrated just how important that consideration may be.
Similarly, up-to-date wills with appropriate executors should be considered a need-to-have. Your Edward Jones advisor can help you understand the documents required based on your situation.
Many Canadian insurance companies have made changes to their underwriting practices in light of COVID-19. Most are no longer requiring paramedical for certain cases and are postponing the requirement in most others. With approval criteria’s relaxed, now may be an opportune time to put in place appropriate life insurance. This may be particularly important for those with unfunded shareholder agreements.
For some small business owners, now may be an opportune time to review their tax strategies with their financial, legal, and tax advisors.
Tax Loss Harvesting & Carryback
Tax-loss selling is a tax strategy that involves selling assets that are in a loss position with the resulting capital loss being used to offset capital gains from other sources. If, in any given year, a taxpayer’s capital losses exceed their capital gains, the excess losses (net capital losses) may be carried back to offset net capital gains realized in any of the three previous years or they are carried forward indefinitely for use against gains in future years. If you have appropriate investments to use for this strategy, there may be an opportunity to reclaim taxes paid during the past three years. A caution, though, to those considering this strategy for corporately-held investments: to the extent there is a positive balance in your Capital Dividend Account, it may be advisable to pay out the capital dividend before the assets are sold at a loss.
Estate Freezes and Thaws
An estate freeze is a strategy whereby a business owner “freezes” the value of their stake in the business and transfers the future value to one or more taxpayers (typically children or grandchildren). As the value of the business goes up, the original owner’s interest remains fixed and the new shareholder(s)’ interest increases in value. When the original owner dies or otherwise disposes of his or her shares, capital gains tax is only payable on the gain up to the point of the “freeze.” As the tax on the gain that has accrued since the freeze is deferred until the new shareholder disposes of their interest, the overall result is a significant tax savings to the family unit. There are, of course, many more considerations that must be evaluated, but that’s the general landscape.
The current depressed market may be an opportunity for those taxpayers whose businesses have temporarily low values. Assuming the value of the business increases in the future, freezing/refreezing now will produce a larger minimization of capital gains tax and deferral of tax liability than would have been possible a short time ago.
Prescribed Rate Loans
The “attribution” rules apply such that certain income earned on assets that were gifted or loaned at low or no interest to a spouse or minor child will be “attributed” back to the individual who gifted or loaned the asset. This means that even though the recipient of the gift legally owns the property, the income earned on that property may be included as income on the gift-giver’s income tax return.
To avoid the application of these rules, a prescribed rate of interest must be charged on the loaned asset and the interest must be paid annually by January 30. The borrower is then able to deduct the interest expense paid and report and pay tax on any income from investments made with the borrowed funds. Because the funds are now taxed in the lower-income family member’s hands (or a trust for their benefit), assuming the investments earn more than the prescribed rate, the family’s overall tax burden would be reduced.
Prescribed rates are set by the CRA each quarter and the lowest rate possible is 1%. On July 1st, the rate will drop from the current 2% to 1% for the third quarter of 2020. The rate is locked in for the duration of the loan. Those who are currently locked into 2% prescribed rate loans should consider repaying their loans and entering into a new loan at the lower 1% rate starting July 1. Those who don’t currently have a loan may wish to consider whether this strategy could be used to reduce their family unit’s overall tax burden. As with all tax strategies, caution must be exercised, and professional advice should be obtained.
As a small business owner, these are some of the many issues you need to think about during this unprecedented time. Your Edward Jones advisor can help guide you through the process and make the appropriate introductions to professional partners.
Edward Jones, its associates and financial advisors cannot provide tax advice. Please consult your qualified tax advisor regarding your situation.