I have written extensively over the years on this subject*. Creditor proofing is not about hiding assets or income from your spouse or the IRS or CRA, it is about doing smart things early in your career and then later on as well that can pay big dividends for you in terms of being tax efficient and providing for yourself and your family if things don’t go well.
(* See also: http://www.eqjournalblog.com/?p=526.)
Recently, Mark Sherboneau from Foundation Private Wealth Management and Susan Tataryn, Ottawa lawyer and CA, have been working with us on the issue of creditor proofing for entrepreneurs, even from the earliest stages of their careers.
Most financial planning groups are not interested in entrepreneurs until they have at least six figures or preferably seven figures of liquid assets. But Mark and Susan have worked out a system that will allow entrepreneurs to set up a trust at an early age with minimal startup costs.
The trust would be:
1. run by a trustee or trustees;
2. the trustee can be a corporation or a tripartite group of three (trusted) persons;
3. the beneficiaries of the trust would, in most cases, be the settlor (the person making the gift himself or herself) plus members of their family and possibly a charity or their alma mater, for example;
4. the division of the trust when it is wound up would probably not be specified as to which beneficiary gets what: this would be subject to discussion between the settlor and the trustee(s) at that time, with the trustee(s) making the final decision;
5. the settlor would set initial conditions for the trust such as it is not to be wound up until age 55 (60 or 65) which would prevent the beneficiaries from accessing the funds in the trust until a certain age. This is to protect the beneficiaries essentially from themselves since most people can not resist buying cool stuff if they could get their hands on the money;
6. the funds invested in the trust would most likely be invested fairly conservatively in vehicles like corporate class mutual funds so that almost all taxes are deferred to the trust windup and, when it is wound up, capital gains taxes would apply which improves tax efficiency by quite a margin;
7. the trustee(s) are obligated to protect the gift as best they can;
8. benefits are distributed according to the settlor grant, the settlor’s wishes and knowledge and best practice of the Trustee(s);
9. the Trustee(s) have legal title (not the beneficiary) so that the assets can not be attacked by creditors;
10. the diversity of interests of the beneficiaries means that a premature windup of the trust is unlikely since all beneficiaries in every Province of Canada (except Alberta) have to unanimously agree to a windup which means the trust is resistant to external pressures from, say, creditors or a money-hungry beneficiary.
This structure is designed to give the entrepreneur some financial assets that would be available to him or her and other beneficiaries at a later stage of life. These financial assets would be difficult for creditors to attack and, at the same time, they would be protected against premature disposition because the entrepreneur himself or herself wanted to use the funds for something else, like another startup or a trip to the DR or a new car…
The financial assets would probably not be invested aggressively in ‘Petrogold’ penny stocks on the VSE, say. This is supposed to be the third or fourth ’silo’ of personal investing, namely:
1. The first silo might be the matrimonial home which, at least in Canada, is likely to be owned directly by the spouse with the lowest risk profile. When it is sold, a principal residence in Canada is not subject to capital gains tax. Also, in most divorces, the matrimonial home is a shared asset so the value of the home (or a share in it) is not likely to run away from the entrepreneur.
2. The second silo is other real estate owned or controlled by the entrepreneur: perhaps a multi-residential dwelling and an office building that is rented to the operating company. This real estate is usually owned by a PHC, Personal Holding Company.
3. The third silo is the operating company where the entrepreneur expects significant returns on equity and where they have perhaps the most risk. The operating company is also likely to be owned by the PHC. This structure allows the controlling mind to move money from eligible Canadian Corporations (say the real estate company or the operating firm) to the PHC tax free using inter-corporate dividends. Funds are also moving from the operating company to the real estate company in the form of a fair market value rent. Real estate also generates CCA, Capital Cost Allowance, which creates a capital dividend account which can be divdended out to individual shareholders, tax free. Finally, the shareholders of the PHC (typically, the entrepreneur and his or her family) can be paid by the PHC or receive dividends from the PHC so as to minimize taxes overall. This is an efficient tax structure, creates diversity in the asset mix and works well operationally.
4. The fourth silo is the Trust we discussed above and it is obviously not owned by the PHC but by the Trustee(s).
These days, if you could see 5% to 6% returns over the long haul from your principal residence, 8% to 12% from your other real estate holdings, 18% to 22% ROE in your operating company and 3% to 5% from your Trust, that would be a realistic and satisfactory result for most of us.
Here is more information provided by Mark and Susan:
Prof Bruce