Thursday, January 31, 2013

The Vanishing Margins

I wish I had the all the answers, but I unfortunately don’t. The automotive industry is going through a tough time right now and after speaking with a number of my automotive clients, I decided to write an industry overview this week.

Auto dealers, much like other franchisees, are being put in a difficult position as the large brands are charging dealers more to purchase their vehicles, yet dealers can’t charge the same amount more to customers as many people are earning less than they did 5 or 10 years ago. It’s reminiscent of the aviation industry where fuel prices rose and rose and the airlines had to fight with consumers and the media to justify their increased surcharges.

Furthermore, while only a few airlines fly to certain cities, there are currently a vast amount of choices available to consumers when it comes to choosing a vehicle to purchase. The result has been that each auto dealer is fighting even more than before for a small percentage of the dwindling consumer purse.

Let’s look at a few of the major issues facing automotive dealerships and the solutions some sharp dealers have come up with.

·        Market share is driven in large part by vehicle quality and corporate marketing, but there are a number of external factors that can’t be controlled by dealer owners, such as consumer taste and the economy. This can make it feel like dealers have few options available to them when trying to maintain market share, profitability and sustained growth.


·        To complicate matters further in this scrambling market, manufacturers have a number of programs that dealers have no say in but have a direct impact on dealers.


·        Many dealers have combatted this trend by acquiring numerous dealership points as a way to spread overhead amongst the different dealerships. The end result is similar margins, lower overheads and thereby same or higher net income. This is a strong model and likely sustainable for the short term. However, this too will eventually become ‘old news’ and dealers will have to become even more creative.


·        Other standalone dealers have explored the idea of offering additional services at their dealership such as a collision center, used car department, stronger F&I department, etc. The additional services offered at the dealership allow for diversification of risk in times when new car sales are not as strong.

·        The government also has a number of programs that can help dealerships – corporate tax rates have been coming down consistently, apprentice tax credits have increased, HST harmonization has improved cash flow

·        Auto dealers can also take advantage of various tax planning arrangements in order to maximize their corporate and personal after tax returns, for example the family trust (a formal discretionary family trust governed by a trust agreement drafted by a lawyer, not to be confused with an “in trust” account provided by your bank).

If my overview leans toward the dreary side, let me know what you think – will margins increase again in the future? Will the cost to produce automobiles stop increasing or decrease?

- Dave 


Monday, January 7, 2013

Holding Company vs. Trust



I am often asked by my automobile dealer clients whether it makes sense to introduce a holding company or family trust into the corporate ownership structure for creditor proofing and/or estate planning purposes. When a person decides to start a new business and incorporates, there is often a level of uncertainty as to whether the new venture will be successful, thus cost control is often paramount.

Most people opt to keep their corporate structure simple (meaning they don’t want to spend money on lawyers and accountants to set-up holding companies and trusts), which is understandable. However, if you have the resources upon incorporation, you should consider having a family trust own the shares of the private corporation from the outset rather than directly owning the shares.

Two reasons to consider this corporate structure are as follows:

  1. A holding company can provide similar benefits to a direct holding company but with less risk.
  2. A family trust provides the ultimate in tax planning flexibility.
Assuming your corporation is an active company, not an investment company, there are several benefits to having a family trust as a shareholder of your private company.

Multiply the Lifetime Capital Gains Exemption
If the company is eventually sold, a family trust potentially provides for the multiplication of the $750,000 lifetime capital gains exemption on a sale of qualifying small business corporation shares. That is, it may be possible to allocate the capital gain upon sale to, your spouse, children, yourself or other beneficiaries, which means substantial income tax savings. For example: where there are four individual beneficiaries of a family trust, the family unit may be able to save as much as $700,000 in income tax if a corporation is sold for $3,000,000 or more.

Family Trust Can Receive Dividends
In addition, where your children are 18 years of age or over, the family trust can receive dividends from the family business and allocate some or all of the dividends to the children. The dividends must be reported in the tax return of the child, but in many cases, the dividends are subject to little or no tax (if a child has no other income, you can allocate almost $40,000 in dividends income tax-free).

Creditor Proof Earnings
Finally, where you have surplus earnings in a corporation and wish to creditor proof them but don’t want to allocate the funds to your spouse or your children, you may be able to allocate those funds tax-free to the holding company if it is a beneficiary of the trust. This allows for an income tax deferral of personal taxes until the holding company pays a dividend to its shareholders.

Why would I ever not choose a family trust? Some of the reasons are as follows:

  1. The initial accounting and legal costs may be as high as $7,000 - $10,000.
  2. You may not have children or, if you do have children, they are young and you cannot allocate them dividends without the dividends being subject to the “Kiddie Tax” (a punitive income tax applied when minors receive dividends of private companies directly or through a trust).
  3. You are not comfortable with allocating to your children any capital gains from a sale of the business and/or any dividends since legally that money would belong to them.
  4. If the business fails, it may be problematic to claim an Allowable Business Investment Loss (a loss that can be deducted against any source of income) that would otherwise be available if the shares of the company were held directly by an individual.
  5. There are some income tax traps beyond the scope of this blog post when a holding company is a beneficiary.

As discussed in the opening paragraph, once a business is established and has become successful, a holding company can still easily be introduced as a shareholder and the transaction can take place on a tax-free basis. A holding company is also often problematic, as the level of cash the holding company holds can put it offside of the rules for claiming the $750,000 lifetime capital gains exemption if the business is sold in the future. Thus, you may wish to consider utilizing a family trust, unless you do not have children or do not anticipate being able to sell the corporation.

If one waits until the business is successful to introduce a family trust, as opposed to introducing one as an original shareholder when the business is first incorporated, the value of the business as at the date of the reorganization must first be attributed to the original owner(s) utilizing special shares (typically referred to as an estate freeze). The costs of introducing a family trust with a holding company beneficiary as part of an estate freeze could be as high as $15,000 -$20,000 as a business valuation is often required.

The Takeaways
This issue is very complex. The key takeaway should be that having a holding company as a direct shareholder of an operating company may not always be the most tax efficient decision. A family trust with a holding company beneficiary may be a more appropriate choice depending on your circumstances.

In any event, you should definitely consult a professional advisor before undertaking such planning in order to understand the issues related to your specific situation and ensure that you are not breaching any hidden income tax traps. 


-- Jeff Carbell