How Tax-Efficient Structures Work

Tax efficiency is a crucial aspect of running a successful business in Canada. Understanding how to structure your business in a tax-efficient manner can result in substantial savings and increased profitability. In Canada, several business structures offer distinct advantages when it comes to minimizing tax liabilities.

One of the most commonly employed structures is the incorporation of a company. By incorporating, entrepreneurs can take advantage of various tax benefits, such as income splitting and tax deferral. Another approach is utilizing a partnership structure, which allows for the allocation of income and expenses among partners, resulting in reduced overall tax burdens. And another popular method, especially for the real estate sector, is a Mutual Fund Trust. 

Tax Efficiency and Growth

Maintaining a tax-efficient structure becomes increasingly important as a company grows and evolves. As the business expands, new considerations arise that can impact its tax efficiency. One crucial aspect is regularly reviewing and adjusting the business structure to align with changing circumstances.

As the company grows, it may be necessary to reassess the most suitable legal entity, such as transitioning from a sole proprietorship to a corporation. This can provide additional tax advantages, such as reduced personal liability and the ability to access more favorable tax rates.

Types of Business Structures and How They Work

There are several types of tax-efficient business structures in Canada, each with its own unique features and benefits. Understanding these structures can help entrepreneurs make informed decisions to minimize their tax liabilities. Here are some common types:

1. Sole Proprietorship: This is the simplest form of business structure, where an individual owns and operates the business. While it offers simplicity, it provides limited tax planning opportunities.
2. Partnership: A partnership involves two or more individuals who share ownership and management responsibilities. Partnerships allow for income splitting, where partners can allocate income and expenses to optimize tax advantages.
3. Corporation: A corporation is a separate legal entity from its owners. It offers liability protection and allows for various tax planning strategies, such as income splitting through dividends, tax deferral, and access to tax incentives and credits.

There is, however, another option that provides many of the advantages of a partnership with much of the flexibility of a sole proprietorship:

4. Mutual Fund Trust: A mutual fund trust operates similarly to a limited partnership, as it involves two or more individuals who share income participation. A Mutual Fund Trust allows for income splitting to unitholders while also allowing individuals to use their RRSP/TFSA funds.

When considering tax-efficient business structures, it is essential to carefully evaluate each option's compatibility with your existing business model. Assess factors such as liability protection, tax planning opportunities, administrative complexity, and long-term growth plans. A thorough evaluation ensures you choose a structure that aligns seamlessly with your business goals and optimizes tax efficiency.

An MFT is a Good Example of a Tax-Efficient Structure.

To provide us with a better insight into the advantages of Mutual Fund Trusts, we reached out to Dwight Martin, the President of Axiom Advisors, Inc. With his 25 years of financial management experience, Mr. Martin knows firsthand how MFTs can assist real estate investors in building their portfolios:

“Well, we’ve found that an investment structure like a Mutual Fund Trust (MFT) provides a compelling avenue for tax-efficient investing. Picture a Limited Partnership for a second. There is a General Partner, who is the one calling the shots. Now, imagine that same setup, but instead of a General Partner, you've got a Trustee at the helm. That's basically an MFT. 

In both these scenarios, the risk for investors is capped at their initial investment, but here's where things get interesting. The MFT has this excellent quality - its tax efficiency. It truly stands out in that department, and that's what makes MFTs really shine in the investment world.”

MFTs accept investments from registered accounts like Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs), making them one of the most tax-efficient methods to distribute income and capital gains to an investor. This unique characteristic makes them particularly useful for ventures such as real estate investments, where substantial capital gains are anticipated.

MFTs are governed by specific requirements from the Canada Revenue Agency (CRA), including the need for at least 150 Unit Holders in one Class of Units by March 31st, which must be maintained subsequently. Falling short of these criteria could result in a deemed withdrawal of funds from registered accounts, leading to unwanted tax implications.

Companies like Axiom Advisors play a critical role in setting up MFTs, ensuring compliance with the CRA's stipulations and efficiently setting up each Class of Units. Axiom's approach involves creating an MFT that satisfies the CRA requirements and setting up an efficient structure that allows funds to flow smoothly from the investor through the MFT and into the corresponding real estate project. The structure also ensures the tax-efficient flow of income and capital gains back to the investor.

Another key feature of Axiom's MFT setup is its ability to insulate different Classes of Units from one another's potential issues, thereby mimicking the benefits of owning multiple MFTs at the cost of one. Additionally, Axiom can tailor the Unit Classes and associated projects to suit specific business requirements, allowing for a flexible investment structure.

In summary, Axiom's MFT provides several unique advantages, including a turnkey MFT structure, ensuring CRA compliance by including 150+ investors, the ability to accept investments from registered accounts to significantly widen the pool of available capital, and a unique structure that safeguards each Class of Units from issues affecting others.

How do I Choose the Most Tax-Efficient Business Structure?

Choosing the most tax-efficient business structure requires a thorough evaluation of various factors to suit your specific circumstances. Begin by assessing your business needs, considering factors such as goals, risk tolerance, industry, and growth plans.

Next, carefully analyze the tax implications of each structure, taking into account income splitting, tax rates, deductions, and credits available. Consider the future growth potential of your business and whether the structure can accommodate expansions, partnerships, or accessing capital.

Seeking professional advice from tax experts, accountants, or legal advisors specialized in business taxation is crucial for informed decision-making. They can provide valuable insights and guide you through complex tax laws and regulations.

Compare the costs associated with each structure, including setup, operational, and compliance expenses. By thoroughly evaluating these factors and seeking professional guidance, you can select the most tax-efficient business structure that aligns with your needs, minimizes tax liabilities, and supports your business's financial success.

To learn more about how Mutual Fund Trusts can help you build a more tax-efficient future, visit Axiom Advisors or email Dwight Martin directly at [email protected].