Transferring a Business to Family Member(s) in Canada [Oct 04, 2019]

You are someone who is close to retirement and considering transferring your shares in the small business to your children. Here are some tips to get you started and avoid some unwanted tax consequences.

The biggest mistake I see that business owners make is transferring (selling) the shares to their family members for no value or nominal value such as $1. If it were this simple everyone would do it. However, there are significant tax consequences for doing this when the business is worth a lot more.

As an example, let’s assume that your business is worth $1,000,000 and you proceed to sell the shares to your adult child for just $1. The Canada Revenue Agency (CRA) will have a problem with this and would reassess the selling price to the fair market value of the business of $1,000,000.

To determine fair market value of your business, the CRA will evaluate:
• The worth of your business’ tangible assets
• The future growth potential of your business
• The current revenues and profitability of your business
• The reputation of your business in the marketplace

Once the CRA has completed their evaluation of your business, they will re-adjust the selling price from $1 to $1,000,000, and will levy capital gains tax on the sale. If the business is a qualified small business corporation, you may be eligible for the Lifetime Capital Gains Exemption (LCGE), presently $867,000.

To make matters worse, your adult child will not receive an upward adjustment in the cost of the shares that he/she purchased from you. Essentially, instead of $1,000,000, the cost of the shares belonging to your adult child will still be $1. If your adult child decides to sell the family business later in life, capital gains tax will be levied again, resulting in the potential for double taxation.

What options are available if you want to transfer (gift) your shares to adult children?

Use an Estate Freeze:

While beyond the scope of this article, here are the simple steps involved in implementing an estate freeze of your company:
1. Create a Family Trust – this is a legal document that the shares of your business are to be held by the Family Trust on behalf of your loved ones. The reason a Family Trust is utilized in an Estate Freeze is to allow you to retain control over your business, even after you transfer it to your loved ones.
2. Cancel your old shares in your company in exchange for newly issued preferred shares that are fixed in value (say $1,000,000). These shares are equal in value to the fair market value immediately before the transfer of your business to your children. Dividends should be paid on your preferred shares, which will ensure you have a steady stream of income in retirement.
3. Issue common shares in your company to the newly created family trust. This allows all of the future growth in the business to accrue to it. The beneficiaries of the family trust shares are your adult children.

If you are contemplating retirement and are considering gifting shares to your adult children, take steps sooner rather than later to avoid unwanted tax consequences. An estate freeze outlined above is one way to ensure an orderly transfer of the shares, and allow the future growth of the business to accrue to the next generation.

For More Information or assistance contact Kevin Cox, CPA, CGA at kevincox [at] coxandcompany {dot} ca

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals