The retirement of many baby boomers from the business world has increased the number of business sales transactions over the past decade. But a transfer is something to be prepared for. Not only do you need to identify and support your successors, but you also need to prepare your for this important milestone.
Unfortunately, many entrepreneurs, faced with a tempting unsolicited offer that must be quickly concluded, must give up a very important tax advantage: the capital gains deduction representing a lifetime exemption of an amount of 971 190$ per taxpayer in 2023.
First, you should know that your business must operate as a corporation. But the good news is that it’s not too late to incorporate, even if you’re about to sell!
On the other hand, if you wish to create a patrimony for your loved ones and multiply these tax savings, you will have to organize your company in a flexible manner and sometimes involve a family trust into your corporate structure to hold shares of your corporation. The shares must be held for a minimum of 24 months prior to the sale. And the longer the holding period, the greater the savings. In addition, it may be necessary to take out from your company’s balance sheet of excess liquidities or other assets not used in the operation of your business. This process must be carefully planned to avoid unwanted tax consequences.
Tax legislation requires that the taxable capital gain (50% of the capital gain) be paid or payable to a beneficiary to be eligible to the capital gain exemption. Many parents do not feel comfortable in transferring such amount of money to their minor children or young adults. Furthermore, parents would have to comply with the applicable law on protection of minors.
Fortunately, tax legislation provides with a mechanism allowing parents to keep control over amounts vested to their children and defer capital distribution while preserving the benefit from the capital gain exemption. Typically, such a plan requires that a new non-discretionary trust be constituted to the benefit of children under the age of 21 years. However, it must be part of an advanced tax plan and be done very carefully in order that conditions under the tax legislation be met. Otherwise, the taxable capital gain would be trapped into the trust and taxed at the highest marginal rate then in force. Other issues shall be considered including the alternative minimum tax a child could be liable.
Though such a tax planning is totally legitimate, under very unexpected situations, it might be subject to the new mandatory disclosure rules with to the tax authorities, on pain of significant penalties. This would be the case, according to a recent tax interpretation from the Quebec revenue agency, where amounts attributed to the founder’s children are invested in a business project of the seller parent. Hence the importance of being well accompanied and monitoring your tax situation.
Finally, the tax rules may restrict access to this deduction where the sale is made within a family group or, in some cases, to a company owned by key employees. However, it will sometimes be possible to structure the terms of the sale to take advantage of the deduction or, alternatively, to minimize the tax burden. Moreover, tax legislation provides with a set of rules applicable to inter-generational transfers allowing that sort of transactions to be eligible to the capital gain exemption, under certain specific circumstances.
Those are just a few aspects of what you should consider on in prevision of your retirement or sale of your business. Be well prepared and address those tax issues sooner than later with your legal and tax advisors.
The comments offered in this article are meant to be general in nature and are not intended to provide legal advice regarding any individual situation. Before taking any action involving your individual situation, you should seek legal advice to ensure it is appropriate for your circumstances.
About the author
Catherine has accumulated nearly 23 years of experience in tax law. She has developed a broad expertise in corporate and personal taxation through a wide variety of mandates in corporate and personal tax planning, wills, estates and philanthropic planning, as well as commercial transactions.