Transferring a business to a family member effectively
January 14, 2019
Now that the baby boomers are nearing retirement age, some may wish to transfer their business to a family member within Canada, and here are some tips on how it is done.
First, mistakes in this procedure could happen, the biggest one is selling their business to the desired family member with a specific dollar value despite being worth a lot more, and this could potentially bring dangerous consequences. For example, hypothetically speaking, if you own a business, and it’s worth $200,000, and the owner sells it to a family member for $10,000, as a result of selling the business for less than its actual value, the Canada Revenue Agency will reassess the sale to the fair market value of the business. To obtain a fair market value, the CRA measures a few things:
1) Tangible assets
2) Future potential growth of the business
3) Current revenue and profitability
4) The reputation of the business in the marketplace.
Once this process is complete, the CRAs could reassess the sale, from the $10,000, to the actual fair market value of $200,000. As a result, the CRA will levy a capital gain tax on the sale. The new owner of the business now does not receive an upward adjustment on the cost of the shares that were purchased, thus the cost of the shares that the family member now owns will not be $200,000, but the initial $10,000. To make matters worse, double taxation (a capital gain tax levied again) could potentially be applied should the family member decide to re-sell the businesses in the future.
Now, let’s take about the correct way of transferring a small business to a family member, and that is an Estate Freeze. This process will allow you the following:
- Transfer your business to a family member without incurring capital gains tax
- Retain control of your business after the transfer
- Have a steady stream of retirement income
How to implement an Estate Freeze? Well, simple:
1: Create a family trust: this states that the shares of the business are to be held by the family trust to the benefit of loved ones. This also allows a person to retain control of the business after its sale.
2: Cancel existing shares in your company: in an exchange with preferred shares, which are fixed in value and are equal to the fair market value of the shares. Dividends should also be paid on the given shares, therefore, guaranteeing consistent income during retirement years.
3: Issue common shares to the Family Trust: this allows future growth of the business to accrue for the benefit of the family business.
In sum, implementing an Estate Freeze to transfer a business to a family member in Canada guarantees that capitals gain tax doesn’t apply, further allowing control of the businesses post-sale, and ultimately secure a steady stream of cash during retirement.