New tax rules for selling your business to family
Who thinks about taxes during the summer? Owners of small, family-owned businesses are celebrating new tax rules that came into effect at the same time barbeques were being fired up. Bill C-208 passed on June 29, 2021, with a promise to facilitate intergenerational transfers for small business owners, including the owners of a family farm or fishing property.
One group of small business owners who are celebrating are insurance brokers. “Many of the 3,400 insurance brokerages represented by our Member Associations are family-owned and operated,” says Peter Braid, chief executive officer for the Insurance Brokers Association of Canada. “IBAC felt that it was important to speak on their behalf and ensure that Ottawa supported the family succession of brokerage firms.”
There’s a lot to consider if you’re thinking of selling your business to family, including the financial benefit, tax options, and developing a plan that will enable you to walk away.
New Tax Rules
Bill C-208 is scheduled to come into effect on Jan. 1, 2022. It’s intended to make it easier for families to transfer a small business between generations, including a family farm or fishing business.
Previously, the Income Tax Act had rules that could make it more financially advantageous for an entrepreneur to sell shares of their business to a third party, instead of to children or grandchildren. A long-standing anti-avoidance rule in the Income Tax Act treats profits from the intergenerational transfer of a business as a dividend rather than a capital gain. Bill C-208 has changed that rule to allow to apply the lifetime capital gains exemption to these profits.
But because the legislation is new, details still need to be ironed out and some accountants expect further amendments.
Taxes Are Complicated
It’s tempting to scribble out a bill of sale on a napkin, “I sell the business to Suzie for $1,” but this isn’t going to pass muster with the Canada Revenue Agency.
There are a number of taxation options to consider as part of a good transition plan, including:
Incorporate: According to the Government of Canada’s Business Development Bank, the profits from the sale of an unincorporated business don’t qualify for the lifetime capital gains exemption and generally can’t engage an estate freeze.
Fair market value: Selling for less than fair market value could disadvantage both the parent (at the time of the sale) and eventually the new owner when they seek to sell the business themselves.
Lifetime capital gains exemption: In some cases, this applies to small business owners when they sell a farm, fishery property or private qualifying shares. The change in taxation rules will make this benefit available to more family-owned businesses.
Estate freeze: This involves locking in the current value of the company and issuing shares to the family members who intend to take over. This can help reduce your taxes and ensures any future growth is taxable in the hands of the new owner. This is a common method used for intergenerational transfers.
When considering the sale or intergenerational transfer of your business, you should always consult a tax-planning professional and experts such as accountants, lawyers, business brokers and banks who can help you figure out a path forward through a thicket of rules.
Plan Early
Maybe you want to sell your business in order to start a new business, to free up cash for another venture, or to retire and enjoy good times with friends and family or on a warm beach in the winter.
Even if you don’t want to sell—yet—it’s a wise idea to start the discussion early with family members. It can minimize family drama to share your thinking if one sibling is chosen over another – or to determine if they even want to take over the family business. Instead of assuming one or more of your relatives are on board, open a conversation about who’s interested and what are their plans.
If you can name a successor and show them the ropes early, that will make the transition easier when you finally decide to hand over the keys and move on.
Discussing the transition early will allow you to plan how to minimize taxes associated with the business’s sale. When a business transition happens suddenly due to the owner’s death or an urgent health issue, there may be fewer options to save on taxes.
Scotiabank suggests questions for an entrepreneur to ask themselves before selling a company to family:
- Who in your family has the drive, aptitude, skills, interest and commitment?
- Will one person or multiple family members take over the business?
- Will I ask for an up-front price or receive payments?
- Who will be disappointed by the transition plan?
- How and when will the transition take place?
- What do I need to do to release my day-to-day responsibilities?
Your walking-away timeline should consider how a smooth transition can best serve the business, what you personally want to do, and how that meshes with the chosen successor’s plans.
Early planning will allow you to figure out a strategy for taxes and other succession issues. Then you’ll be on your way out the door, secure in the future of the business you created, and on your way to your next great adventure.
SOURCES
https://www.mnp.ca/en/insights/directory/tax-alert-bill-c-208-approved?sc_trk=%7B2B89DFFC-02C6-41B8-BF0E-4A7DD54D1169%7D
https://www.pwc.com/ca/en/services/tax/publications/tax-insights/tax-relief-intergenerational-transfers-small-businesses-family-farms-2021.html
https://www.scotiabank.com/ca/en/small-business/advice-centre/selling/sell-your-business-to-family-or-strangers.html
https://www.bdc.ca/en/articles-tools/change-ownership/plan-succession/how-to-minimize-the-tax-hit-in-a-family-succession