Transferring Business to Family Member in Canada

Allan Madan, CA
 Jul 6, 2016
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As a baby-boomer coming close to retirement, you may consider transferring your business to a loved one in the future. Here are a few simple tips to get you started.

Mistakes You Can Make When Transferring a Business

Selling Business to adult child

The biggest mistake that business owners make is selling a business to their family members for a nominal value, such as $1. If it were that simple, everyone would do it. However, there are significant, negative consequences for selling your business at $1, when it’s worth a lot more.

For example, let’s assume that your business is worth $500,000 and that you sold it for $1 to your adult child. As a result of selling your business for less than its actual value, the Canada Revenue Agency (CRA) will reassess the selling price to the fair market value of your business.

To determine fair market value of your business, the CRA will evaluate:

Fair Market Value of Business

  •   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 $500,000, and will levy capital gains tax on the sale.

    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 $500,000, 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.

    Use an Estate Freeze

    The correct method to transfer your business to a family member in Canada is to utilize an Estate Freeze.

    Using an Estate Freeze will allow you to:

    • Transfer your business to family members without incurring any income tax whatsoever;
    • Retain control of your business after the transfer; and
    • Have a steady stream of retirement income

    How to Implement an Estate Freeze

    Step 1: Create a Family Trust
    A Family Trust is a legal document which states that the shares of your business are to be held by the Family Trust on behalf of your loved ones. The main reason a Family Trust is used in an Estate Freeze is to allow you to retain control over your business, even after you have transferred it to your family members.

    For instance, imagine that you sold a multi-million-dollar business to your 19-year-old son without a Family Trust. Your son may say, “Mom and dad, thanks for giving me your company. You no longer have control, so I’m going to buy a Ferrari and squander all of the money.”

    Step 2: Cancel your old shares in your company in exchange for new preferred shares
    Preferred shares are fixed in value, and are equal to the fair market value of your business immediately before the transfer of your business to your family members. Dividends should be paid on your preferred shareholdings, in order to ensure that you have a steady stream of income during your retirement years.

    Step 3: Issue common shares in your company to your newly created Family Trust
    This will allow the future growth value of your family business to accrue to your Family Trust.

    Conclusion

    You must implement an Estate Freeze in order to transfer your business over to a family member in Canada. It will avoid any income tax on the transfer of your business to your loved one and allow you to retain control of your business through the use of a family trust. This will also ensure a steady stream of retirement income for you in the long run.
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    Disclaimer

    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. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.

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    Comments 16

    1. Hi there,

      I looking for the best possible way to transfer ownership of the family business. My main concern is tax implications not retention of control.

      Thanks
      Victor

      1. Hi Victor,

        The best method of transferring ownership of a business is to transfer the shares of the company to the other party.
        If you are transferring the shares to your family members, you have the option of selling the shares or the option of gifting the shares. In terms of tax implications, if you sell the shares at a gain or loss, it will be reflected according in your personal tax return, and 50% will be taxable. You may be able to claim the capital gains exemption on the sale of shares.

    2. Hi Allan,

      I have a family business in Canada, and I would like to know how can I transfer my sister’s shares of the company to my niece (my sister passed away, thus i would like to transfer her shares to her daughter).

      Thanks,
      Reema
      r

      1. Hi Reema,

        I presume that you inherited the shares from your deceased sister. I will answer your question based on this presumption. When your sister passed away, her shares were deemed by the Canadian Income Tax Act to be sold at their fair market value on the date of death. If your sister’s shares increased in value from when she acquired them, then her estate would have to pay tax on the capital gain realized on the deemed sale.

        Since your sister’s shares were transferred to you on her death, we must determine the cost basis of those shares to you. Your cost basis in your sister’s shares is equal to the fair market value on the date of your sister’s death. If you plan on immediately ‘gifting’ or selling those shares for market value to your niece, you will not realize a capital gain on the transfer.

    3. Hi Allan,

      I would like to know if you can please explain how a flexible estate freeze works ? Can I redeem my newly exchanged preferred shares over years? Lets say 10% in each of the next 4 years and then remaining 60% down the road ?

      Thanks

      1. Hi Shumaila,
        Thank you for your question.
        It depends on whether the freeze shares issued to you are redeemable and retractable. Assuming that they are, the board of directors must pass a resolution to have the corporation redeem the shares in the manner you prescribed.

    4. Hi,

      My brother and I are considering doing an estate freeze with our corporation. We will take back preferred shares and then the kids can acquire common shares. However our sister passed away a while back. She never had any shares of the company but we would like to transfer some of the business over to her daughter. I was wondering what was the best way to do this? Would our niece be able to acquire common shares too after the estate freeze without any major tax implications?

      Riley

      1. Hi Rilley

        Once you freeze the corporation, you can issue common shares to your niece. She will have to pay a nominal amount to acquire the common shares. Note that if she is a minor, then the shares must be held in trust for her.

    5. My younger brother and I each own 50% of our company. Can I (only) freeze my shares in return for preferred shares while my brother keeps his original shares ? My son will then be issued different shares in the corporation going forward.

      1. Hi Blair,

        Yes, this can be done. If you and your son have the same class of shares, then you must exchange your shares pursuant to Section 85 of the Income Tax Act and complete form T2057 along with a Section 85 rollover agreement. If you and your son have separate classes of shares, then you can exchange your shares pursuant to Section 86 of the Income Tax Act and complete a Section 86 Share for Share Exchange Agreement.

    6. Hello Allan,
      I run a business in Vancouver BC. The other 50% share holder is my husband who has abandoned the business and left the country. I am in the process of divorcing him. He is wanting to give his 50% of his shares to our 3 children and wants nothing more to do with the business at all. I am wondering how this can be done?

      Thank you,
      Pam

    7. Thank you Madan for the informative video and tips. can the settler be a third party who has no interest in the business nor associated with the business?

    8. Hi SuperAmin!
      I want to know if there will be any ramifications in this transaction: Nephew is running the business for Uncle, Uncle owns 100% of the shares. Nephew and Uncle have agreed that Nephew should have controlling interest in the business because Uncle is getting older, and Nephew wants to ensure the continuation of the business he’s invested 10 years into. Nephew will buy Uncle’s shares (51%) for FMV with his after-tax earnings. Uncle will claim the proceeds under his lifetime exemption on his personal tax return as he’s not used any of it so far.
      Will this trigger any tax complications for Uncle?
      Is Uncle able to give Nephew a payment arrangement for the proceeds of disposition?

      thanks kindly.

      1. Hi, Barb. The uncle should make sure that his shares are “Qualified Small Business Corporation Shares” so that he can claim the life time capital gains exemption. Note: The uncle may have to pay Alternative Minimum Tax on the sale of the shares, but he can have this amount credited against taxes payable in future years. A payment arrangement can be made.

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