Many business owners neglect to adequately consider the importance of planning a smooth transition to the next generation. Too often business owners find themselves in a position where they are ready to transfer ownership to their children, but have done nothing to prepare for that day in advance.
It is not all bleak. The government has implemented a number of rules to ease the burden of transition, but they may be inadequate depending on the size of the company. The most significant rule governing the transfer of shares to a child is the capital gain exemption which enables the transfer of shares of a Canadian Controlled Private Corporation to a maximum value of $850,000 on a more or less tax free basis . If a husband and wife each own 50% of the shares, this amount is increased to $1,700,000. Most small business will fall squarely within this threshold. There are a number of caveats to be aware of when structuring such a deal.
a) A Canadian Controlled Private Corporation is defined as a company that is carrying on an active business in Canada. It cannot be a company that holds a stock portfolio or rental properties that employs less than five full time employees. In other words, it must be involved in the provision of a good or service to customers for profit.
b) A majority of the assets on the balance sheet (>50%) must be involved in the conduct of the active business for a period of 2 years prior to the disposal
c) At the date of disposal, 90% of the value of the assets must be involved in the conduct of the business. This is a tricky one, Often corporations particularly small private ones have a build up of redundant assets on their balance sheet.
d) The determination of the value of a business is a complex process that involves a number of detailed calculations. A valuation is required to determine what 50% or 90% of the value of the business is at the date of succession. All of this needs to be documented since it may be reviewed by CRA should they wish to determine that you were operating within the lines.
There are other strategies available in planning for succession rather than a direct transfer of shares to children. The primary one is an estate freeze which involves a complex series of steps to allow future growth of the enterprise to accrue to the next generation. Regrettably,it is beyond the scope of this paper.
So we can see that a number of steps need to be performed and adequate consideration given to any transfer to children. Anything done without careful consideration of the tax consequences could result in substantial penalties.