INFocus: Passing your business to the next generation

Date: November, 2012 chess board pawn piece

Originally published in the Fall 2012 issue of Comments.

Are you a business owner planning to transfer your business to a younger family member? While it is a proud moment to be able to keep the business in the family, many factors need to be considered to ensure the best result possible.

Tax implications

When shares of a private company are given or sold to a family member, the owner must (for income tax purposes) declare the fair market value of the shares. The declared value is then used to calculate the income tax consequences as of the date that they are given or sold. However, with appropriate tax planning it is generally possible to defer that tax for an extended period of time. This is commonly referred to as a tax freeze.

The fair market value of the company at the time of the tax freeze will be the amount that the original owner will eventually have to pay tax on. To avoid immediate tax consequences, it is important to make a reasonable attempt to place a correct value on the shares at the time of the tax freeze. This could be accomplished by hiring a Chartered Business Valuator (CBV) to prepare the valuation.

Some tax freezes cannot be undone if circumstances change, so it is important to have a full understanding of the implications before undertaking such a step. Be sure to consult with your tax advisor.

Retaining control

In cases where the day-to-day operations of the business are being handed down, the original owner does not have to relinquish all of his or her power. He or she can continue to offer significant contributions and advice. In addition, even if the common shares are passed on, there is no requirement to give up control. This is especially important if the company remains a source of retirement income for the original owner. Retaining control of the ‘bigger issues’ such as selling the company, and mergers and acquisitions is worth consideration.

If a retirement income stream is going to be drawn from the company, the former and new owners should discuss these details beforehand. This could be in the form of dividends on preference shares, from a continued salary, management fees, etcetera, and should be in an amount that meets the objectives of both family members.

Equally does not mean identically

With more than one child, or intended beneficiary of your estate, it can be difficult to treat each individual equally. This is particularly true if there aren’t enough other assets to balance the value scales between beneficiaries, and/or if only one child is interested in operating the business.

As a starting point, it is a good idea to figure out what the fair market value of the business is. In fact, this process may already be underway for tax planning purposes. If other assets are available, it may be possible to have an equal distribution between all intended beneficiaries (albeit of different assets).

One possible solution is to grant shares to the beneficiaries who aren’t active in the business. This way, they can still enjoy some of the benefits of ownership (i.e., dividends, or proceeds from an eventual sale). The shareholders who are active in the business deserve to be compensated for their time and effort, but should not be able to withdraw profits beyond that amount, if there are other shareholders. Deciding how much the active shareholders should receive, and how much influence, if any, the non-active shareholders should have will require considerable planning. Any such plan will have to be specifically tailored to each unique situation.

Family law considerations

Family law and tax planning can often create conflicting goals. The reason for this is that an early transfer of assets to the next generation is generally considered good tax planning. While a later transfer of assets may be considered good family law planning. That said, there remain many strategies, which can be used to help insulate assets from a potential future matrimonial separation of the new owner.

In Ontario, when a person separates from their spouse, each spouse is generally entitled to one-half the net assets accumulated during the marriage. Third party gifts and inheritance can be excluded from that pool of assets if they were received during the marriage (referred to as ‘excluded property’). If you intend to pass along an asset (such as a business),you may wish to ensure that it, as well as any growth in value, remain with the person you gave it to, and will not have to be shared with their spouse in the event of a separation. If so, it is advisable to wait until after the recipient is married before you gift the shares to them. If the transfer is to be by way of a sale instead of a gift, then the exclusion rules from family law will not apply. In any event,


If there are no successors to the business in the family than it may be time to consider selling to a third party. Our winter 2012-1 issue of Comments contains an article, which provides some insight into issues surrounding the sale of a business to a third party.

When transferring a business to a family member, it is critically important not to make decisions about business succession in isolation; everything is related and interconnected. Tax, retirement, estate, and family law planning all require ‘big-picture’ thinking, for not only existing owners but future recipients as well. When you decide to have these discussions with your financial advisors, the more complete the background and information you can provide, the more comprehensive the advice they will be able to offer.

Connect with the Author

For more information about Crowe Soberman’s Succession | Retirement | Estate Planning (SuRE) Group, please contact Alan Wainer or Jordan Caplan.

Specific professional advice should be obtained prior to the implementation of any suggestion contained in this article.

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