If you are looking to transition your business to your children or grandchildren in the near future, there is a tremendous opportunity to do so under the new intergenerational transfer rules contained in section 84.1 of the Income Tax Act (Canada) (the “ITA”).
In the simplest terms, where you qualify for these rules, you can transfer your business to your children or grandchildren using your lifetime capital gains exemption to shelter part or all of the tax (depending on the size of the business and how many capital gains exemptions are available to you) AND you can essentially use the retained earnings (i.e., after corporate tax money) inside of your company to pay the purchase price. In simple terms, you can “strip” money out of your corporation tax-free.
Let me tie this into a couple of related questions that I am frequently asked. A business owner wants to transfer the business to his children and asks me if he can simply gift the shares of the corporation to his children. The answer to this is, yes, for sure you can. HOWEVER, a gift of the shares (or any asset for that matter) to a non-arm’s length party (such as a child) will be deemed to occur (per section 69 of the ITA) at fair market value. Accordingly, although you wish to gift the asset to your child and, indeed, you are not receiving any proceeds of disposition (as it is a gift), you are deemed to have received proceeds of disposition equal to fair market value of the asset. If your shares qualify as “qualified small business corporation shares” (“QSBC Shares”), and you have not used (or not fully used) your lifetime capital gains exemption, you may be able to shelter the tax using the lifetime capital gains exemption (subject to other considerations like Alternative Minimum Tax). If the shares are not QSBC Shares, you can still gift the shares of course, but you will trigger a capital gain equal to the difference between the then fair market value of the shares and your adjusted cost base of the shares.
The intergenerational transfer rules are very advantageous if you qualify and if the circumstances are right. You can still use your capital gains exemption but take it one step further and actually remove excess retained earnings from your company tax free. If you simply pay a dividend out of your company to yourself you will likely pay at least 40% (and possibly as much as over 50%) tax. Using the intergenerational transfer rules you may be able to pull out, completely tax-free, an amount equal to the purchase price of the business. Of course, the rules have to be properly analyzed to ensure that you qualify for these rules. As of January 1st, 2024, the rules were amended to ensure that these transactions are limited to genuine intergenerational transfers. Please inform yourself as to what your most tax-efficient method is to transfer your business to your children, and preserve that wealth for your family.
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