Intergenerational Business Transfer and Family Tax Planning

Neufeld Legal PC: Chris@NeufeldLegal.com - 403-400-4092 / 905-616-8864

An intergenerational business transfer is a complex, multi-faceted tax planning strategy, which builds on recent legislative changes to facilitate a more advantageous outcome for business owners to pass their business on to family members. The key is to structure the transaction to minimize tax liability, particularly by leveraging the Lifetime Capital Gains Exemption.

The New Intergenerational Transfer Rules

Prior to recent changes, there was a tax disadvantage to selling a business to a family member compared to selling it to a third party. The profits from an intergenerational transfer could be treated as a dividend rather than a capital gain, which meant the seller couldn't use their Lifetime Capital Gains Exemption.

New rules, stemming from Bill C-208 and subsequent amendments in 2024, aim to level the playing field. These rules allow for the disposition of shares to a family member to be treated as a capital gain, enabling the use of the Lifetime Capital Gains Exemption.

To qualify, a "genuine" intergenerational business transfer must occur, which is defined by several conditions and is divided into two main options:

  • Immediate Transfer: The transfer must be completed within 36 months. This is suitable for businesses where the child is already actively involved and the parent is ready to step away completely.

  • Gradual Transfer: This phased approach allows for the transfer to be completed over a period of 5 to 10 years. It's better for larger, more complex businesses that require a longer transition period for management and ownership.

Core Requirements for Both Approaches:

  • The transferred shares must qualify as Qualified Small Business Corporation (QSBC) shares or Family Farm or Family Fishing Corporation (FFFC) shares.

  • The child (including nieces, nephews, and grandchildren) must be at least 18 years old and must control the purchasing corporation.

  • The parent and child must file a joint election with the Canada Revenue Agency (CRA).

  • The child must be actively engaged in the business during the required period.

  • The parent must relinquish control and management of the business within the specified timeline for the chosen transfer type.

  • The business must continue to be an active business.

Failing to meet these conditions can be a significant risk, as it could result in the transaction being reclassified as a dividend, leading to a substantial increase in tax liability.

Key Tax Planning Strategies

Beyond the new rules, several established tax strategies are crucial for a successful intergenerational business transfer:

A. Utilizing the Lifetime Capital Gains Exemption:

  • The Lifetime Capital Gains Exemption allows individuals to realize a certain amount of capital gains tax-free on the disposition of qualifying property, such as QSBC or FFFC shares.

  • This is often the cornerstone of the tax plan for a business transfer, as it can significantly reduce or eliminate the tax on the sale.

  • The amount of the Lifetime Capital Gains Exemption is indexed to inflation and has increased in recent years.

B. Estate Freeze:

  • An estate freeze is a common and effective strategy to lock in the current value of the business for the owner and transfer future growth to the next generation.

  • The owner exchanges their common shares for fixed-value preferred shares. Any future growth in the company's value accrues to new common shares, which are then issued to the children (or a family trust).

  • This allows the parent to crystalize their capital gain at a specific value, which can be covered by their Lifetime Capital Gains Exemption, and ensures that any future appreciation is taxed in the hands of the children.

C. Use of a Family Trust:

  • A family trust can be used to hold the new common shares after an estate freeze.

  • This provides flexibility and control, especially if the children are young or there are multiple heirs.

  • It can also be a powerful tool for income splitting and multiplying the Lifetime Capital Gains Exemption across multiple family members, as the sale proceeds from a future transaction can be distributed to multiple beneficiaries, each able to claim their own Lifetime Capital Gains Exemption.

D. Vendor Take-Back Debt and Capital Gains Reserve:

  • If the business transfer is structured as a sale where the parent provides financing to the children (a vendor take-back debt), the parent may be able to use the capital gains reserve.

  • This allows the parent to defer the tax on the capital gain over the period of the payments, spreading the tax liability out over several years (up to 10 years for qualifying transfers).

E. Other Important Considerations

  • Valuation: The CRA expects a "reasonable" valuation of the business to support the transaction's fair market value. An independent, third-party valuation is highly recommended.

  • Legal and Operational Transition: Tax planning is only one part of the equation. A comprehensive plan should also address the legal structure of the new business, management succession, and family governance to minimize conflicts.

  • Professional Advice: Due to the complexity of the new rules and the significant tax risks involved, it is essential to consult with a team of professional advisors, including tax accountants and lawyers, to ensure the plan is structured correctly and all conditions are met.

For knowledgeable and experienced legal representation for business succession planning, including intergenerational business transfers, contact lawyer Christopher R. Neufeld at Chris@NeufeldLegal.com or call 403-400-4092 (Calgary, Alberta) / 905-616-8864 (Toronto, Ontario).

Keys to a Business Succession Plan

Business succession planning is a complex but crucial process designed to ensure the smooth transition of ownership and/or management of a business when the current ownership is ready to exit, or circumstances have effectively necessitated a transition in business ownership, on account of death or disability. Read more.

Keys to a Personal Wealth Succession Plan

A personal wealth succession plan is a comprehensive strategy for managing and distributing your assets during your lifetime and after your death, while minimizing taxes, maximizing value for beneficiaries, and ensuring your wishes are carried out, which goes beyond a last will & testatment. Read more.

Business Succession Planning - Contingency Arrangements

Business succession planning isn't just about planning for the optimal outcome, it is also about establishing contingency arrangements in the event the original plan cannot be implemented as originally intended or its actual implementation (as impacted by how the business situation has changed over time) would run counter to the planner's overarching objectives. Read more.

Mistakes when developing a Business Succession Plan

To develop a successful business succession plan, it is important to avoid common mistakes that have been previously made by other business owners with respect to their own failures in business succession planning. As such, it is worthwhile to review and understand those common mistakes when developing a business succession plan, . .  . Read more.

 

What is Estate Planning

NOT LEGAL ADVICE. Information made available on this website in any form is for information purposes only. It is not, and should not be taken as legal advice or tax advice. You should not rely upon, or take or fail to take any action, based upon this information. Never disregard professional legal advice or delay in seeking legal advice because of something you have read on this website. The law firm of Neufeld Legal PC would be pleased to discuss legal matters referenced in this website upon their retention in accordance with applicable requirements pertaining to client retention by this law firm. Thank you.