FP Solutions: What are the tax penalties of promoting a small enterprise to my son?

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By Julie Cazzin with Andrew Dobson

Q: I wish to promote our franchise to my oldest son. The revenue yr after yr is $75,000 to $100,000, however gross sales are greater than $2 million. We don’t personal the constructing; we lease it from a big firm. We solely personal the tools inside and the signage. I want to promote it to my son on the honest market worth I personally imagine it to be, so the Canada Income Company won’t come again someday sooner or later and request extra capital positive factors taxes. I assess it to be price $400,000 to $450,000. The switch of the franchise rights to my son is free from the franchise proprietor and the tools is about $250,000. Will the CRA be OK with this or will there be issues? What do you recommend I do? — Larry

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FP Solutions: Transferring or promoting a enterprise to kids is usually a technique for enterprise house owners to perform intergenerational wealth switch. Since franchisees are sure by franchise agreements, that’s probably the very best place to start out reviewing any restrictions relating to a sale. A franchise settlement may dictate the phrases the franchisee should adjust to earlier than promoting their franchise. For instance, many franchises require pre-approval of recent patrons/franchisees in an effort to permit the franchise to switch to that new possession.

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A enterprise proprietor contemplating the sale of their enterprise ought to think about acquiring a enterprise appraisal to evaluate the worth previous to the sale. Chartered enterprise valuators (CBVs) are specialists on this discipline and will guarantee your small business is correctly valued, which is vital for a sale involving a non-arm’s-length member of the family.

CBVs will test objects akin to tools depreciation, gross sales, monetary ratios (for instance, value to guide and value to earnings), goodwill and stock turnover, amongst different objects. They might additionally evaluate your small business to comparable, just lately appraised companies to pretty worth your small business.

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You made the purpose that figuring out your honest market worth for the enterprise can be vital for tax functions and that may be a right assertion. You can’t promote your small business or one other asset for a low worth to a member of the family to scale back tax. The disposition is usually thought of to be executed at honest market worth when transferring or promoting belongings to a non-arm’s-length recipient akin to a member of the family.

Acquiring a valuation can guarantee you’re approaching this a part of the transaction pretty. It may additionally are available helpful should you resolve to promote your small business to a 3rd occasion or in case your son decides to not take over the enterprise.

Your shares may additionally qualify for the lifetime capital positive factors exemption, which may will let you have a capital achieve of as much as $1,016,836 upon the sale of shares in your small business and qualify for an offsetting deduction in your taxes. This might make the sale proceeds tax free.

With a view to qualify for the exemption, your small business should go a number of checks, together with:

• The certified small enterprise company take a look at: Your enterprise should be a Canadian-controlled non-public company.
• The holding interval take a look at: You will need to have held the shares for at the least 24 months previous the sale.
• The honest market worth asset take a look at: 24 months previous to promoting your small business, at the least 50 per cent of its honest market worth should be used within the energetic enterprise. Additionally, on the time of sale, 90 per cent of the honest market worth of the belongings will need to have been used within the energetic enterprise.

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There are a couple of further concerns about how a enterprise is taxed upon its sale. For instance, you could have insurance coverage insurance policies, a automobile or accrued financial savings you wish to extract from the enterprise previous to the sale which will end in tax payable to you.

Or your purchaser, whether or not your son or in any other case, may supply to purchase the belongings of the enterprise, akin to tools, goodwill and the lease, as a substitute of the shares. In case your company sells the belongings of the corporate, the sale wouldn’t be tax free and the corporate would pay capital positive factors tax.

Even when your share sale qualifies for the lifetime capital positive factors exemption, there is likely to be a must pay the choice minimal tax (AMT). The AMT is levied primarily based on a system and may apply in conditions the place somebody’s earnings tax payable is simply too low in any given yr, however they’d vital earnings that was topic to preferential tax remedy.

Word that the AMT is a type of recoverable tax that may be carried ahead and claimed sooner or later to scale back tax in a subsequent yr. It might not apply to your state of affairs particularly, however it’s good to at the least point out it for others within the context of this dialogue.

Andrew Dobson is a fee-only, advice-only licensed monetary planner (CFP) and chartered funding supervisor (CIM) at Goal Monetary Companions Inc. in London, Ont. He doesn’t promote any monetary merchandise in anyway. He will be reached at adobson@objectivecfp.com.

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