What Are the Tax Consequences of Selling a Small Business I Have Invested in to My Son?

Article content

By Julie Cazzin with Andrew Dobson

Q: I want to sell our franchise to my eldest son. Profits are $75,000 to $100,000 year after year, but sales are more than $2 million. We don’t own the building; We lease it from a large company. We only own the interior and signage. I want to sell it to my son at what I consider to be its fair market value so that the Canada Revenue Agency doesn’t come back at some point in the future and demand more capital gains taxes. I estimate the value to be between $400,000 and $450,000. The transfer of franchise rights to my son is done free of charge by the franchise owner and the equipment costs approximately $250,000. Will the CRA agree to this or will there be problems? What do you suggest me? –Larry

Article content

Article content

FP answers: Transferring or selling a business to children can be a strategy for business owners to achieve intergenerational wealth transfer. Since franchisees are bound by franchise agreements, this is probably the best place to start examining any sales restrictions. A franchise agreement could dictate the terms and conditions that the franchisee must comply with before selling their franchise. For example, many franchises require pre-approval from new buyers/franchisees in order for the franchise to be transferred to the new owner.

Article content

A business owner thinking about selling their business should consider obtaining a business appraisal to determine value before selling. Chartered Business Valorators (CBVs) are experts in this field and can ensure your business is properly valued, which is important in a sale involving a non-privileged family member.

CBVs examine items such as equipment depreciation, sales, financial ratios (e.g., price-to-book ratio and price-to-earnings ratio), goodwill, and inventory turnover, among other things. You can also compare your business with similar, recently valued companies to properly value your business.

Article content

Article content

You pointed out that determining your fair market value is important to the company for tax purposes, and that is a correct statement. You cannot sell your business or other asset to a family member at low value to reduce tax. When assets are transferred or sold to a non-arm’s length recipient, such as a family member, the sale is generally considered to have been made at fair market value.

By obtaining an appraisal, you can ensure that you approach this part of the transaction fairly. It can also be useful if you decide to sell your business to a third party or if your son decides not to take over the business.

Your shares may also qualify for the lifetime capital gains exemption, which could allow you to realize a capital gain of up to $1,016,836 when you sell shares in your company and qualify for a counterdeduction on your taxes. This could make the sales proceeds tax-free.

To qualify for the exemption, your business must pass several tests, including:

• The Qualifying Small Business Test: Your business must be a Canadian-controlled private corporation.
• The holding period test: You must have held the shares for at least 24 months before selling them.
• The fair market asset test: 24 months before selling your company, at least 50 percent of the fair market value must be invested in the active company. In addition, 90 percent of the assets’ fair value must have been used in active business operations at the time of sale.

Article content

There are some additional considerations regarding how a business is taxed upon sale. For example, you may have insurance policies, a vehicle, or accumulated savings that you want to get out of the business before selling, which could result in you having to pay taxes.

Or your buyer, whether your son or someone else, could offer to buy the company’s assets, such as shares, in lieu of shares. B. Equipment, goodwill and leasing. If your company sells the company’s assets, the sale would not be tax-free and the company would pay capital gains tax.

Even if your stock sale falls under the lifetime capital gains exemption, you may be required to pay the alternative minimum tax (AMT). The AMT is collected based on a formula and can be applied in situations where an individual’s income tax payable in a given year is too low, but he or she has significant income that is subject to preferential tax treatment.

Note that AMT is a form of refundable tax that can be carried forward and claimed in the future to reduce tax in a subsequent year. It may not apply specifically to your situation, but it’s good to at least mention it for others as part of this discussion.

Andrew Dobson is a fee-only and advisory Certified Financial Planner (CFP) and Chartered Investment Manager (CIM) with Objective Financial Partners Inc. in London, Ontario. He does not sell any financial products. He can be reached at [email protected].

Article content