Transferring Your Business to the Next Generation
So, there are some common mistakes that people often make when they are transferring a business to the next generation.
The biggest mistake is that business owners will set the value of their business at a dollar and sell it for a nominal value to the next generation because they essentially want to gift it to the next generation. The problem with this is that the Canada Revenue Agency (CRA) will take a look at that transaction and will assess the value of the shares at the actual fair market value of the shares.
So, if the Canada Revenue Agency discovers that the actual fair market value of your business is a million dollars, then they will adjust the selling point of those shares from a dollar to a million dollars, which means that the seller will be hit with the capital gains tax on that amount.
What does this mean for the Purchaser?
But meanwhile, the purchaser, the value of their shares will not move from a dollar. So, they’ll still have shares with an adjusted cost base of $1, which means that down the line, when they sell those shares, they’re going to pay a huge capital gain tax on that as well. So, whatever the difference is between a dollar and the value of the sale of the business in the future.
So, if it’s worth $2 million, at that point, they’ll pay a capital gains tax of just under $2 million, which means that at the end of the day, $3 million in capital gains taxes has been paid, which is double taxation and a huge waste of resources.
So, don’t fall into that trap.
So what is the proper way of transferring your business to the next generation?
The use of an estate freeze and a family trust. An estate freeze permits you to transfer your business from yourself to the next generation, without incurring any capital gains taxes and allows you to retain control over the business, and also allows you to maintain a steady stream of income that’s going to serve you throughout retirement.
Step 1: Create a Family Trust
So the first step is to create a family trust, also known as a discretionary family trust. A family trust is a legal document that will hold shares in your operating company for the benefit of your chosen beneficiaries. So your loved ones, the next generation, or their holding companies, however, you choose to set it up. You or another person of your choosing will act as a trustee and will control the trust. So this way, instead of transferring your shares to the next generation, so that your 20-year-old son or daughter can take those shares, cash it out and then buy that Lambo, you are able to maintain control over the business while allowing them to receive proceeds from the business as they become more and more involved and take on more responsibility in running the family business.
Step 2: Cancel your Common Shares
The second step is that you are going to cancel your existing common shares in the company and exchange them through what’s called a Section 86 rollover for preferred shares. These preferred shares are going to freeze the current value of your business so that you retain the full value of the business and can redeem those shares over time so that you can continue to receive an income from your business.
Finally, you’re going to issue new common shares, which are going to be subscribed for by the family trust that you’ve just set up. So, the family trust can receive dividends from the operating company and then distribute those dividends to the beneficiaries according to your wishes.
The estate freeze family trust is a cost-effective and efficient way for you to transfer the wealth of your business from this generation to the next generation while allowing you to continue to retain control and autonomy over your business.
So, if you have any other questions about the family trust or estate freeze planning, please don’t hesitate to reach out, drop a comment below, and as always, thanks for watching, and please hit subscribe.