by Martin Saxton
PASSING THE TORCH
– a.k.a. Cashing in your Chips
At some point in every business owner’s life, most begin to ask the question, ‘What comes next?’ Whether it is to pass the torch to the next generation, enjoy a well-earned retirement or to fund your next entrepreneurial endeavour, selling a business has major fi nancial implications. Maximizing the value, and minimizing the tax bite, requires detailed planning that should start well ahead.
WHAT ARE YOU DOING?
When planning an exit strategy, consider fi rst what you are try- ing to achieve. If you hope to transfer a viable business to your kids, you may not want to squeeze every drop of value from the transaction. At the same time, the failure of a business founder to let go of his or her ‘baby’ is almost guaranteed to cause strife, damaging both business and family.
When selling your business to a third party, your focus should be entirely on maximizing the value realized. Avoid the pitfall of accepting a higher offer that includes a staggered payout in the form of dividends or residuals. Having a fi nancial interest in something that you have no control over has great potential for disaster.
MAKE A PLAN, WORK THE PLAN
Planning should start well before it comes time to sign on the dotted line. Make sure that tax fi lings (GST/HST, payroll and corporations tax) are up-to-date and that the books are ‘clean’ and in good shape. Having the books prepared by a profession- al bookkeeper using a software package such as QuickBooks helps to make it easier for a buyer to verify the numbers, reassuring them that you have nothing to hide. It may also be worth getting your fi nancial statements audited for a year or two before the planned sale to demonstrate that the numbers are trustworthy. Take the time to check that ownership of the business is clear, and that everybody is onboard with your plan. Regardless of who is taking over the business, as the seller you need to plan ahead to minimize the taxes payable. The Lifetime Capital Gains Exemption (LCGE) has been described as the best tax break left in Canada, and you need to make
This diagram illustrates the ownership structure after a basic estate freeze Parent Fixed-value preferred shares Company Child
Common shares
sure that you take maximum advantage of it.
On 50% of capital gains,
the difference between how much you paid for an asset and how much it cost you, are subject to tax. However, the LCGE allows Canadian residents to avoid paying tax on a portion of the net gains realized on the dispos- ition of qualified property. Qualified property includes qualified small business cor- poration shares, and for 2016 the exemption is $824,176. Even better, it applies to each shareholder, so if you and your partner each own 50%, the total exempt capital gain is $1,648,352!
Although the LCGE may protect you from tax, the government holds a joker in the form of the Alternative Minimum Tax (AMT). This is a special tax that comes into play when someone has high gross income but a lot of favourable tax deductions. Get professional advice before embarking on this or any other tax strategy.
ALL IN THE FAMILY
If you intend to hand over control to your kids or other family members, the situation may be more complex. Mini- mizing capital gains is still a priority, but the kids may not have the capital to buy you out, and you may want to maintain a degree of infl u- ence. In this situation, it may be time to put a chill on things in the form of an estate freeze. This reorganizes the owner- ship structure of the corpora- tion so that the current value is ‘locked in’ for the parent while future growth is trans- ferred to the child. (I have used the terms parent and child for the two parties in the trans- action, but an estate freeze could just as easily be used between siblings, or between existing owners and staff who are buying them out.) A basic estate freeze is implemented by the parent exchanging their common shares in the corporation for preferred shares, the value of which is equal to the fair market value of the common shares given up. The child
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2016 May/June FABRICARE CANADA 19
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