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Succession planning: Don’t blame the taxman if you failed to prepare

Two Sales Assistant At Vegetable Counter Of Farm Shop
Two Sales Assistant At Vegetable Counter Of Farm Shop

Author: Paul Spare, CPA, CA

Your retirement plan is to sell your business.

Fair enough. But will the proceeds be sufficient to support your desired standard of living in retirement?

This is my last post on the subject of succession planning. In my previous post, I presented some of the considerations and options that pertain to passing on a business to heirs that may be children or other family members.

Selling to a third-party outside of family can be more challenging. As my colleague Rick Evans has written before, some businesses, and some industries, simply do not lend themselves to a profitable sale that will support a retirement plan.

A long-term planning horizon is crucial to determine the best way to unlock value from your business, and put all the necessary pieces in place. This takes years – I can’t emphasize that enough.

If you do have a worthy asset to sell …

There are a few different paths to take.

One option is to sell shares in an incorporated business rather than its assets. This will result in a capital gain or loss, only half of which is taxable to the business owner. The after-tax proceeds can be used at your discretion to invest or as income.

Another option is to have the operating business owned by a holding company, and then sell assets or shares of the operating business. This results in sale proceeds being taxed within the corporation. Different tax implications kick in depending on the type of asset being sold, and whether the income generated is active business income or investment income.

Either way, the owner ends up with a corporation that holds the after-tax proceeds of the sale. The choice is to then either close down the corporation or continue it. Both options open up a host of new possibilities in terms of how to derive monetary value, create income and minimize the tax implications for the owner and their heirs.

Look out for the fine print of capital gains

Regardless of what path you take, always be mindful of potholes that could trip up your eligibility to claim the capital gains exemption.

A well-designed succession plan can save you well above $100,000, depending on your individual circumstances.

Over the course of its existence, however, your business can acquire a number of assets that may throw a possible claim for the capital gains exemption offside. For example, only 10 per cent of your business’s assets can be non-active assets. These include surplus cash that may be in GICs or term deposits, and any investment properties that don’t contribute to the growth or operation of the business.

It may take time to liquidate or transfer these assets to ensure that you qualify for the capital gains exemption.

Time is not on your side

Successfully navigating all this requires a trusted team of advisors to maximize your net after-tax proceeds. Otherwise, you could find yourself paying tens, or even hundreds of thousands, of dollars in excessive tax.

As I said in my first post on the subject of succession planning, a robust and comprehensive succession plan is a three-to-five-year exercise, regardless of how you want to exit your business. Take a moment to consider that. If you want to retire in 2019 or 2020, the time to start planning is now.

Succession planning: Keeping it in the family, without starting a feud

Author: Paul Spare, CPA, CA

In my previous post, I emphasized the importance of long-term and comprehensive planning to ensure that a business succession is as trouble-free as possible, and will leave the most after-tax dollars in your pocket.

When that succession plan involves passing the business to a child or other family member, a host of considerations come in to play. Many of these have nothing to do with dollars and cents. Interpersonal relationships can quickly complicate, even sink, any business transaction.

But, regardless of who is involved, this is a business transaction. The best way to minimize the potential for conflict and financial loss is to develop a plan that addresses all of the possible tax, income and legal issues that can arise.

Cap your expectations

In a majority of cases, business owners are accustomed to pulling whatever available cash from the business they want, for whatever purpose, at their discretion. But that cash is an asset of the business, and your successor(s) may have something to say about how it’s expended.

Your successor(s), on the other hand, must appreciate that you will likely maintain some ownership in the business. This stake may represent a source of passive retirement income on which you will depend for a number of years. They are obligated to ensure the business decisions they make don’t put that in peril.

It’s vital for both parties to appreciate that a relationship of give, take, and mutual consideration and respect, must reign for years, if not decades, to come.

Then cap your tax liability

The next step is to consider how this transfer of ownership will take place. Will it be in the form of a gift, a sale at fair market value or an estate freeze? There is no one right answer. Each scenario has its own considerations and implications for you and your successor(s). This is where you need that group of trusted tax, legal and financial advisors to help you clarify your needs and identify the most beneficial course of action.

One approach is an estate freeze. In most instances, the owner will exchange their existing common shares for fixed-value preferred shares. The company then issues common stock to the successors. This allows the current owner to “freeze” the value of their shares and their ultimate tax liability, while continuing to control the asset. The successors, meanwhile, can benefit from (and be liable for the taxes payable on) the increase in value of the asset after the date of the estate freeze.

To decide which course of action is best, everyone must be at the table. Clear and honest communication among all your business’s stakeholders and advisors is crucial.

And remember – if your intent is to pass the business on to your children, you must have a plan in place now, regardless of how far off that transition may be. Tragedy strikes when we least expect it. Take the time to sort out your will and consider the role that family trusts can play in your estate planning.

In my final post on the subject, I’ll discuss the options and challenges related to a third-party sale.

Types of Valuation Reports

We are frequently asked the question: what are the types of Valuation Reports? Here is a summary of each and what these Valuation Reports entail.

Comprehensive Valuation Report

  • Contains a conclusion as to the value of shares, assets or an interest in a business
  • Based on a comprehensive review and analysis of the business, its industry and all other relevant factors, adequately corroborated and
  • Generally set out in a detailed report.
  • This report provides the highest level of assurance with respect to the value conclusion.
  • It would be the equivalent to the Audit.

Estimate Valuation Report

  • Contains a conclusion as to the value of shares, assets or an interest in a business
  • Based on limited review, analysis and corroboration of relevant information,
  • Generally set out in a Valuation Report that is less detailed than the Comprehensive Valuation Report.
  • This report provides a lower level of assurance with respect to the value conclusion.
  • Equivalent to the Review Engagement.

Calculation Valuation Report

  • Contains a conclusion as to the value of shares, assets or an interest in a business
  • Based on minimal review and analysis and little or no corroboration of relevant information.
  • Generally set out in a brief Valuation Report.
  • This type of report provides the least amount of assurance with respect to the value conclusion.
  • Equivalent to the Compilation Engagement.