Tax on the Sale of a Family Business

Family businesses have a special place in Quebec’s entrepreneurial landscape. Forged by decades of dedication and passion, these family treasures are subject to specific taxation laws when it comes time to sell or transfer ownership. In short, selling a family business can be complex.

Whether you're already at the head of a family business, or planning to take the reins, understanding the tax details of selling a family business in Quebec is a must. This not only helps maintain the business's legacy but also ensures a smooth financial transition for everyone involved.

In this article, the business tax accountants at T2inc offer you a comprehensive guide including sound advice on this important topic.

Understanding the basics of corporate taxation in Quebec

Before we look specifically at the tax implications of selling a family business, let's review the general corporate tax framework in Quebec.

Quebec's corporate tax system

Like every other Canadian province, Quebec has a unique provincial tax system, therefore any Quebec-based company is subject to both federal and provincial taxes.

• Tax rates: Quebec corporate tax rates vary according to business size and income. SMBs generally benefit from a reduced rate on a part of their eligible income.
• Tax credits: The Quebec government also offers various tax credits to encourage investment, innovation or even hiring, in certain sectors.
• Deductions and write-offs: Companies can also benefit from various tax deductions and write-offs on their capital investments, which can influence the value of the company when it is sold.

Distinction between selling assets and shares

When selling a business, it's important to understand the difference between selling assets and selling shares, as the tax implications can vary considerably.

• Sale of assets: In this situation, the company itself sells its assets, which could include real estate, equipment, inventory or intellectual property. The proceeds of these sales are considered income for the company, which will be taxed accordingly. This type of sale can minimize risk for the buyer, who can choose precisely which assets to buy and which liabilities to avoid.
• Sale of shares: Here, the company's shareholders, and not the company itself, sell their shares to the buyer. Proceeds from the sale of shares are treated as capital gains [1] for the shareholders. In Quebec (and at the federal level) a capital gains exemption may be available for the sale of qualifying small business shares, which can offer significant tax advantages.

Why sell a family business in Quebec?

The sale of a family business is a pivotal moment, often the culmination of generations of effort. In Quebec, the government recognizes that this is an important transition, and offers tax benefits to facilitate the transfer and reward the economic contribution of family businesses.

Lifetime capital gains exemption

One of the major advantages of selling a family business is the lifetime capital gains exemption. In short, this means that a specified amount of gain realized on the sale of qualifying small business shares is tax-exempt.

• Exemption ceiling: The exact amount may vary from year to year, but the lifetime capital gains exemption is designed to cover a substantial capital gain, making the sale of a family business potentially very tax-efficient.

Making the most of this exemption

To take full advantage of the lifetime capital gains exemption, you need a strategy. To help with this, you can always call in a corporate accountant.

• Splitting the gains: If several family members hold shares in the business, it's possible to split the capital gains among them, allowing each member to use their own exemption.
• Purification of the company: Before the sale, it may be appropriate to "purify" the company, i.e. to ensure that it meets all the necessary criteria to be considered a small business. This may involve restructuring certain assets or liabilities.
• Gradual sale: In some cases, it may be beneficial to sell the business in tranches, spreading the capital gain over several years to maximize the exemption available each year.

Eligibility criteria for family businesses

To benefit from the lifetime capital gains exemption, family businesses must meet certain conditions:

• Company structure: To benefit from a capital gains strategy, the company must be incorporated, i.e. hold shares. Capital gains exemptions are not applicable to partnerships (which own shares but not stock) or sole proprietorships (without shares or stock).
• Nature of assets: A significant proportion (generally 90% or more) of the company's assets must be used primarily in a business operating in Canada.
• Holding period: The shares must have been held by the vendor or a family member for at least 24 months prior to the sale.
• Canadian ownership: The business must be a Canadian-controlled private corporation and not be publicly traded.
• Length of employment: Prior to the sale, the seller must have been actively involved in the business for at least 24 months. However, their post-transaction involvement should be limited.
• Control of the company: Following the sale, the seller must no longer hold legal control of the company.

To find out more, contact a specialist!

Tax implications for the seller

When selling a family business, the transferor, i.e. the person or family selling, can expect significant tax consequences. While some tax measures may offer advantages, others may require careful planning to minimize the impact. Here are the main tax implications for the person selling a family business.

Tax on capital gain

The capital gain is the difference between the sale price of the business and its acquisition cost. In Quebec, as in the rest of Canada, 50% of this gain is taxable.

Tax considerations for retired sellers

For a seller who plans to retire after the sale, there are several things to consider:

• Withdrawal strategy: The seller must plan how and when to withdraw funds from the proceeds of the sale to finance their retirement, with taxation implications in mind.
• Registered plans: The seller may consider maximizing contributions to registered plans, such as RRSPs, to defer taxes.
• Transfer of assets: In some cases, it may be advantageous to transfer a portion of the assets to younger family members, or to set up a family trust, to spread income and minimize overall family taxes.

The importance of effective pre-sale tax planning

Since tax implications can be complex when selling a family business, it is important to implement tax planning in advance.

• Pre-sale appraisal: Having your business appraised prior to the proposed sale will help you understand its value and your potential capital gain.
• Expert advice: Using tax accountants and financial advisors helps you navigate the tax landscape effectively.
• Sales strategy: The structure of the transaction (sale of assets vs. sale of shares) and the timing of the sale can have major tax implications. Careful planning can greatly reduce the amount of tax due.

Tax implications for the buyer

The person taking over the family business, especially if they are a family member, will also need to understand taxation in order to maximize the benefits and minimize the risks of the purchase.

Possible financing and deductions

Buying a business can involve a substantial financial investment. Fortunately, there are ways for a buyer to finance the purchase while benefiting from tax advantages:

• Loans and tax credits: Both the Quebec provincial government and the Canadian government often offer tax credits and specific loan programs to help with business acquisitions.
• Tax deductions: Interest on loans used to acquire a business can often be deductible, reducing the buyer's taxable income.

Tax considerations for family members buying a family business

When the buyer is a family member, unique tax implications come into play:

• Gratuitous transfers: In some cases, part of the business can be donated rather than sold. This may have gift tax implications, but can also offer tax advantages if done correctly.
• "Family" sale price: The sale price agreed between family members may differ from the market price. However, this price must be considered "fair" in the eyes of the tax authorities, to avoid complications later on.

Avoiding common tax pitfalls in takeovers

Acquiring a family business can present unique challenges, and buyers need to be aware of common pitfalls:

• Hidden tax liabilities: The buyer must be sure to assess all the company's potential tax liabilities. This includes tax arrears, ongoing tax litigation and potential tax adjustments.
• Business valuation: An inaccurate valuation can lead to tax complications, particularly if the tax authorities consider that the business has been undervalued as part of a transaction between family members.
• Purchase structure: As mentioned above, you need to choose the structure that is most advantageous from a tax point of view.

How to organize estate planning

Estate planning is a strategic tool used to minimize the tax impact of transferring a business:

• Inheritance freeze: This technique consists of freezing the value of the company's assets at a given point in time, so that any future appreciation is attributed to the heirs. This can minimize capital gains taxes on inheritance.
• Family trusts: By using a trust, it is possible to distribute capital gains among several beneficiaries, which can reduce the overall tax payable.

Impact on equity between family members

In many families, not all members are involved in the business. This can pose problems when the business is transferred:

• Asset distribution: Careful planning can ensure that family members who are not involved in the business receive a fair share of family assets, even if they do not receive a share of the business itself.
• Annuities and income: Structures can be put in place to provide income to family members who are not directly involved in the business, thus ensuring financial equity.

Collaboration with tax experts for optimum planning

Taxation is a complex field, and estate planning is no exception:

• Expert advice: Working with a tax expert can help you identify and implement strategies that minimize taxes while maximizing benefits for family members.
• Regular updates: Tax laws change. Effective estate planning requires regularly updating your strategy to ensure that it remains optimal in the face of changing legislation.

Get advice from T2inc when selling your family business

Selling a family business involves more than a simple transaction. At T2inc, we understand the importance of taking this step and we are committed to providing you with the best advice to ensure a tax-efficient transition while preserving your family legacy.

Don't let taxation stand in the way of your business. Put your trust in T2inc for a smooth, balanced and beneficial business transfer. Contact us today to find out how we can make a difference when you sell or transfer your family business.