Almost two-thirds of independent business owners in Canada are planning to exit their business within the next decade. Many business owners, part of the baby boom generation, have built thriving businesses and are considering what might be next. That perplexing word "retirement" is starting to be considered.
Perhaps from time to time you have wondered who will carry on the business after you choose to exit. It's only natural to think of this after a business operates successfully for some time.
There might be family members or managers who are capable of keeping it going – or not. It can be difficult sometimes to decide between selling the business and passing it on to management or family. There could be a market for it – or not.
These are some of the vexing issues that are now facing successful entrepreneurs.
Effective succession planning must start early – when business owners are in their forties or fifties, at the latest. But too often a plan is not in place and the value that could be achieved for the owners or their heirs is not fully realized.
It's a mistake that is made too often but can be avoided with some advance planning.
Strategic tax planning – in advance of your transition – can maximize the proceeds of business disposition and after-tax cash.
One of the most significant planning considerations to investigate is a capital gain. In many cases, capital gains taxation resulting from the sale of a business can severely impact the owner's retirement plans. A capital gains exemption may not outweigh the taxation of a business, resulting in a loss on the sale.
It is possible, however, to eliminate or significantly reduce the tax on the sale. This can be achieved by having other family members (spouse, children or a trust for spouse and/or children) own shares, even if they are not employed in the business. That way, they participate in the growth of the business.
By diversifying the shares, shareholders utilize their individual capital gains exemption, often eliminating tax entirely.
Even if the business ownership was not structured to include additional family owners from the beginning, it can be changed to enable them to benefit from future growth in value.
Let's say that you are the sole owner of a business worth $750,000 today. To implement a plan to save tax on the capital gains when selling the business in the future, change your common (growth) shares into new preference shares that have a "frozen value" of $750,000. These preference shares can be voting shares, so that you still have voting control of the company. New common shares can now be issued to your spouse and (let's assume) two children, or to a trust for either or both of these parties.
Over time, as the value of the business continues to increase, all of the growth in value will go to these new common shares, as you "froze" the value of your shares when you transferred them to preference shares. This will allow you to preserve your capital in the long run.
This is a simple example of how advance planning can result in significant tax savings upon the sale of the business. Many of these structures provide an immediate tax advantage by permitting income splitting through the payment of dividends to the new shareholders.
Recently, the Canada Revenue Agency (CRA) has begun to audit cases that may prevent the deduction of the salary by the company and may lead to the double taxation of your income.
Unlike salaries, there is no requirement for the shareholder to be actively involved in the business in order to receive dividends.
In our experience, many businesses attempt to "income split" by paying salaries to spouses or children who have little or no involvement in the business. The CRA has started to crack down on excessive income-splitting and the consequences can be extremely punitive. Not only will CRA disallow the deduction of the salary by the company, but also they may not remove the income from the tax return of the recipient.
Being taxed on income once may not be fun, but you can imagine how it feels to be taxed on the same income twice.
It is extremely important that you involve professional advisers in any restructuring of the business. The tax planning must be done properly in order to be deemed acceptable to the CRA and thus avoid the many pitfalls that result from faulty tax planning.
Whatever may happen, don't delay. Remember business owners should start planning in their forties or fifties. So what are you waiting for?
Jordan Gould is a partner at SBLR LLP Chartered Accountants in Toronto.