Wealth Transfer Tax Planning Strategies for Canadian Businesses

Canadian business owners who have achieved financial success often develop comprehensive estate plans to transfer their wealth, including their business and its associated assets. Tax matters should be an integral component of such plans. With the right tax planning strategies, Canadians can minimize their business tax liabilities and maximize the assets they are able to pass on to their successors, in business and family. At Jeremy Scott Law, our Canadian tax lawyers help our clients with a wide range of tax matters, including transfers of businesses and other assets. Contact Jeremy Scott Law today at (902) 403-7201 to discuss your situation.

2024 Changes to Intergenerational Business Transfers

On January 1, 2024, the federal government of Canada implemented significant changes to Canada Revenue Agency tax rules regarding intergenerational business transfers and Employee Ownership Trusts. Small business owners should be aware of these changes and how they could impact future transfers. 

New Business Transfer Requirements

Under the new rules, business owners must meet specific conditions to transfer their business to children or family members: Economic interests, control, and active management must all be transferred to the business owner’s own children. In addition, the business must remain in active operation. If any of these conditions should not be met, the owner will realize a dividend instead of a capital gain, with the latter being taxed at a higher rate.

Business owners may choose between two transfer options: rapid transfer within 36 months or a gradual transfer for up to 10 years. Each avenue is subjected to specific criteria and stages that must be met. Canadian entrepreneurs may wish to consult with an experienced Canadian business tax lawyer to discuss the new rules and how they apply to different tax situations.

Employee Ownership Trusts (EOTs)

While many entrepreneurs do hope to someday pass the business they have built on to their children, others may prefer to see their legacy carried forward by trusted employees they have mentored along the way. Employee ownership trusts (EOTs) offer an alternate transfer option for business owners looking to sell to employees. Business owners can also transition their companies to employees through holding company ownership.

Understanding Capital Gains Taxes in Canada

Many successful business owners purchase more spacious homes, or build in more desirable locations, as their affluence grows. They may also substantially expand or remodel their existing property. The Canada Revenue Agency (CRA) allows Canadians to sell their primary residences without paying capital gains taxes, even if the property has significantly appreciated since it was purchased. However, the CRA does charge capital gains taxes on the sales of cottages or vacation homes. These secondary residential properties are viewed as investment properties and thus are bound by the same capital gains taxes that apply to other investments, typically 25% of the value increase. As an example, someone who purchased a home for $200,000 and sold it for $400,000 would pay 25% of the $200,000 gain, or $50,000, in capital gains taxes once the home had been sold.

Successful entrepreneurs who own cottages or vacation hopes should plan to avoid issues with capital gains taxes. Some smart tax planning strategies for cottages include:

• Create a fund for cottage capital gains taxes
  • Start saving early to cover future capital gains taxes on the cottage sale.
  • About double the tax amount in pre-tax dollars must be saved. For example, if you expect to owe $100,000 in capital gains taxes, you will need to save $200,000.
• Borrow against cottage equity
  • Leverage the equity in the cottage, but remember that the loan must be paid back with interest, which is not tax-deductible.
  • Borrowing can be more complex due to uncertainties about market conditions during the sale, concerns over lending conditions, and interest rates.
• Sell the cottage to children
  • Cottage owners can sell their properties to their children with a mortgage or promissory note with equal payments over at least five years.
  • This sale allows the children to report just 20 percent of the capital gains taxes each year.
  • This allows capital gains taxes to be paid over five years, instead of all at once.
• Create a trust
  • Establish an inter-vivos trust for control over assets while deferring decisions about the future of the cottage. This adds flexibility, but capital gains taxes may still apply at transfer.
• Consider making the cottage the primary residence
  • If the cottage’s value has appreciated more than the value of the primary residence, the owner could designate the cottage as the primary residence and pay lower capital gains taxes on the primary residence.

In addition to their personal use as residence or recreation, cottages and vacation homes may sometimes be held as part of a company’s investment portfolio. If you have questions about tax planning strategies for cottages, businesses, or other assets, you can learn more by contacting Jeremy Scott Law.

Take Advantage of Retirement and Pension Beneficiary Payments

Benefits from retirement plans like the Registered Retirement Income Fund (RRIF), Registered Retirement Savings Plan (RRSP), and Registered Pension Plan (RPP), can all be directly paid to named beneficiaries, without needing to go through the long and expensive probate process. Canadian business owners concerned about how a prolonged probate period may affect their families and even their business legacy may wish to consider streamlining the process by taking advantage of these direct-to-beneficiary plans.

RRIF beneficiaries who are considered “qualified beneficiaries”––such as spouses or financially dependent children and grandchildren – can receive RRIF payments tax-free in their RRSP or RRIF accounts. Non-qualified beneficiaries who receive RRIF payments will have these funds taxed as income. Thus, account holders should consider choosing only qualified beneficiaries to receive these funds.

Consider Setting Up a Family Trust

A trust suits families dealing with wealth-sharing and complicated tax matters. Trusts aid in tax management during property transfers, estate planning, and asset protection. Trusts have numerous tax benefits and may make it easier to distribute wealth to heirs and reduce the family’s overall tax liability. 

Trusts are legal entities that the CRA considers taxpayers. The roles involved in a trust consist of a grantor and the trust’s, trustees and beneficiaries. Trustees hold the power to make decisions regarding the distribution of assets in accordance with the terms of the trust document. Beyond the tax benefits, trusts can be used to shield wealth from creditor or spousal claims and to reduce probate fees. Trusts are generally valid for 21 years, and after this period the assets must be disposed of at market value. Families who set up trusts may wish to revisit their tax planning strategy needs before the 21 years expire

Learn More From a Business Tax Lawyer in Nova Scotia

The transfer of businesses, real estate properties, and other assets often involves complex tax implications. Fortunately, smart tax planning strategies can help ensure that these assets are transferred easily without excessive tax burdens. If you have questions about the tax implications of asset transfers or another tax matter, consider contacting the experienced Canada tax lawyers of Jeremy Scott Law at (902) 403-7201.