Tag: Succession

Your business succession in 49 questions

7×7 questions to frame your future

Your business is the source of your income, and the store of years of hard work. But despite your dedication as an entrepreneur, there will likely come a time when your focus shifts toward harvesting that value and moving on to the next stage of your life. 

Whether you’re thinking of selling or succession, it can be a complicated and time-consuming process. Setting the stage for the technical guidance from your legal and tax advisors, here are some questions to help prepare you and your business for succession, grouped as follows:

1. You personally – Financial planning perspective
2. Understanding you in the business
3. Your family and your business
4. Your people – Key players in the enterprise
5. Your time – Planning, closing and post deal date
6. Your payday – Who’s paying, how much & when
7. Your estate planning

1. You personally – Financial planning perspective

Financial planning is about where you are financially, where you’re headed, and how you’ll get there. It’s extra complicated for business owners, because the source of your income is also the store of a significant portion of your wealth – the old goose and golden egg situation. Still, we need to start and end with what it means on the personal level.

    1. Do you have a written personal financial plan?
    2. Are parts of your personal finances tied to the business, and do you know how you’ll make that break?
    3. Are you comfortable with your spending habits now, and what that will look like in your later years?
    4. Have you put your personal debt behind you, or do have a plan to get there?
    5. How much do you expect to realize from the business –or– how much must you realize to meet your needs?
    6. Do you understand investment markets, retirement savings plans and public pensions?
    7. How will you spend your time in your post-business years, whether or not you call it ‘retirement’?

2. Understanding you in the business

You need clarity on your importance to the business, to know what business you have to transfer. This is a cold hard look at your value in the business, so that it’s clear what is left when you are out of it. Think of this in terms of both personal satisfaction and financial return, then ask these questions about yourself and about your potential suitors/successors.

    1. Do you have a special entrepreneurial passion that makes the whole worth more than the sum of its parts?
    2. What technical skills, regulatory licences and proprietary knowledge are required to run this business?
    3. How much does your management experience and leadership factor into the business’ success?
    4. In all cases above, how long will it take to cultivate or transfer those elements to someone else?
    5. All that in mind, is this or can it be a self-sustaining business that can operate independent of who owns it?
    6. Alternatively, is this an occupation that requires a skilled substitute in place of you?
    7. Or finally, is the business uniquely you, and if so, what implication does that have for winding-down?

3. Your family and your business

Here’s your second cold hard look, this time at the people you care most about – your family. As tough as it may sound, your first priority must be to make sure that you realize from the business what you need to meet your own financial needs. That said, one of those goals is usually caring for family, individually and collectively, which in turn presents its own challenges.

    1. Who among your children/family have the skills to carry on the business?
    2. What skills may be lacking, how can they be obtained, and how long will that take?
    3. Who among the family expect to be future owners, and are you managing those expectations?
    4. What interpersonal conflicts have you observed, and will those get better or worse in your absence?
    5. Will those left out of leadership be content to continue in supporting roles as employees?
    6. Is it viable to have non-active owners, and how do you shield the active ones from any interference?
    7. Whether the transfer is a buyout or inheritance, how will you provide for those excluded – or will you?

4. Your people – Key players in the enterprise

As much as a business is an economic endeavour, it requires people to make it work. And in a small business, there is often a close connection with and among those people. These may be the future buyers of the business, or at least continuing contributors, so it’s important to know where opportunities and exposure may lie.

    1. Who are your key people in the business?
    2. When was the last time that you updated their job descriptions?
    3. Do they have critical knowledge or skills, the loss of which would endanger the business?
    4. Do you have employment contracts that include non-competition & non-solicitation terms?
    5. Are there operations manuals for all your main business processes?
    6. What are their expectations of continuing employment and/or eventual ownership?
    7. Upon an ownership change, would they remain with the business?

5. Your time – Planning, closing and post deal date

Running a business is one thing; arranging for its transfer is another. With family or internal buyers, it can be years of grooming. With an outsider, a get-to-know-you time period will be followed by a more formal due diligence process where you can take the lead from your legal and accounting advisors. Either way, it takes time.

    1. For arm’s length transfers to colleagues or family, is there a documented plan with agreed timelines?
    2. For non-arm’s length, practically how much time will it take to identify and close with a successor?
    3. In due diligence, how much time can you be away from the business without it being a strain?
    4. How long will your successor want you to remain to support the transition, and will you be compensated?
    5. With current business partners, do you have an executed buy-sell agreement?
    6. On disability or death, is each financially capable of carrying out the buy-sell, and/or is there insurance?
    7. If your successor is paying over the course of years,is there insurance in case of that person’s death?

6. Your payday – Who’s paying, how much and when?

The old adage is that a business is worth what someone is willing to pay. In a family succession, perhaps it’s what the owner may be willing to accept. As you look to determine value, whether in a sales negotiation or setting up for succession, you will need to come to a value first, and then determine how the transaction will be structured.

    1. What sustainable free cash flow does the business generate? (Discuss with a business valuator.)
    2. What’s the difference in value to you operating the business, versus someone paying to buy it from you?
    3. Assuming a corporation, will the sale/transfer be the assets or shares?
    4. Will payment happen all at once on the closing date, or in instalments over some years?
    5. Will future payments be charged interest and/or be adjusted by future performance of the business?
    6. For payments over time, can capital gains recognition be deferred to later years, and how long?
    7. How will payments be taxed, and for a corporation, do shares qualify for the lifetime capital gains exemption?

7. Your estate planning

The best laid plans can be unravelled if there is no adequate safety net to deal with untimely events like disability and death. These are personal tragedies that can be compounded when a business is involved. Whether you are in the process of running the business or turning your attention to passing it on, estate planning is good business planning.

    1. Do you have a Will that has been drafted with the business in mind?
    2. To support your executor, have you identified a steward who knows and can manage the business?
    3. Do you have Powers of Attorney for property & personal care, or a POA specific to the business?
    4. Is it worth having a secondary Will that isolates business corporation shares from probate exposure?
    5. For a complex business, have you considered a trust as part of the business ownership structure?
    6. Do your corporate documents allow for operation of an attorney or executor, as the case may be?
    7. For any tax-deferred transfers, have you arranged life insurance to settle any remaining tax liability?

Family farm succession

Estate and tax tips to help keep the family farm in the family

Every business has its own distinct features, but farming really is in a field of its own. The intimate connection between economic activity and family dynamics feeds into farming operations, and in turn into farm succession.

This complexity presents both challenges and opportunities for farmers looking to transfer the farm in an effective and efficient manner. Fortunately, with astute estate planning and strategic application of targeted tax rules, a family farm can indeed be successfully passed down generations.

What’s so special about farm succession?

Nature of the business

Farming is both capital and land intensive, together reinforcing the need for a long-term view and a long-term commitment. Arguably, it’s the prototypical asset-rich/cash-poor business. But, adopting a positive planning perspective, it may be more helpful to think of it as a call to farmers to be vigilantly cash-conscious.

Like other businesses, the farm is usually both the main income source and the main store of a farmer’s wealth. It’s the classic goose and golden egg, with the added element that the farm is also traditionally the family home.

Three-legged succession planning

This intertwined nature may have a farmer feeling paralyzed at the prospect of having to combine everything into a cohesive succession plan. To make it manageable, it may help to approach it as three legs of a succession stool:

    1. Farmer’s retirement plan
    • Will the farmer/couple continue to live on the farm in retirement, or is another living arrangement intended?
    • What kind of retirement lifestyle do they envision, and how much income is needed to fund that?
    • What non-farming savings will provide that income, and will it need to be supplemented by farm income?
    • If there is a projected shortfall, will retirement be adjusted or might some farm assets have to be sold?
    1. Farm management plan
    • Have the successor(s) been identified, have they committed, and is there a clear transition timeline?
    • Are there gaps in the successors’ farming or management skills, and how long will those take to upgrade?
    • Are there any critical employees, and how has their continuing involvement been assured?
    • Has the business been analyzed and documented to make it as turnkey as possible for the successors?
    1. Family heir/ownership plan
    • Will ownership transfer be by sale, by gift, by bequest out of a parent’s Will, or a combination of these?
    • Will the successors own the farm outright, or will non-farming family members also have an interest?
    • If so, how and when will they get their part of income or assets, and what legal changes might facilitate that?
    • If not, will the estate be equalized/‘equitized’ with other property, or will life insurance be used as a stand-in?

For each planning leg, the questions are openers to help organize thoughts and couch expectations of what lies ahead. As in any planning exercise, initial intentions will have to be balanced with practical constraints, possibly leading to difficult trade-offs among farmer, farm and family.

The goal is to make sure each leg is stable on its own, and that together they comfortably support the succession that rests upon them.

Estate planning foundation

Choosing heirs is obviously a key decision, but estate planning is much more than that. Ideally, it comes out of a focused review of a person/couple’s own needs, available resources and wishes for others, followed by legal steps to carry out the plan.

For many people’s estate planning, it can be sufficient to execute powers of attorney (or equivalent legal document for the province) to name someone to make decisions in the case of incapacity, and a Will to deal with property at death, possibly including some brief trust provisions to allow for unexpected contingencies.

For farmers, these core documents will likely need more detailed drafting, possibly accompanied by one or more trusts or corporations. In addition, intended successors may be asked/required to revise and coordinate their own estate planning, including executing domestic contracts to protect against potential marital claims if there is a future relationship breakdown.

This is particularly important with family farms, where financial viability can hinge on keeping the whole intact, and sustaining the scale and momentum of the enterprise.

Targeted tax rules allow flexibility in farm transfers

Alongside economic and interpersonal issues, a major concern in family farm succession is the spectre of tax. When capital property is transferred, tax is generally levied on the capital gain. Ironically, that could cause a profitable farm to be the victim of its own success. Having committed substantial time, effort and resources into the business, a farmer may have only one place to get the cash to pay the tax on its transfer – the farm itself!

Happily, there are a number of rules in our tax system designed to help farmers defer, distribute or eliminate the tax that would otherwise apply on farm property transfers. The key provisions are summarized below, understanding that the qualifying criteria are complex, both for the property and the people involved. Consider this to be a
high-level overview of options and issues to be explored in-depth with the farmer’s own tax professionals.

Lifetime capital gains exemption

The lifetime capital gains exemption (LCGE) can eliminate tax on capital gains when transferring qualified farm or fishing property, or small business corporation shares. The 2024 Federal Budget increased the LCGE from $1,016,836 to $1,250,000 for dispositions after June 24, 2024, with indexing to resume in 2026.

Planning points

    • The LCGE can be claimed by individuals, or by partners when gains are allocated from a partnership. A corporation can’t claim it, but shares of the corporation may qualify. (See “qualifying farm property” below.)
    • The principal residence exemption (PRE) is available in addition to the LCGE. There are two methods for calculating the PRE when a home is situated on a farm, and the farmer may choose the method that is most advantageous. The PRE may be claimed by individuals and possibly by a partner of a partnership that owns a subject property, but not by a corporation.
    • A large capital gain in one year (even if claimed/reduced using the LCGE) can affect eligibility for income-tested benefits in the following year, including Old Age Security, Guaranteed Income Supplement, Canada Child Benefit, G/HST refundable tax credit, age credit and possibly some provincial tax credits.
    • Alternative minimum tax (AMT) is often triggered when LCGE is elected, as it brings the non-taxed portion of capital gains into income. AMT is recovered as a credit against taxes payable for up to seven years. Significant changes were passed into law in 2024, which may make it more or less of a concern in a given situation, as advised by tax counsel.
    • A parent realizes a capital gain when selling shares to a child, but historically this has been deemed to be a dividend (at higher tax) when selling to a child’s corporation. Bill C-208 was passed in 2021 to allow capital gains treatment in such family transfer situations. Implementation was delayed until further amendments were passed in 2024, designed to prevent surplus stripping and assure that the rules only apply to genuine intergenerational business transfers.

Qualifying farm property

For the LCGE, qualifying farm property includes land and buildings, shares in a family farm corporation, an interest in a family farm partnership, as well as quota and other intangible assets used in the farm business.

The property must be principally used in farming by the individual, a spouse or common-law partner (CLP), child or parent, or by a farm corporation or partnership belonging to one of them. If the property was purchased before June 18, 1987, this requirement can be met if it is being farmed on the date of sale or had been farmed any five years while owned. The use rules are more stringent if purchased after this date, including having to show that gross farm revenue was more than all other income sources over a two-year period during ownership.

Planning points

    • Equipment, machinery and inventory are NOT eligible for the LCGE if they are personally owned. However, if those assets are held within a family farm corporation or partnership, their value will contribute to the value of the respective corporate shares or partnership interest, which in turn may be eligible for the LCGE.
    • According to the Canada Revenue Agency (CRA), land may not qualify as farm property if it is leased or is under a sharecropping arrangement. Consult a tax advisor to determine how to meet CRA’s requirements.
    • When the $100,000 personal capital gains exemption was eliminated in 1994, individuals were allowed to increase the adjusted cost base (ACB) on their property by up to $100,000 that year. Even if farm property was owned prior to 1987, the owner would be deemed to have disposed and reacquired the property in 1994.

Tax-free rollover to a child

When farming or fishing property is transferred to a child, the parent may choose a disposition value between cost (ACB for capital property, or undepreciated capital cost for depreciable property) and current fair market value. This can postpone the tax until the child sells the property. The child must be resident in Canada, and the property must have been actively engaged in farming or fishing activity on a regular and ongoing basis before the transfer.

The transferee may be a natural or adopted child, grandchild or great-grandchild of the individual or of a spouse/CLP, or a spouse/CLP of that person. It may also be someone who, while under the age of 19, had been financially dependent and under the custody and control of the transferor.

Planning points

    • If a parent dies before a transfer has occurred, the rollover may also apply on transfer from a parent’s estate.
    • If a child dies before a parent, the rollover will not be available to the deceased child’s spouse/CLP.
    • If a rollover to a child has been made and the child later dies, the property may be rolled back to the parent.
    • If a child sells to a third party within three years of the transfer from the parent, that original transfer will be deemed to have occurred at fair market value for the transferor parent, effectively undoing the rollover to the child.
    • Though it is possible to use this rule to transfer to minor children, if the property is sold to a third party while the child is still a minor, the resulting capital gain will be deemed to be the parent’s.
    • An estate freeze is a technique used to shift tax on future capital gains to later generations. These rollover rules make it unnecessary to do an estate freeze for tax rollover purposes, but a freeze may still be used to provide ownership certainty to the next generation, and to provide comfort of continuity to the parent farmer.
    • The rollover can be used vertically between generations, but not laterally between siblings. Farmers should take this into consideration when deciding when and how to structure a succession among multiple children.

Tax-free rollover to spouse

Any capital property (not just farm property) may be transferred by rollover to a spouse/CLP, but any income or capital gains arising out of that property will be attributed to the transferor under the spousal attribution rules.

Alternatively, if it is a purchase at fair market value, the spouse/CLP will be taxed on the year-to-year income and realized capital gains, achieving some family income splitting. Even better, when that property is later sold, this ensures that the capital gain is realized by that spouse/CLP who can then use his/her LCGE.

Extending the capital gains reserve from 5 years generally, to 10 years for farm property

Generally, a capital gain is recognized and taxed in the year of disposition. If payment is deferred, the taxpayer may elect to recognize the gain across as many as five years, being the year of closing plus four years.

For disposition of a family farm, a fishing property or small business corporation shares to a child (using the same extended definition of child outlined above), the reserve period may be as long as nine years following the year of disposition, spreading the tax liability across as many as ten years.

Coordinating professional advice

Business succession planning can be a challenge, with farm succession being a breed unto itself. Add in family dynamics, and things can get especially complicated.

While there are many tax rules designed to facilitate family farm succession, they are most effective when applied in the context of each particular farmer, farm and family. Through early engagement of qualified legal and tax advisors – and with the commitment and participation of all affected family members – a farmer can be confident that the family farm succession will indeed be a success.

Estate freezing in an economic downturn?

A tax planning prompt for business owners[1]

For a few years beginning in 2020, the COVID-19 pandemic caused tremendous disruption and pain in both the personal sphere and in business activity. Owners of closely-held small businesses were especially vulnerable, with both their primary income source and invested capital at risk.

The stops and starts of multiple waves of the virus wreaked havoc and sewed uncertainty. Ironically though, this strange economic rollercoaster opened a window of tax opportunity for business owners who may have been hemming-and-hawing about succession. At the time it was the pandemic, but any economic condition that causes a dip in business value could present a ripe opportunity to proceed with an estate freeze.

Tax exposure on succession

Think of an entrepreneur who established a business corporation years ago, and now wants to bring adult children into ownership. The problem is that a direct share transfer would be a disposition. The capital gain is calculated as the difference between the fair market value and adjusted cost base (ACB). That could be a hefty tax bill for the parent, with a 1/2 income inclusion on capital gains up to $250,000 in the year such a transfer happens, and 2/3 inclusion on gains beyond that.

Whether the parent intends to make a gift or to have the children buy their way in, quite often the children don’t have the cash at present anyway. That means the parent will have to use other cash to pay that tax bill. A more likely reality for many business owners is that the bulk of their wealth is tied up in the business, so there is little if any readily available cash.

Thus, the prospect of paying that tax could be paralyzing. Business growth would continue to accrue to the parent as current full owner, as would the associated growing tax ty.

Enter the estate freeze

An estate freeze offers a more tax-efficient way to go about it. Future business growth is transferred to the successors, and the past growth is frozen in a way that ensures that no tax is incurred by the current owner in the present.

A familiar scenario is for the parent to exchange their common shares for preferred shares with the same value. These new ‘freeze’ shares won’t increase in value but will usually carry voting control and dividend rights. Often, it’s possible to increase the ACB on the shares using the lifetime capital gains exemption (LCGE), which stands at $1,250,000 in 2024 . Whether or not the LCGE is used in this way, no tax arises at the time of the exchange.

Tax is deferred until the parent disposes of these freeze shares. Sometimes the shares are redeemed by the corporation over a course of years, providing cash to the parent and spreading tax recognition. Otherwise, there’s a deemed disposition at the parent’s death, or on the later death of a spouse if the shares are rolled over to the spouse on that first death.

A new class of ‘growth’ shares is issued to the children for nominal cost. Alternatively, a trust may be set up to hold these shares for the children as beneficiaries, with legal control left in the hands of the parent as one of the trustees. No tax arises on this part of the plan either.

Future growth has been pushed down a generation, allowing for years or decades of deferral before future gains are exposed to tax.

Why freeze on a dip? Or re-freeze?

Apart from the terrible health crisis of COVID-19, it also had a negative impact on the financial value of many businesses. But with that downturn came opportunity. While there was no guarantee when and how much a given business may recover, those who executed a freeze at a depressed value were able to push a greater amount of future growth to their next generation.

Consider as well the LCGE, this time looking at the successors. The exemption applies on a per-person basis, allowing for a multiplication of its total benefit based on the number of new shareholders. And if the value falls so far that the parent is not able to use the full LCGE on the share exchange, the parent could choose to take some of the growth shares and thereby also participate in the upswing.

What about those who undertook a freeze years ago at a much higher value before the economic downturn (pandemic or otherwise) ate away at the business value? In that case, a thaw and re-freeze might be in order, effectively resetting at the current depressed value, again in anticipation of the recovery of the business itself.

As to determining the appropriate value, it needs to stand up to scrutiny should the Canada Revenue Agency inquire, so the best approach is to have a professional valuation.

Implications for life insurance

Upon a freeze, the parent’s taxable gain becomes both known and capped. This is an ideal application for life insurance on that parent, or a joint last-to-die policy on the parent-couple. Of course, less insurance is needed with a freeze at a lower value, but that’s only half the story.

The successor children will now expect to reap a greater proportion of the gain. Allowing that the amount of the gain is unknown (unlike for the parent) and that the LCGE may reduce the tax, this is a still a good time to open the insurance dialogue. If the child’s entrepreneurial drive matches the parent’s, greater growth may yet be ahead, and the insurance put in place today will feel like a bargain in hindsight when the child considers their own estate freeze down the line.

[1] A version of this article appeared in Advocis Forum.