How to minimize taxes when transferring shares in your corporation
If your business is incorporated, you have a shareholder register that specifies who owns shares of the business, how many, and how those shares are classified. Transferring any of those shares to another person can have tax implications for you—but there are ways to manage that expense.
Stephane Leblanc, a Chartered Professional Accountant and tax partner at professional services firm EY, says the key is to plan ahead: “You need to give yourself plenty of time to plan out the transfer to make sure everything goes well.”
What you plan for depends on who you’re transferring shares to—whether it’s someone inside your family, or someone outside your family.
Leblanc offers the following advice:
1. Take advantage of your capital gains exemption
The money you make from selling shares is called a capital gain. Every Canadian is entitled to a lifetime capital gains exemption, meaning individuals are allowed a certain amount of capital gains they don’t have to pay tax on. This increases with inflation each year: in 2017, it was around $830,000. That means you only have to pay tax on any amount above that threshold.
How much the capital gains exemption will save you depends on which province or territory you live in and, of course, how much you’re paid for your shares. You also have to be eligible for the exemption. Here are the rules:
- You can’t be selling shares to a family member
- You or a family member must have owned the shares during the 24 months before the sale
- At least 50 percent of the company’s assets in that 24-month period must have been used for business purposes in Canada
- When you sell the shares, at least 90 percent of your company’s assets—meaning anything the company owns that adds value to it—must be engaged in doing business in Canada
This is where that advance planning Leblanc mentioned pays off. “I remember a client who had just signed a letter of intent to sell shares, then found out they didn’t qualify for the exemption,” he says, “But by that point, the deal was done. It was too late to do anything about it.”
2. Set up a family trust
If you expect sharing your wealth within your family, you can look at setting up a family trust. In this scenario, you freeze the value of the shares in the company—locking them in at a fixed dollar figure. The trust then buys new shares at a nominal (i.e., low dollar-value) amount. Anyone who is part of the trust becomes a beneficiary, meaning that if company shares are later sold to someone outside of the trust, the value of that sale is spread across all family members.
How does this help with your tax situation?
“Because the money from the sale of shares is distributed across multiple family members, each person’s capital gain is only part of the total amount,” explains Leblanc. “So if you have four people in your family trust, for example, each of you can claim up to $830,000 in capital gains exemptions—so the total sale amount would have to exceed $3,320,000 for you to owe any tax.”
Leblanc notes some entrepreneurs use this family trust mechanism and then have family members pay them back whatever they have gained, so the proceeds of the sale of shares go to the business owner. He cautions that, under the law, those earnings belong to each family member. “Getting them to write you a cheque after the transaction could prompt the Canada Revenue Agency to step in and refuse it.”
Family trusts are complex legal instruments, so if you’re going to set one up, get the help of a lawyer.
3. Defer your taxes
Deferring taxes from share transfers won’t eliminate gains from your income but does allow you to put off paying them until a later date. Consider a deferral when the capital gains exemption isn’t an option or to further your capital gains exemption savings. Two ways to defer taxes are:
- Use a holding company—transfer your company’s “safe income” (for tax purposes, any leftover cash earned through your business) to a holding company. You can invest these earnings in the market and withdraw at a later time.
- Transfer your shares over time—if your intention is for a family member to take ownership of your business, you can sell the shares over an extended period of time to spread out the taxes you have to pay. This strategy is useful if you’re planning for your child to take ownership once they’re older.
Sell shares, not assets
One last bit of advice offered by Leblanc is that if you’re looking to raise cash, it’s always better to sell shares instead of assets. Buyers may want to purchase assets because of the tax benefits it gives them, but selling assets makes you ineligible for the capital gains exemption.
If you’re faced with a buyer who’s only willing to buy assets and you don’t have any other options, Leblanc advises asking for more money. Taking the favourable tax implications into account, the buyer is likely to be onboard with this.