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Will a Tax Bill Put Your Succession at Risk?


​​​​​​​​​All too often, real estate and construction company owners find their plans for an orderly succession or business transition thrown into disarray by a sizeable tax bill. Finding the funds to pay these tax bills can put retirement plans at risk and even threaten the viability of the business. To avoid this fate, business owners should make tax planning an integral part of their succession planning efforts — and get started as early as possible.

Tax Shocks Can Easily Derail the Best-Planned Business Transition

Every business eventually experiences a succession or transition of some form. The owner of a real estate development or construction company might wish to hand the business over to his or her children; the founder of an engineering or architectural firm may intend to pass control on to the management team. Whatever form the transition takes, the disposition of the business will give rise to a taxable event. And it’s this unavoidable fact that can cause so much trouble for those involved.

Why? In our experience, it’s because business owners tend to focus on day-to-day operations, building their business and creating wealth for their company, themselves and their family. Few owners spare the time to develop a well-structured succession plan to set out what happens to the business and the wealth that’s been created over the years. Fewer still consider the tax burden they’ll incur on the handover itself.

​This article is part of a series on key tax issues facing Canada’s real estate and construction companies.

​ ​ Read other articles in the series.​ ​​

That tax burden can be significant and easily underestimated. For example, properties built for next to nothing decades ago can now be worth many multiples more now, thanks to market dynamics and years of inflation. As well, business and asset values can change for a host of factors outside a company’s control, from government legislation to currency fluctuation and beyond. It can all add up to an unpleasant surprise.

As a result, companies can suddenly find themselves in an 11th-hour scramble to find the means to fund a major tax bill. Unfortunately, real estate and construction companies tend to be asset-rich but cash-poor. This lack of liquidity can force owners to sell off important assets in a hurry to pay off their tax bill and still fund their retirement. In worst-case scenarios, owners may have to liquidate the business itself — leaving nothing to pass on to a new generation.

Keep Your Succession Plan on Track by Taking Tax Action Early

A tax bill is an unavoidable part of any business transition, but it doesn’t have to put the company handover or the owner’s retirement in jeopardy. To keep succession plans on track, owners need to take action, as early as possible.

Tax planning should be an integral part of any succession planning effort, not an afterthought. And succession planning isn’t a short-term project: it can take years to properly plan and prepare for the orderly transition of a business. While tax matters should never be the main driver of any succession planning decisions, it’s vital that tax issues be addressed from the outset.

Owners, family members and business advisors should sit down to take a hard look at the business, as well as the retirement and other financial needs of the family. Developing a range of scenarios can help determine what the company’s likely to be worth at the handover point and what the future tax obligation is likely to be. Armed with this knowledge, owners can establish a plan to ensure the funds are in place when they’re needed down the road.

Funding a future tax cost can take many forms. It could involve setting aside funds each year as the transition date draws closer. Some owners may decide the business needs to change its corporate or tax structure to lower or otherwise mitigate the future tax obligation. Other owners may opt to pursue new sources of growth to boost revenues and generate funds. Ultimately, it’s important owners and their advisors explore all the available options and their tax implications to make the best decision for their unique situation. The earlier companies act, the better: some tax structures, for example, need to be in place for years to be considered valid.

Is an Estate Freeze Right for Your Business?

Canada’s Income Tax Act offers a number or techniques that can be used, if implemented correctly, to minimize the tax burden of a business transition. One such technique is the estate freeze, which is particularly useful for owners who plan to pass control of the business to family members.

An estate freeze caps the value of the company for the founder as at a certain date; value accretion beyond that date is then taxed in the hands of the other family members. Estate freezes don’t eliminate the owner’s tax liability, which remains payable on the owner’s death. However, this liability can be paid over a number of years. Companies intending to use an estate freeze should supplement it with a legal and corporate structure that will allow companies to fund the owner’s tax liability as well as the residual interest of the family.

Best Practices for Avoiding Tax Surprises During Transitions

  • Start early. Proper planning can make all the difference—but it can take time to put the necessary structures in place. Start now to achieve optimum results. If you wait, it may prove too late to achieve your objectives.
  • Understand the full picture when it comes to tax. Are you prepared for the tax consequences of a sharp rise in asset values? What if tax authorities take a different view of a business transaction?  Understanding the range of tax risks you may face will help you be better prepared.
  • Develop a plan. When planning for succession and its tax consequences, explore a range of scenarios and follow them to their logical conclusion. Some will prove feasible; others won’t. Better to find that out now.
  • Capitalize on external advisors’ expertise. Tax planning for succession can be highly complex, and tackling it on your own may prove risky. Outside advisors can prove the experience and specialized expertise your company needs to develop a tax plan that will stand up to tax authorities’ scrutiny and achieve your succession objectives.

Don’t let tax issues upend your business transition

A lack of timely tax planning can put even the most carefully planned business transition at risk. By taking action early, real estate and construction companies can better prepare to tackle the issues they face — and keep their transition on track.

For more information, contact:

Eddy Burrello, CPA, CA
T: 647.943.4081
E: [email protected]

Glenn Willis, CPA, CA, CPA, CMA
T: 416.515.3850
E: [email protected]

This is the second in a series of MNP perspectives on key tax issues facing Canada’s real estate and construction companies. Other pieces have explored important tax considerations at play in tax cost minimization, doing business across borders, valuations and business consolidation. Click here to read the next article in the series.

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