How tax rules affect brokers selling business to children

If you own your brokerage and are concerned you would face a hefty tax bill if you sell the business to your kids, the federal government wants to hear from you.

In his 2019-20 budget document, Finance Minister Bill Morneau promised the government will reach out this year to business owners to develop new proposals to “better accommodate” the transfers of businesses from one generation to the next, while protecting what he calls the “integrity” of the tax system.

While the budget did not specifically mention property and casualty insurance brokers, the paragraph on intergenerational business transfers did catch the eye of the industry.

“I was pleased to see the government’s commitment in the budget to find ways to better accommodate the intergenerational transfer of businesses,” Peter Braid, CEO of the Insurance Brokers Association of Canada, said in an interview. “This is an issue that affects many brokerages in Canada that are still family owned.”

Whether you are a farmer, fisher or a small business owners, as a general rule, if you sell your business to your children that can result in a higher federal personal income tax then if you sell to someone who is not a family member.

“Right now the way it works, is if you sell it to a family member the money you receive is taxed as if it is a dividend,” Corinne Pohlmann, senior vice president of of national affairs for the Canadian Federation Independent Business, said in an interview.

By contrast, the money you earn by selling your business to someone who is not related to you is treated as a capital gain.

Under Canada’s federal personal income tax rule, employment and interest income is taxed at a higher rate than dividends, which in turn are taxed at a higher rate than capital gains.

“As a small business owner you have access to the lifetime capital gains exemption, which gives you a bit of a break on the taxation side,” Pohlmann said.

She was referring to a tax break which was set at $800,000 in 2014 an indexed to inflation. Essentially this means over a lifetime you could earn nearly $1 million in capital gains by selling shares in a private business – in certain circumstances – without paying any tax.

“If they are selling it to their child, the government treats it as a dividend because they don’t think that’s an arms-length relationship. As a result, they don’t let you treat it as a capital gain,” said Pohlmann.

This is what the feds are promising to look at in their budget, she suggested.

“It does create almost a disincentive to sell your business to your children. You want to have the revenue coming out of your business that you can use for retirement purposes, which is mostly the reason people exit their businesses these days,” said Pohlmann.