Canada has attracted so many talented immigrants over the years; many did not have jobs waiting for them on arrival and instead started their own businesses or prudently invested in real estate to build up their wealth.

For those entrepreneurs living in Canada who worked hard to build up a successful business or real estate portfolio, death and taxes have significant meaning, and both require advance planning.

I am personally well aware of the challenges immigrants face when moving to a new country. As a Canadian Chartered Professional Accountant, I moved to Hong Kong in 1994 to assist Asian families with pre-immigration tax planning before landing in Canada. I then moved to Singapore, and then on to Europe to work with clients in many countries across Asia, Europe, the Middle East and Africa. I lived overseas for almost 20 years, and during that time I witnessed many businesses and real estate portfolios growing and flourishing, resulting in values that today exceed the wildest imaginations of the owners.

Taxation After Death

Now back to “Death and Taxes.” You may be aware that Canada does not have an Estate Tax, but it does have something almost as expensive, called a “deemed disposition” arising on a person’s death. The deemed disposition is a mechanism in our Income Tax Act which causes taxes on a capital gain to be triggered on death, based on the fair market value of any taxable assets you hold at the time of passing. If you leave your assets to a spouse or to a spousal testamentary trust, there is a tax-free rollover allowed of your assets to the survivor, However, when your spouse passes, the deemed disposition cannot be avoided.

This “death tax”, together with probate formalities (which vary by province) may be considered in advance of your passing as part of your estate planning. It must be remembered too, if you own foreign assets (e.g., a Florida home) on passing away, your estate may still face estate taxes in other countries like the U.S., which must be carefully considered.

Family Arguments Over Your Estate

Besides the tax and legal issues that arise at death, whenever Canadians own valuable businesses or real estate, there is also a risk that their heirs may disagree over what to do with those assets if left to them in shared ownership with siblings or others. This can be very worrisome, as it can lead to terrible disputes and family or business breakdowns.

The risk of family disputes is heightened when estate assets include a family business where only some children work in the business and other children do not. That’s because the heirs who don’t work in the business often prefer to receive their inheritance from other estate assets and not be left as a passive minority co-owners with their working siblings, even if they have voting shares.

Shareholder agreements and co-ownership agreements can be helpful tools to allow multiple owners to make harmonious decisions and avoid disputes. Your legal advisor can help determine their suitability and help ensure that they are drafted correctly.

Imagine leaving a substantial estate, but it causes your children to stop speaking to one another because of the way the estate was left to them. We all know that this sad outcome has happened and may await families who fail to properly plan. Good planning, with fewer opportunities for misunderstanding or surprises and with measures in place for the tax bill arising on death, can help a family business or significant real estate portfolio transition to the heirs.

The Need for a Plan to Transition Your Business

With age comes a need for families with substantial assets to plan in advance and take in good advice to consider the best way to leave their assets to their loved ones, and also anticipate any taxes that may be payable upon passing away.

In response to the growth of successful family-owned businesses across Canada, and the growing aging population, a new financial planning service area has recently emerged called “Business Succession Planning”.

"Mr. Chan was shocked by the tax estimate that awaited his estate, and also that his wife would not automatically inherit all his properties."

JEFF HALPERN,
BUSINESS SUCCESSION ADVISOR,
TD WEALTH

Many business owners expect to transition the management and/or ownership of their businesses to the next generation, and those who aren’t thinking of passing down the business often contemplate selling or bringing in new shareholders. Yet, even with all of these major changes being contemplated, many business owners simply do not have a formal succession plan in place.

Dying without a business succession plan can trigger a big tax bill. Take the case of Mr. Alex Chan (not his real name). Mr. Chan, 53, a well-educated man, married, with two university-aged children, immigrated to Canada in 1989. Since moving to Toronto, he wisely invested in a number of retail shopping plazas and commercial buildings which he has renovated and leased, taking advantage of the strengthening real estate market. Through his hard work, risk taking and good timing, Mr. Chan amassed a property portfolio valued at $51 million today. The property is held in a Canadian holding company and he is the sole shareholder. The cost of his properties was around $21 million, and he therefore has a capital gain of $30 million.

When I met Mr. Chan for his succession review, I asked him if he had a will and how he wants to distribute his estate when he passes away. He told me he intends to leave his wife all of his assets, and that she would take over running the rental property portfolio. I explained that that this was a good plan, as Canada’s tax laws allows him to leave his assets to his wife on a tax-free rollover basis. I then asked Mr. Chan if he had a will, to which he replied “No!”

I told Mr. Chan that when a person passes away without a will, the government has a set formula for how assets pass to heirs. Under the law in Ontario, his wife would not automatically inherit all of his assets, as the set formula gives her the first $200,000 of his asset value and a further one-third of his assets, but two-thirds of his estate would go directly to their two grown children. I explained that while one-third of his estate would flow to his wife as a tax-free rollover, unfortunately the two-thirds share of his assets passing to his children would cause a $20 million capital gain (two-thirds of $30 million gain), and a tax bill of around $5 million!

"A will review is just one of the important areas covered in a comprehensive business succession plan."

JEFF HALPERN,
BUSINESS SUCCESSION ADVISOR,
TD WEALTH

Mr. Chan was shocked by the tax estimate that awaited his estate, and also that his wife would not automatically inherit all his properties.

He was very pleased to hear that there were practical solutions he could put in place now to mitigate some of the tax risks that awaited him. I suggested that he speak to his lawyer about putting a will in place to designate his wife as the beneficiary of his estate or to make her the beneficiary of a trust set out in the will (testamentary trust), as well as a similar will for his wife should she pre-decease him. These solutions could allow a deferral of the capital gains tax until his wife passed away. I also suggested he explore having multiple wills which could allow Mr. Chan’s private company shares (and certain other private assets he owns including his rare watch and art collection) to bypass probate and save the 1.5% (approximate) probate fee in Ontario.

A will review is just one of the important areas covered in a comprehensive business succession plan. As well as a will, Mr. Chan was a candidate for an “estate freeze” and family trust strategies for his estate and tax planning. An estate freeze is a strategy that puts in place provisions to defer tax on an estate and to pay tax that arises from resources that don’t require the sale of principal assets of an estate. This helps the beneficiaries who can’t easily sell or don’t want to sell, such as a business or cottage. For Mr. Chan, it was possible to estimate his ultimate final capital gains tax liability payable on who dies last — either himself or his wife — and purchase corporate-owned life insurance to pay the ultimate income taxes arising at death. This would allow his heirs to inherit the company assets without having to sell or encumber them to pay the tax.

With the growing numbers of successful entrepreneurs and real estate investors living in Canada who came from abroad, many may not be aware of Canada’s tax laws and deemed disposition on death, and do not have a will in place or know about the consequences that await their survivors in the absence of a well thought-out succession and estate plan.

Given that a family business or real estate portfolio may be the single most valuable family asset, it is critical to develop an orderly succession plan, as early as practical.

What Is Business Succession Planning,
And Why Is It So Critical?

When it comes to business succession, there are two main aspects that need to be attended to — namely, a plan for transferring ownership of assets and secondly the transition of management of the business. Often, these two go hand-in-hand (i.e. leaving ownership to someone who takes over management). But in some cases, a family can retain the ownership of assets but hire professional management to manage them if this makes more sense.

Business succession planning involves creating the framework for the future transfer of ownership and management of a business or valuable real estate to a chosen successor, be it a family member, business partner/shareholder, management or outside third party. Equally, it is a plan that seeks to maximize value, family harmony, and overall security to all interested parties.

What does a Business Succession Plan encompass?
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A well thought-out business succession plan takes a comprehensive approach to evaluating all the relevant elements that need to be considered and implemented for the asset transition. Ordinarily, a succession planning review can cover:

  1. options available to exit either during life or on passing,
  2. a management transition plan,
  3. the perspectives of the different stakeholders and what they would like to see happen,
  4. business valuation, and how to optimize value prior to an exit,
  5. advance retirement planning,
  6. tax strategies,
  7. buyer financing,
  8. discussion of estate planning tools and strategies (e.g. wills, powers of attorney, estate freeze),
  9. understanding life insurance, and,
  10. the possibility of a business sale (e.g. a sale outside the family or inside the family) and understanding who can help to sell the business.

Finding the Right Management for Your Business

Business succession planning for owner-managed businesses typically includes a management transition plan. This may involve a list of tasks; defining the timeframe for the current owner(s) and or manager(s) to exit, identifying the skills needed in a successor, scoping out compensation, determining if a suitable internal candidate exists, or if there is a need to conduct an external search, discussing the succession plan with a proposed candidate and the board of directors to set expectations, discussing the succession plan with the senior management team, grooming the successor to take over, and implementing and communicating the succession plan to any third parties.

Normally, management transition is one of the longest and most complex steps in implementing a succession plan, and can take several years. If the potential successor only possesses some of the skills needed to succeed, the deficient skills need to be filled by a combination of skills training where possible, or hiring additional skilled managers to fill the gap. In the case of a family business where the next generation (i.e., child of the owner) wishes to participate in management, but does not possess all the skills needed to succeed, sometimes a partial equity sale to key non-family senior management may be practical to lock-in the extra skills required. Another option is to implement compensation or incentives to lock-in externally hired managers whose skills are essential to see through the transition.

When Is the Right Time to Plan an Exit?

Planning an exit is prudent well in advance of retirement and may involve developing arrangements for future scenarios; before an illness strikes, before liquidity may be needed by the family, to diversify the family’s concentration of risk, when a suitable successor is groomed and ready to take over, when market timing assures a good valuation and ample buyers exist, before declining market conditions deteriorate the business value, or when partners and stakeholders signal they are getting anxious about succession.

Who to Turn to for Advice?

Business Succession Planning is a relatively new specialty advice area, and can be obtained through professional advisors and some of the major banks, who have specialists in Tax and Estate Planning, High Net Worth Planning and Insurance Solutions to provide advice.

Speak to your advisor, investment specialist or commercial banker to learn more about how you can access these specialists, and begin to put your plan into action.

Benefits of implementing a succession plan
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Business owners who don’t have a succession plan often make various excuses. These can include, not having the time to plan, feeling it is too early to plan, finding it is too complex a process, saying they can’t find adequate advice or tools, that they don’t want to exit their business, or fear of causing a family conflict. The potential benefits of implementing a well thought-out business succession plan are many, and may include:

  • helping to ensure the smooth transition and continuity of the business/real estate
  • maximizing the value of the business/real estate
  • minimizing taxes payable
  • minimizing probate fees
  • minimizing estate taxes and inheritance issues
  • providing financial security for the family
  • preserving family harmony
  • inspiring confidence in family, management, employees, customers, suppliers and bankers

— Jeff Halpern, Business Succession Planner, TD Wealth,
Special to MoneyTalk Life