Succession Planning for Family Businesses in Alberta

Family businesses are the backbone of Alberta’s economy, driving both local prosperity and contributing to the broader Canadian market. According to recent studies, nearly 80% of businesses in Canada are family-owned, and these enterprises create a significant share of private-sector jobs. However, the future of many of these businesses remains uncertain due to the lack of proper succession planning. Without a well-structured plan, the transition from one generation to the next can lead to disruptions, financial strain, and even conflict within the family.

In Alberta, family business owners must consider not only the logistics of handing over the reins but also the tax implications involved. Succession planning that takes these factors into account can help ensure a smooth transition, protect the financial stability of the business, and preserve family harmony.

This guide explores the key elements of succession planning for family businesses in Alberta, focusing on minimizing tax liabilities, preserving business value, and navigating the complex family dynamics that often accompany ownership transfers.

The Importance of Succession Planning

A solid succession plan is critical for the long-term survival of family businesses. Without one, businesses face risks that could lead to operational disruptions, financial loss, and even failure. Below are the key reasons why family businesses must prioritize succession planning.

1. Continuity of Business Operations

• Minimize Disruptions: A well-structured succession plan ensures that business operations continue seamlessly during the ownership transition. Planning in advance allows the outgoing owner to transfer knowledge, contacts, and strategies to the next generation, minimizing downtime and ensuring client confidence.
• Maintain Client Confidence: Clients, partners, and stakeholders are more likely to continue their relationships with a business if they see a clear and organized succession plan in place. A transparent transition helps prevent client attrition, which can otherwise occur if the transfer of power seems chaotic or uncertain.

Example: A family-run construction company in Alberta faced client hesitancy when it became clear that the founder was stepping down without a formal plan. After working with advisors to create a succession plan that included leadership training for the next generation, they were able to retain key clients and maintain growth during the transition.

2. Family Harmony

• Avoid Conflicts: Family businesses often face internal disputes over leadership and ownership. Succession planning helps prevent these conflicts by clearly outlining roles, responsibilities, and the distribution of assets. It ensures all family members are on the same page, reducing the chances of misunderstandings or resentment.
• Align Expectations: A succession plan aligns the expectations of all involved family members. Whether the business is to remain within the family or be sold, clearly defining each person’s role and stake in the business helps avoid feelings of favoritism or unfair treatment.

3. Financial Stability

• Protect Business Value: Planning for succession allows you to preserve the business’s financial health. A structured plan ensures that the business remains profitable and sustainable after the ownership transfer, safeguarding the wealth and livelihood of the family.
• Tax Efficiency: Effective succession planning also focuses on minimizing the tax burden that often accompanies ownership transfers. This is particularly important in Alberta, where business owners can take advantage of federal and provincial tax benefits if they plan appropriately.

Tax Implications of Transferring Business Ownership

One of the most significant aspects of succession planning for family businesses in Alberta is managing the tax liabilities that arise from the transfer of ownership. Understanding the tax implications ahead of time will help you develop strategies to mitigate potential costs.

1. Capital Gains Tax

When you transfer ownership of a business, you may trigger capital gains tax, which applies to the appreciation in the value of the business shares since they were acquired. This tax liability can have a substantial financial impact, especially if the business has grown significantly over time.

• Disposition of Shares: Transferring ownership of shares in the family business may be seen as a sale by the CRA, even if the transfer is between family members. This can trigger capital gains tax, requiring the owner to pay tax on the increase in value since the shares were first acquired.
• Lifetime Capital Gains Exemption (LCGE): Fortunately, the Lifetime Capital Gains Exemption (LCGE) provides some relief. As of 2023, business owners can exempt up to CAD 913,630 of capital gains on the sale of qualified small business corporation shares. This exemption is a powerful tool for family business owners looking to minimize their tax burden.

Example: A family-owned small manufacturing company in Alberta was passed from father to son. Over the years, the company’s value had grown from CAD 500,000 to CAD 1.5 million. Without the LCGE, the father would have been taxed on the CAD 1 million gain. However, using the exemption, he was able to avoid paying capital gains tax on CAD 913,630 of the gain, significantly reducing his tax liability.

2. Estate Taxes

If the business owner passes away without a proper succession plan, the CRA treats their assets as being sold at fair market value. This “deemed disposition” can trigger significant capital gains tax, potentially causing financial strain on the heirs.

• Deemed Disposition at Death: Upon the death of the business owner, the CRA assumes that the business assets have been sold, which can result in a sizable tax bill for the heirs. This tax burden can be especially difficult to manage if the business lacks sufficient liquidity to cover the tax liability.
• Rollovers to Spouse or Children: Some provisions allow for tax deferral when transferring business assets to a spouse or children. For example, assets can be rolled over tax-free to a spouse, deferring the capital gains tax until the spouse sells the business. Similarly, rollovers to children can sometimes be arranged under specific circumstances to defer taxes.

Example: A restaurant owner in Alberta passed away unexpectedly. The business was valued at CAD 2 million, which led to a significant deemed disposition tax liability. By implementing a tax-deferred rollover to his spouse through careful estate planning, the family was able to keep the business running without having to sell assets to cover the tax bill.

3. Income Splitting and the Tax on Split Income (TOSI)

Income splitting is a common strategy to reduce tax liability by dividing income among family members who are in lower tax brackets. However, the Tax on Split Income (TOSI) rules introduced in 2018 impose higher tax rates on certain income-splitting arrangements involving family members.

• TOSI Rules: If a family business attempts to split income among family members who are not actively involved in the business, the income may be subject to the highest marginal tax rate under TOSI regulations. It’s important to carefully evaluate income-splitting strategies to ensure compliance with these rules.

Example: A family business in Alberta attempted to split income by paying dividends to a non-active family member. Under the TOSI rules, these dividends were taxed at the highest marginal rate, negating any tax-saving benefits. After consulting a tax advisor, the family restructured the business to comply with TOSI rules, enabling more tax-efficient income splitting.

Strategies for a Smooth Transition

While taxes are a significant consideration in succession planning, they are just one aspect of the broader process. Ensuring a smooth transition also involves careful planning around leadership, business valuation, and financing.

1. Start Early

Succession planning should begin well in advance of the anticipated transition. Giving yourself and the next generation time to prepare ensures a smoother process.

• Advance Planning: Start the succession process at least five to ten years before you plan to retire. This allows time to train and mentor the next generation, giving them the skills and experience they need to successfully take over the business.
• Training and Mentorship: Mentorship is critical. As a business owner, your hands-on experience is invaluable, and transferring this knowledge to your successor will ensure that they’re prepared to lead the company effectively.

2. Valuation of the Business

Obtaining an accurate valuation of your business is essential for both tax planning and ensuring a fair transfer of ownership.

• Professional Appraisal: Hire a professional business valuator to assess the market value of your business. A clear understanding of the business’s worth will help you plan for taxes and negotiate terms with potential successors.
• Adjustments: It’s important to update the business valuation regularly to account for changes in the market and the company’s performance. This helps ensure that your succession plan reflects the current state of the business.

3. Choose the Right Successor(s)

Not all family members may be suited to take over the family business. Selecting the right successor is critical to the long-term success of the business.

• Assess Skills and Interests: Assess the skills, interests, and commitment of each potential successor. Not every family member will want to take on the responsibility of running the business, and that’s okay. It’s essential to have open conversations about expectations and desires to avoid future conflicts.

4. Legal Documentation

Clear and legally binding documentation is critical to ensuring that your succession plan is implemented as intended.

• Shareholder Agreements: Draft shareholder agreements that outline the terms of the ownership transfer, including decision-making processes, buyout provisions, and roles for different family members.
• Wills and Estate Planning: Ensure that your will and estate planning documents are aligned with your succession plan. Any discrepancies between your estate plan and the business succession plan could lead to costly legal disputes.

5. Tax Planning

Work with tax professionals who understand both federal and Alberta tax laws to optimize your tax strategy.

• Consult Tax Professionals: The tax implications of transferring a family business can be complex. An experienced tax professional can help you navigate the landscape and take advantage of available exemptions, rollovers, and deferrals.
• Optimize Tax Benefits: Maximize tax benefits by making use of the LCGE, rollovers, and other tax-planning tools. Structuring the transaction properly can significantly reduce the tax burden on both the outgoing owner and the successor.

6. Financing the Transition

The financial aspects of the transition can be just as challenging as the tax implications. Consider various options for financing the transfer.

• Payment Structures: Options like gradual buyouts or installment payments can make the transition more manageable. Instead of requiring an upfront payment, the new owners can buy the business over time, reducing the financial strain.
• External Financing: If the new owners don’t have sufficient capital, external financing options such as business loans or investor involvement may be necessary.

Common Challenges and How to Overcome Them

1. Emotional Attachments

Family businesses are often built with deep emotional investment, which can complicate the succession process.

• Objective Decision-Making: It’s important to involve neutral advisors, such as business consultants or accountants, to provide objective guidance during the transition.
• Counseling: Engaging family business consultants can help navigate the emotional complexities that often accompany these decisions.

2. Regulatory Compliance

Tax laws and regulations are constantly changing, and staying up to date is essential to avoid costly penalties.

• Stay Updated: Keep current with changes to federal and Alberta tax laws. Regular consultations with legal and tax professionals will ensure that your succession plan remains compliant.

3. Fairness vs. Equality

In family businesses, it’s important to distinguish between fairness and equality. Fair distribution of assets may not always be equal.

• Equitable Distribution: Tailor your succession plan based on individual contributions and roles within the business. Not all family members may have the same level of involvement or interest in the business.
• Transparent Communication: Explain your decisions to all family members to mitigate misunderstandings. Transparency is key to avoiding conflict down the road.

How BOMCAS Canada Accounting Firm Can Help

Succession planning is a complex process that involves legal, financial, and emotional considerations. At BOMCAS Canada Accounting Firm, we specialize in helping family businesses in Edmonton and across Alberta navigate the challenges of succession planning.

• Personalized Planning: We tailor strategies to meet your family’s unique needs and business goals, ensuring that your legacy is preserved for future generations.
• Tax Optimization: Our experts are well-versed in both federal and Alberta tax laws. We help you minimize tax liabilities and take full advantage of available exemptions and deferrals.
• Legal Coordination: We collaborate with legal professionals to ensure that all documents, from shareholder agreements to wills, are properly executed and in line with your succession plan.
• Ongoing Support: From the initial planning phase to the final transfer of ownership, we provide continuous guidance to ensure a smooth transition.

Contact Us Today

Secure your family’s legacy and ensure the longevity of your business with professional succession planning.

Phone: 780-667-5250
Fax: 780-851-2520
Email: info@bomcas.ca
Website: https://bomcas.ca

At BOMCAS Canada, we’re committed to helping you navigate the complexities of succession planning, so you can pass the torch with confidence.