Structure Your Business for Maximum Tax Savings
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Structure Your Business for Maximum Tax Savings

Unsure which business structure is right for you? Make sure to download Small Business BC’s Business Structure Information Sheet.

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Many factors can influence the success of your business — not least of which is the structure of the business itself.

Unfortunately, there’s no “one-size-fits-all” solution; you must consider the specifics of your situation before determining the optimal business structure. Using the wrong structure for your situation can have far-reaching tax consequences, so it will also become increasingly important to update the structure as your enterprise grows and becomes more successful.

With that in mind, here are some key factors to consider when determining the most appropriate business structure:

Exit Planning

It’s never too early to start thinking about your exit strategy, and to make sure your company is structured in a way that maximizes tax savings upon its sale. One of the biggest tax breaks provided by the Income Tax Act is the $800,000 Capital Gains Exemption (CGE).

Each individual shareholder in a business is entitled to claim all or a portion of his or her CGE on the sale of shares of the company – provided certain conditions are met. In other words, the capital gains you incur from the sale of your shares could potentially be sheltered by the exemption and, therefore, be tax free.

In very simple terms, in order to claim this exemption you must sell shares of a private company actively engaged in business in Canada. In addition, all or a substantial amount of the company’s assets must be in-use in the business at the time of sale. (According to the Canada Revenue Agency, “all or substantially all” means 90 percent.) Other tests, such as the two-year holding period test and a two-year asset test, must also be met.

If you think that you will sell your company in the future, you’ll want to ensure it will qualify for the exemption by removing excess assets from the corporation, and that you multiply the number of CGE exemptions available to the greatest extent possible.

Redundant Assets

There are two reasons why it’s important to remove redundant assets from your corporation. First, as mentioned above, you need to remove all non-business assets from the corporation in order to qualify for the CGE. In addition, it’s extremely important from a legal liability standpoint that you keep the asset value of the operating company as low as possible.

Redundant assets can include, but are not limited to, cash, marketable securities, loans receivable, and rental properties.

You can remove these redundant assets by simply flowing them to the individual shareholders by way of a dividend, however, they will incur significant personal taxes. (The highest personal BC tax rate on dividends is approximately 38 percent). One of the tax advantages of a corporation is the ability to defer personal taxes until you actually require the funds that have accumulated in the corporation; if redundant assets are moved into an individual’s hands by way of dividends, this benefit is forgone.

If structured correctly, redundant assets can be moved into a holding company without incurring any taxes, thereby ensuring the operating company qualifies for the CGE, and deferring personal taxes until the funds are actually required. This can be achieved in different ways, although it is very common to use family trusts.

Significant Business Assets

It’s not unusual for companies to hold significant assets that are used in an active business – real estate or major construction equipment, for example. In such situations, it may make sense to hold these assets in a separate corporation.

Doing so can have a couple of benefits. Firstly, it may make the business easier to sell, as a purchaser may not want or be able to afford these additional assets. Secondly, an extra layer of creditor protection may be provided should a lawsuit be filed against the operating business.

Family-Owned Businesses

Family-owned businesses have both benefits and complications. One benefit is the flexibility of being able to split income with family members. Using a trust, or direct share ownership, family members over the age of 18 can receive dividends from the company, enabling their lowest tax brackets to be used. This can mean significant tax savings for a family every year that the business is operated.

An added complication of a family-owned business is the potential for hurt feelings among family members when the business is transitioned from one generation to the next. It’s imperative that a structure be in place that allows the first generation the flexibility to determine who in the second generation should receive control of the business and who may only receive some benefit from it.

Successful family businesses commonly use family trusts, which allow for both income splitting and flexibility on the transfer of the business.

 

Disclaimer: This article deals with complex matters which have not been addressed in full and may not apply to your particular facts and circumstances. As well, the matters presented and the references contained in the article reflect laws and practices that are subject to change. Please consult a tax advisor for advice on how the above information should be applied.

Unsure which business structure is right for you? Make sure to download Small Business BC’s Business Structure Information Sheet.

Download Now

About Jamie Kungel

Jamie Kungel, CPA, CA is a Taxation Specialist with the Nanaimo office of MNP LLP, a national accounting, tax and business consulting firm with 16 offices across B.C. For more information, contact Jamie at 250.287.2131 or james.kungel@mnp.ca, or view his LinkedIn profile at https://ca.linkedin.com/in/jamiekungel. You can follow MNP on: Twitter, LinkedIn, YouTube