A tax-efficient exit: time invested now pays off later
This article was updated on March 29, 2018.
Many entrepreneurs are focused on their present reality, and rightly so – making their business grow and succeed is more than a full-time job. Properly structuring for an exit too often seems like a distant consideration, until the right offer comes along or a sudden illness, disability or life circumstance occurs which brings that distant consideration into immediate focus.
It’s human nature to defer devoting precious time and resources to decisions we perceive to be out of our immediate view, somewhere on the horizon. However, experience has found that business owners who are able to plan years ahead of an exit achieve much better outcomes for themselves and the business than those who leave it too late. This is particularly true when ensuring that your business affairs are appropriately structured from an income tax perspective to provide access to available tax planning opportunities and maximize your after-tax retained capital.
The upfront tax rate arising from gains realized in a sale transaction can be upwards of 25 per cent without any planning steps taken in advance. For many owners, it’s often a mistaken assumption when entering into an exit process that little can be done about the tax liability and they simply let the after-tax chips fall where they may. For others, tax planning is deferred until the time an exit becomes a reality and they are disappointed to discover that available options are limited and needed to have been implemented years ahead of the exit in order to be utilized. For example, being able to access multiple capital gains exemptions on a qualifying share sale may result in tax free proceeds - but such a structure generally needs to be implemented years in advance. Still others believed they were structured correctly to reduce tax on an exit but haven’t reviewed or re-visited their tax plan in years and are horrified to learn that their structure is tainted or less than optimal based on the current planning opportunities available.
The 2017 private company proposals, 2017 fall announcements and 2018 Budget left many business owners uncertain and wary about their future state. Indeed, many transactions and plans which were in process in 2017 were halted or paused altogether due to the looming tax uncertainties that existed, so there is perhaps no better time than now to understand how these changes could impact any previous planning implemented and what entrepreneurs need to be aware of moving forward.
Begin with the end in mind
One of your first steps is to consider some of the following questions together with your advisor:
- How do the 2018 Budget and 2017 private company proposals impact my structure? What uncertainties continue to exist and what steps can I take to address?
- Can I take advantage of the lifetime capital gains exemption under my current structure to reduce or eliminate tax?
- Are there any opportunities to multiply the lifetime capital gains exemption under my current structure with other family members?
- Are my operating companies clean of any ‘bad assets’?
- Do I have different business ventures comingled in one operating entity and are these businesses separately saleable?
- Who would be most likely to purchase my business?
- One of my current employees or a group of employees, performing a management buyout – possibly wanting to strike a deal in which they will gradually earn-in the established value of the company
- Someone who has no relationship to the business now, and may be looking for me to stay involved in the business for a stated period of time, with the total purchase price based partly on my abilities to help keep the business successful
- A strategic buyer such as a peer or competitor, who might want to fold my operations into theirs, perhaps with a commitment to retaining my employees – or conversely, to shut the business down to remove some competition
- If I have family members that will take over the enterprise how can they be introduced on a tax-efficient basis while preserving the value I’ve built? How will family members that are not involved in the business be equalized?
- Will I need all the cash from an exit for personal expenses or will proceeds be used to invest in other opportunities?
Developing your tax plan
The questions above can lead to a meaningful discussion about what tax planning alternatives are available to you and your business on an exit. A good tax advisor will be able to implement a tax plan that provides you with the most flexibility to cover a variety of exit scenarios and also take advantage of immediate planning options. Some of the advantages of a comprehensive tax plan include:
- Ability to extract and retain corporate profits not required for personal expenses on a tax-deferred basis for reinvestment into other opportunities while simultaneously allowing the operating company to be kept clean of passive assets which may permit the shares to qualify for the capital gains exemption on a share sale.
- Appropriately structure foreign operations to provide access to beneficial Canadian tax rules for such business investments
- Multiplication of the lifetime capital gains exemption among family members. Each exemption that may be utilized can shelter in excess of $225,000 of income tax otherwise payable for dispositions occurring in 2018.
Stop taxes from taking too big a bite
Many entrepreneurs are leaving significant sums of money with the taxman, when some planning will help preserve wealth. A suitable plan depends very much on the personal circumstances of the entrepreneur, the company, family members, other shareholders and other factors and consequently requires a tailored approach.
Success in tax strategy for exiting your business depends on taking steps early enough so that a full range of options is available to you, and having advice from a qualified professional to discuss those options. You are then able to develop an exit plan that meets your circumstances and objectives.