This is the second part of our series on succession planning for family businesses. We continue to follow the Johnstone family as they navigate the emotional journey of passing a business from one generation to the next. One aspect of an intergenerational business transfer is creating a robust strategy to execute the sale in a way that’s as tax efficient as possible. We break down the tax considerations and guide you through the process to demonstrate the steps needed for a smooth and compliant transition.
In Part 1 of our series, A legacy in limbo: Building bridges to family harmony, we meet the Johnstone family for the first time. John Johnstone, founder and president of JJ Construction, is considering how he can progressively step back from his business to enjoy retirement. Two (out of three) of his children, Mark and Morgan, both hold management roles and are deeply ingrained in the operations of the business. John’s wife, Anna, holds an ownership role in JJ Construction but is no longer active in the business, and Kim, their youngest daughter, chose a different career path as a teacher, but remains part of family business decision-making. At first, family members experienced a misalignment in expectations and values, which caused friction in the transition process. To help achieve harmony, the Johnstones brought on a family enterprise advisor (FEA) to help navigate the transition, facilitate open communication and collaborative decision-making, formalize governance, and clarify roles and responsibilities.
Now that the Johnstones are ready to formalize the transfer of ownership to Mark, Morgan, and Kim, the family reached out to their Doane Grant Thornton tax advisor, Cody, to help them determine the right strategy to ensure a smooth and tax-efficient transaction.
Before they begin to discuss the possibilities for the transaction, Cody sits down with the family and their Family Enterprise Advisor, Lou, to understand the steps the family has taken up to this point, the family dynamics, and the progress the family has made. Cody also spends time understanding the business, and the goals that the incoming and exiting leadership team would like to achieve. The Johnstones tell Cody that they’d like a transition where the payment plan takes place over time. This would allow John to remain involved in the business and gradually step back, as Mark and Morgan expand their roles and their stake in ownership.
At this stage, Cody explains how the intergenerational business transfer rules could help them achieve a tax-efficient transition. Primary benefits of the intergenerational business transfer rules includes the ability for John and Anna to access their capital gains exemption, and “spread out” the tax implication of the sale over a longer period of time through the extended capital gains reserve. While these rules often present the most tax-efficient option, they are complex—and some requirements are difficult to meet. Cody breaks down the rules and requirements to help the family understand how they work and determine whether they can leverage them during the transfer of JJ Construction to the Johnstone successors. If the transfer doesn’t meet the requirements of the rules, Cody can help the Johnstones explore whether there are ways to meet the criteria of the rules or consider other options, such as using an estate freeze.
The intergenerational business transfer rules, which were introduced as part of Bill C-208, were enacted in 2021 to level the playing field for family business sales. New measures were enacted in June 2024 to ensure that the business transfers that benefit from these rules are genuine family business transfers. These changes introduced requirements that are much more complex and challenging to meet. Previously, selling a business to a family member could have resulted in a less favourable tax treatment compared to if it was sold to a third-party. The intergenerational business transfer rules allow family business transfers to be treated similarly to a third-party sale by allowing the sales to be taxed as capital gains (instead of full taxable dividends).
As another important benefit to the intergenerational business transfer rules, John and Anna will be able to access the capital gains exemption. In addition, as the sellers of the business, they’re able to claim a capital gains reserve on the share transfer for a maximum of 10 years (rather than five years), provided they follow through with meeting the gradual IBT conditions.
To qualify for these rules, JJ Construction must be incorporated and must qualify as a qualified small business corporation (QSBC), family farm, or fishing corporation at the time of the transfer. John and Anna must transfer JJ Construction shares to the holding company controlled by Mark, Morgan, and Kim. In addition, no previous intergenerational business transfers under these rules should have taken place. If this first set of requirements are met, the Johnstones then consider whether they can structure their transition plan to meet one of the timing requirements.
The measures introduced in 2024 are intended to ensure that the business transfers that benefit from these rules are genuine family business transfers. They require the transaction to meet timing requirements for either an immediate intergenerational business transfer (i.e., three-year test) or a gradual intergenerational business transfer (i.e., a five-to-ten-year test).
For both the gradual and immediate intergenerational business transfers, the following criteria must be met after the transfer takes place:
There are other requirements that are dependent on whether you are trying to meet the timing requirements for the immediate or gradual intergenerational business transfer. These include the transfer of control and economic interests, transfer of management, how long Mark, Morgan, and Kim will retain control of JJ Construction, and how long Mark and Morgan must continue to work in the business.
Given that the Johnstones want a longer transition plan so that John can remain involved in the business for a while, the gradual intergenerational business transfer appears to be a good fit. This means certain conditions must be met—for example, at least one of the children will have to retain legal control of JJ Construction for either 60 months or until the business transfer is complete (whichever is greater) and remain actively involved in the business for that time. Since Morgan, Mark, and Kim don’t have any plans to sell the business, and Morgan and Mark intend on continuing to carry out their management positions at JJ Construction, they should be able to meet these conditions.
For more information on these rules, see our tax alert on Intergenerational business transfer: Changes you should know.
The transfer of JJ Construction to the next generation meets the requirements for the intergenerational business transfer rules, which is the most tax-efficient options for the Johnstone family. However, there are other options if this were not the case. The first option would be to determine whether there is a way to meet the standards. For example, if JJ Construction was not a QSBC, the family could look at what conditions they’d need to meet to become one.
Otherwise, the Johnstone family would have to consider another option to transfer the business, such as an estate freeze.
Before the intergenerational business transfer rules were introduced, an estate freeze was a popular tax-planning strategy that transfers future growth of the business to the next generation while maintaining control for the current owner. If the Johnstones weren’t able to meet the conditions of the intergenerational business transfer rules, this is likely the other avenue that would be available to them. An estate freeze would limit the taxable value of John and Anna’s estate by “hitting the pause button” on today’s fair market value of JJ Contruction. Any growth in value from the time of the freeze will go into a trust with Mark, Morgan, and Kim as trustees or common shares owned by each of the children.
Passing down a family business requires proper planning to ensure the long-term success of the business—but also to protect your family’s legacy and wealth. It requires setting up the new generation of owners and their newly retired parents for success.
By helping the Johnstones create a strong transition plan that includes leveraging the intergenerational business transfer rules, Anna and John will be able to sell their business to their children—tax-efficiently—and retire confidently. Now their family business is staying in the family, and they have a plan to continue working with their team of Doane Grant Thornton advisors through the transition.
If your succession plan could involve passing your business down to a family member, we can help review whether your transition would qualify for the intergenerational business transfer rules, or whether there are steps you can take so that you can benefit from the rules in the future.
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