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In February, the Quebec government tabled a document entitled A Plan to Strengthen the Quebec Economy as an Executive-Driven Economy, which announced a series of measures to strengthen the economy. We have analyzed the impact that one of these measures will undoubtedly have on many incorporated professionals.

Selling your business to a corporation not dealing at arm’s length

Before the new measures were announced, selling a business to a corporation not dealing at arm’s length could be very disadvantageous from a tax standpoint, compared to a sale to a corporation dealing at arm’s length.

Generally, when selling a business, the seller wants to sell the shares to benefit from the capital gains deduction (CGD). Under certain conditions, the seller obtains a tax exemption on the capital gain generated at the time of sale.

In 2017, the maximum amount eligible for the CGD is $835,716.

Scenario

He started his practice from scratch 30 years ago. Over the years, he built a clientele and grew his business, which is now worth $800,000.

A dentist who works with Patrick on a percentage basis. It is preferable for her to buy Patrick’s practice through a corporation that she has set up.

  • Because of the potentially high personal tax rates, buying a $800,000 dental practice personally would require $1,713,429 (gross).
  • The tax rate for the corporation is lower and the same purchase would require only $981,595 (gross).

A significant difference, which explains Annie’s choice to buy Patrick’s practice through a corporation.

  • For Patrick, the possibility of selling the shares he holds in the dental practice to Annie’s corporation would enable him to benefit from the CGD and to avoid tax on the $800,000 capital gain. Patrick could realize a tax savings of up to $213,240.

In 2015, she offered to buy the practice for $800,000. For the same reasons as Annie, Judith wanted to set up a corporation to buy the shares of the corporation. Unfortunately, under the Income Tax Act, Patrick’s and Judith’s corporations are not considered to be at arm’s length.

  • If Judith had bought the shares through her corporation, Patrick could not have benefited from the CGD.
  • What’s worse, the gain realized at the time of the transaction would have been considered a taxable dividend, on which the tax rate could exceed the capital gains rate. In this case, Patrick could have had to pay up to $350,720 in taxes.
  • If Judith had chosen to buy the shares of her father’s practice personally, Patrick could have benefited from the CGD, but Judith would have had to earn a much higher gross income to make this purchase.

Today, Judith is making the same purchase offer to her father. Transactions made after March 18, 2016 are now eligible for the CGD in Quebec, even when the buyer’s corporation is not dealing at arm’s length with the sellers’ corporation.

  • If Judith buys her father’s practice through her own corporation, although Patrick will benefit from the CGD in Quebec, he will still have to pay taxes to the federal government of up to $175,680.
Maximum tax payable by Patrick
($800,00 capital gain)
Sale to Annie’s corporation (arm’s length) $0
Sale before March 18, 2016 to Judith’s corporation (non-arm’s length) $350,720
Sale after March 18, 2016 to Judith’s corporation (non-arm’s length) $175,680

Although the tax situation has improved for entrepreneurs who want to sell to a family member, it is still more tax advantageous to sell the shares of your corporation to a person who is dealing at arm’s length.

The possibility of benefiting from the CGD depends on a number of factors that must be analyzed. Before making any transaction with a family member, be sure to consult a specialist in the matter. You can always contact your advisor at the Financial, who is backed by the expertise of tax specialists who can analyze your situation and recommend the best solution.

Want to know the impact of the federal and provincial budgets on the taxation of professionals?  Read the article on the subject by our tax specialists.

For an analysis of your situation,
get in touch with one of our advisors