How to Transfer Your Small Business to Your Children Tax-Free: The Power of Smart Tax Planning

Passing your business on to your children isn’t just a financial decision—it’s about preserving your legacy. It reflects the hard work, commitment, and vision you’ve built over the years. But without a solid strategy in place, you could lose up to 50% of your business’s value to taxes.

Fortunately, with proper planning and knowledge of Canadian tax laws, it’s possible to transfer your small business with minimal or no tax burden. Here’s how effective tax planning can help you protect the value of your business and ensure a smooth transition.

Why Strategic Tax Planning Is Crucial

Many entrepreneurs believe that handing over their business to their children is a simple task. In reality, without a structured tax plan, this transfer can trigger steep capital gains and dividend taxes—significantly reducing the value passed on.

Capital Gains Tax

Any increase in your business’s value since you started it is subject to capital gains tax when sold or transferred. In Canada, this could mean paying up to 35% of the gain in taxes.

Dividend Tax

If your children inherit the business through a holding company, future earnings might be distributed as dividends. While intercorporate dividends can be tax-free under specific conditions, an improper setup can lead to hefty taxes.

Using tools like the Lifetime Capital Gains Exemption (LCGE) and Qualified Small Business Corporation (QSBC) shares, you can structure the transfer to be tax-efficient or even tax-free.

Step-by-Step Guide to a Tax-Free Business Transfer

If your company qualifies as a QSBC, you can take advantage of several tax-saving options. The process involves careful compliance with CRA requirements.

Step 1: Ensure QSBC Share Eligibility

To claim the LCGE (up to $971,190 in 2024), your shares must meet QSBC conditions:

• Your business must be a Canadian-Controlled Private Corporation (CCPC).

• Over 90% of its assets must be used in active business within Canada.

• The shares must have been held by you or a relative for at least 24 months.

Step 2: Transfer Shares to a Holding Company

Rather than transferring shares directly to your children, move them to a Holdco owned by them. If the shares qualify for the LCGE, you can apply the exemption and avoid capital gains tax.

Step 3: Use a Promissory Note

Holdco can issue a promissory note in exchange for the shares. This IOU ensures you’re fairly compensated without creating an immediate tax obligation.

Step 4: Pay Down the Note with Tax-Free Dividends

The operating company (Opco) pays tax-free dividends to Holdco under Section 112(1) of the Income Tax Act. Holdco can use those dividends to repay the promissory note—allowing you to access the business’s full value without incurring taxes.

Case Study: $375,000 in Tax Savings

Imagine your business is worth $500,000 and your cost base is just $1. Without planning, here’s what you’d owe:

• Capital Gains Tax:
  $499,999 gain × 66.67% × 45% = $150,000

• Dividend Tax:
  $500,000 × 45% = $225,000

• Total Tax: $375,000

With proper planning:

• Capital Gains Tax: $0 (via LCGE)

• Dividend Tax: $0 (tax-free intercorporate dividends)

Don’t Forget About AMT

Even if you qualify for the LCGE, the Alternative Minimum Tax (AMT) may still apply. AMT ensures high-income individuals pay a minimum amount of tax, but it’s usually recoverable over seven years if future tax liabilities exceed the AMT paid.

Why Choose Dexado Accounting and Tax?

At Dexado Accounting and Tax, we help small business owners transfer their companies efficiently—with minimal tax impact. Here’s what makes us different:

✅ Former CRA Auditor
With over 13 years of CRA experience, we know what tax authorities expect and help you stay compliant.

✅ Small Business Focus
We specialize in small business accounting and intergenerational transfers, ensuring your family benefits from every available tax break.

✅ Tailored Tax Strategies
Every business is different. We design customized solutions based on your goals and structure.

✅ Real Savings
Our strategies can help you legally save up to $375,000 on a $500,000 transfer.

What Does It Cost?

Planning fees vary based on complexity:

• Basic Setup (One Opco + Holdco): $5,000 – $7,500

• Moderate Complexity (Trusts, Valuations): $7,500 – $10,000

• Advanced Structures (Restructuring, Multiple Owners): $10,000 – $15,000

• Audit Protection Add-On: from $1,500

Considering the savings, this investment is more than worthwhile.

Final Thoughts: Protect Your Legacy with a Plan

Transferring your business to your children is about more than ownership—it’s about securing your life’s work and future generations. Without proper guidance, taxes can erase much of your business’s value. But with smart planning, you can make the transition tax-free.

At Dexado, we’re committed to helping small business owners like you preserve what you’ve built. Whether you’re beginning the process or ready to act, we’re here to help every step of the way.

Get in touch with Dexado today to start building your tax-free business succession plan.