Family business succession: passing a Canadian company to the next generation

1. Why it is the hardest sale

Of the Canadian owners who plan to leave their business in the next 10 years, about a quarter plan to sell it to a family member, and a fifth plan to hand it over without a sale. It is the hardest sale there is, for a reason that has nothing to do with the family: there is no market. A sale to a stranger has a price the market set, a buyer who paid it, and a closing after which everyone goes home. A transfer to a child has a price somebody had to invent, a buyer who usually cannot pay it, and a table everyone is still sitting at next Christmas.

The Canadian Federation of Independent Business found that the top obstacle to succession for 54% of owners is finding a buyer or a successor, that 43% struggle to put a value on the business, and that 39% say it depends too much on them. A family transfer solves the first and makes the other 2 worse, because the successor is chosen before the value is known, and the business has usually depended on the parent for 30 years.

The home page calls this kind of exit succession or family transfer, and says the hard parts are price, fairness between siblings, and tax. This guide takes the 3 in turn, then the calendar, so that you recognise the stages when your accountant and lawyer name them. It does not value anything, and it is not advice.

2. The 3 ways a company passes to a child

Every family transfer is 1 of 3 things, or a sequence of them.

Inheritance. The plan that happens when there is no plan. The Income Tax Act treats you as having sold everything you own, at fair market value, the moment before you die, and the tax on the gain lands on your final return. Shares of a family farm or fishing corporation can pass to a child at cost and defer the tax. Shares of an ordinary company cannot. Property left to a spouse passes at cost, which is why the bill often arrives on the second death rather than the first. Either way the tax is due when there has been no sale to pay it from, and the children inherit a company they may have no way to keep.

A sale. Your child, or more often a corporation your child controls, buys your shares at a price. It is rarely paid in cash. The usual pattern is a payment at closing and the rest over years, out of the profits of the company your child now runs, with you holding the debt. On your side it is a capital gain, with the lifetime exemption if the shares qualify, and a reserve that can spread the gain over the years the money arrives, up to 10 of them on a transfer to a child. This is the deal the 2024 rules were written for.

A freeze. The structure under most family transfers, and the one most owners have never heard named. You exchange the common shares you hold, which carry all of the future growth, for preferred shares fixed at what the company is worth today. Your child, or a family trust for the children, then subscribes for new common shares at a nominal price. From that day the growth belongs to the next generation and your interest is frozen at today’s value. You are paid out over years as the company buys back your preferred shares, and your tax is on a number that no longer grows. Budget 2023 described the gradual route in the 2024 rules as built on exactly this.

3. The price, and why a discount is taxed

There is no buyer to say what the company is worth, so the Act sets a floor. If you give the shares to your child, you are taxed as if you had sold them at fair market value. If you sell them to your child for less than fair market value, you are taxed on the full value while your child’s cost is only what they paid, so the discount is taxed once in your hands now and again in theirs when they sell. Section 69 of the Act closes the door on the family discount.

That means a family transfer needs a valuation as much as a sale to a stranger does, and needs it more, because there is no offer to point to. An independent valuation in writing, before the terms are settled, is the number everything else hangs from: the price, the freeze, the estate. The Canada Revenue Agency can ask what the number was based on, and the answer has to be better than the family agreed. Nobody on this site values companies. Your accountant will know who should.

The second half of the price question is how it gets paid. A child rarely has the money, so the price comes from 1 of 4 places: the company’s own future profits, through payments to you over years; a loan from you, secured on the shares; a bank loan to your child’s holding company; or the redemption of your frozen shares, which is the same thing in different clothes. In every version your retirement is being paid out of the business your child is running, which is the honest description of most family transfers and the reason the lawyer’s paperwork matters. The security you keep, what happens if the payments stop or your child divorces, and insurance on the person who now owes you the money are ordinary questions, and they belong in the agreement rather than in a conversation nobody wants to have later.

4. Fairness between the children

The most common shape of the problem: 1 child works in the company, 2 do not, and the company is most of what you own. Give it to the child who runs it and the other 2 inherit less. Sell it to that child at full value and share the estate equally, and the working child has paid for what they spent 15 years building. Leave it to the 3 of them equally and the working child has 2 business partners who want dividends from a company they do not work in.

Fair and equal are not the same word, and the families that get through this are the ones that say so out loud, early. The tools are the lawyer’s, and there are only a few of them.

• Other assets. The house, the investments, the cottage and life insurance can balance the estate so that the company goes to 1 child and the value goes to all of them. Insurance is often the only asset large enough, which is why it sits inside most family plans.
• Different shares. The children outside the business can hold shares that pay them without giving them a say: non-voting shares, or preferred shares with a fixed return. The tax on split income rules, in section 7, limit what a company can pay a family member who does not work in it, so this is designed with the accountant rather than assumed.
• A shareholders’ agreement. If more than 1 child will own shares, an agreement that says who runs the company, how decisions are made, and whether, when and at what price formula the others can be bought out. The single most common failure in a family transfer is a will that leaves the shares 3 ways and a shareholders’ agreement written for 1 owner, or no agreement at all.
• Someone from outside the family in the room. A facilitator, an accountant or a lawyer who is nobody’s parent and nobody’s sibling. Most families need 1 for the meeting where the plan is read out.

5. The tax trap that stood until 2021

For decades the Income Tax Act made it more expensive to sell a company to your own child than to a stranger. The rule is section 84.1. It exists to stop owners turning dividends into capital gains by selling shares to a corporation they control, and it applies whenever an individual sells shares to a corporation they do not deal with at arm’s length. A corporation controlled by your child is exactly that. So when a parent sold shares to a child’s holding company and took back cash or a note, the Act treated the money as a dividend rather than a capital gain: taxed at dividend rates, with no lifetime exemption. A stranger’s holding company paying the same price produced a capital gain and the exemption. Families paid for being families.

Bill C-208, a private member’s bill, opened an exception from 29 June 2021 for transfers to a corporation controlled by a child or grandchild. Within weeks Finance Canada said the exception had insufficient safeguards: the parent did not have to give up control, the child did not have to work in the business, and the child did not have to keep the shares. Budget 2023 rewrote it. From 1 January 2024 the exception applies only to what the Act calls a genuine intergenerational business transfer, and there are 2 ways to qualify.

3 things are true of both. The shares have to be qualified small business corporation shares, or shares of a family farm or fishing corporation, at the time of the transfer. The buyer has to be a corporation controlled by 1 or more of your children, each of them 18 or older, and child is read widely: children, grandchildren, stepchildren, children-in-law, nieces and nephews, and the children of nieces and nephews. And you can use the exception once. A parent who has used it after 2023 does not get it again.

6. The 2 routes since 2024: immediate and gradual

The immediate transfer, the 3 year test. Written for a sale on the terms a stranger would get.

• You give up control at once, both the legal control that comes with a majority of the votes and the practical control that comes from being the person everyone depends on. A majority of the voting shares move on the day, and the rest within 36 months.
• A majority of the growth shares move on the day, and the rest within 36 months, after which you hold nothing but non-voting preferred shares.
• For 36 months after the transfer, your child or children control the buyer, at least 1 of them works in the business, and the business carries on. The Act treats a child who works an average of 20 hours a week as actively engaged.
• Within 36 months, or longer if that is reasonable in the circumstances, you and your spouse have taken reasonable steps to hand over management and to stop managing for good.

The gradual transfer, the 5 to 10 year test. Written around the freeze.

• You give up legal control at once: a majority of the voting shares on the day, and the rest within 36 months. You may keep the practical control for a while.
• A majority of the growth shares move on the day, and the rest within 36 months.
• Within 10 years of the first sale, what you and your spouse still hold in the business, shares and debt together, has to be worth no more than 30% of what your interest was worth on the day of the first sale. For a farm or fishing corporation the figure is 50%.
• Your child or children keep control, and at least 1 of them works in the business, until the later of 60 months and the day the transfer completes.
• Within 60 months, or longer if reasonable, you have taken reasonable steps to hand over management and stop.

On either route. You and each child elect together, on the Canada Revenue Agency’s Form T2066, by your filing due date for the year of the transfer, and the Agency’s instruction is to keep the form with your records rather than send it in. There is no cap on the value transferred. The child shares the liability for the tax if the conditions are broken later, which is the reason for the joint election. The Agency has longer to reassess the transfer, 3 extra years on the immediate route and 10 on the gradual. And if the child dies, becomes disabled, or the business is sold to an outsider before the period is up, relieving rules stop the transfer failing for it.

None of that is a checklist to run yourself. It is what your accountant will be designing the transfer around, and the reason the conversation with them starts years before the conversation with your child ends.

7. The exemption, the freeze and the trust

The lifetime capital gains exemption is what the 2024 rules were fought over. If your shares are qualified small business corporation shares, each individual shareholder can shelter a lifetime total of capital gains: $1,250,000 for sales after 24 June 2024, indexed from 2026, which puts it at $1,275,000 this year. The 3 tests, and the 24 month clock that has to run before any sale, are set out in the guide to share sales and asset sales, and they apply to a sale to your child exactly as to anyone else. A company that has built up cash or investments inside the operating business usually fails them until those are moved out, and moving them can take 2 years.

3 things about the exemption matter more in a family than in a sale to a stranger.

It is per person. Each adult child who holds shares, and each parent, has their own. A freeze in which a family trust takes up the growth shares can, with the structure set up years ahead and your accountant’s sign off, allocate a gain to each adult beneficiary so that more than 1 exemption is used.

It can be used at the freeze. An owner can choose to trigger a gain on the day of the freeze and claim the exemption then, which accountants call crystallizing it. The reasons are that the company passes the tests today and might not later, that the rules might change, and that the exemption is then in the bank whatever the transfer turns into.

The rules on paying family. Since 2018, dividends paid by a private company to a family member who does not work in it can be taxed at the top personal rate, under the tax on split income rules. The exclusions turn on the person’s involvement and stake: working in the business an average of 20 hours a week, in the current year or any 5 earlier years; being 25 or older and holding 10% or more of the votes and the value, in a company that is not a professional corporation and does not earn almost all of its income from services; or being the spouse of an owner who is 65 or over. A capital gain on qualified small business corporation shares is outside the rules altogether. This is why the freeze is designed around who actually works in the company, and why the children outside it are usually looked after through the estate rather than through dividends.

8. When the next generation says no

Many owners who want a family transfer do not get one, because the child does not want the company, or is not the person to run it and everyone knows it. The CFIB found that nearly as many owners plan to sell to their employees as to their family. The other ways out are on the home page, and 3 of them keep something of the succession.

• A management buyout. The people already running the company buy it, usually paid over several years, with a family member often among them. Section 84.1 does not apply to a buyer you deal with at arm’s length, so a sale to a management team’s holding company is a capital gain in the ordinary way.
• An employee ownership trust. Since 1 January 2024 a trust for the employees can buy the company, financed over time, and the first $10 million of the seller’s gain on a qualifying sale is exempt from tax, with a 10 year reserve where the price is paid over time. The exemption was written to expire at the end of 2026 and was made permanent by Bill C-30, which received Royal Assent on 18 June 2026. The conditions are strict: the trust must control the company, it must be for all of the employees, and the former owner and their relatives cannot make up more than 40% of the trustees or the board.
• A sale with the child inside it. An outside buyer who wants the business, and a child who wants a career in it rather than the whole of it. The child stays as a manager, sometimes with a minority stake, and the parent gets a market price. A partial sale, where an investor buys part and the child buys part, is the same idea with the family keeping more.

The one that is not an option is waiting. Section 2 describes the plan that applies when there is no plan.

9. The calendar

A family succession is measured in years, and the years are set by the rules rather than by anyone’s patience.

• The exemption’s 24 months, which have to be running before any sale, and up to 2 years of purification before that if the company fails the tests.
• The freeze, done early enough for the growth to have somewhere to go and for the trust to have been in place for a while.
• The immediate route’s 36 months of the children in control and you out of management.
• The gradual route’s 10 years, and its 60 months at least of the children in control.
• The reserve’s 10 years, if the price is paid over time.

Put together, the honest horizon for a family transfer is 5 to 10 years from the first conversation to the last payment, and 3 years from the sale is the minimum on the fastest route. The order that works is the family conversation first, the valuation and the accountant’s plan second, then the freeze or the first sale, then the years of your child running the company while you provably do not, then the completion. The guide to how long a sale takes puts weeks against the stages of a sale to a stranger, and the readiness checklist runs the 2 to 3 years of preparation backwards from a sale. A family transfer needs all of that preparation, because the buyer inherits the company’s weaknesses along with its keys.

10. Where we fit

Sell My Company is a finder, and proudly Canadian. Owners of Canadian companies with $1 million or more in revenue tell us 4 things, and we introduce them to 1 vetted Canadian M&A advisory firm that has closed deals at their size in their sector. 1 introduction, never a list, and free to you at every stage, because the advisory firm pays our fee.

A family transfer the family agrees on is mostly your accountant’s and your lawyer’s work, and you may not need us at all. We would rather say so. Where an M&A advisor earns a place is where the family needs an answer from outside it: when the price with a child has to stand against what the market would pay, when part of the company is being sold to an outside investor to fund your exit alongside a child, when the succession has fallen through and the company is going to market after all, or when the plan is a sale to management or to an employee trust and someone has to run it. The guide to brokers and M&A advisors explains what that person does. If that is you, tell us 4 things and say which. If you are years away, take the scorecard: the gaps it names are the ones your child will inherit.