Trusts and Taxes – Answering Some Key Questions About Two Crucial Business Mechanisms

What types of taxes will you pay when you sell your business? And when should you file for a family trust? Find out the answers to these essential questions.

Trusts and taxes.

Those two words can send shivers down the spines of anybody unfamiliar with them. 

Of course, we all know that we have to pay taxes on our businesses. But many business owners don’t know what they can do to minimize their taxes. 

Maybe you’re the same.

And in some cases, you may not even know what taxes you’re supposed to pay in different situations.

As for trusts…

They can be complicated mechanisms if you have little experience with them.

I’ve decided to use this article to answer a couple of frequently asked questions I get about trusts and taxes.

Question #1 – When Should I File for a Family Trust?

Before I answer this question, I want to let you know that you don’t have to worry about this when working with Gauvreau Accounting Tax Law Advisory. We deal with trust filings on your behalf, meaning you can just let us do the hard work.

But let’s say you’re not working with us. Or, you just want to know what the filing deadline is.

The answer:

March 31st. 

The requirements have changed, meaning you no longer need to file for your family trust on December 31st. 

Now, what does filing mean in the context of a family trust?

You need to fill out T3 slips for every individual in the trust.

For example, say you have a family trust that owns some investments, or it has some shares in your private corporation. These investments create income, which you issue as dividends to all members, or beneficiaries, in your trust. That income gets earned on a calendar year basis. 

Your first task is to ensure that all of the income earned from these investments gets allocated to the beneficiaries within the same calendar year it's made. 

Now, your second task is to ensure you document all of those payouts so you can use T3 forms to tell the government exactly how much each beneficiary earns.

I recommend starting work on this at the end of the calendar year. That gives you three months to get all of your ducks in a row so you don’t have any issues with filing.

Question #2 – What Taxes Will I Pay When I Sell My Business?

The answer to this question depends on how you sell your business.

So, there are two fundamental ways you can sell a business:

1. Sell all of the assets inside the business, which includes the goodwill the company has generated in the market.
2. Sell shares of the business, which essentially sells everything inside one package.

Each method has pros and cons when it comes to taxes.

Selling Assets

When you sell all of the assets, you’re offering all of the equipment, land, and goodwill sitting inside the corporation.

Here, you have to pay capital gains tax on the money made from the sale, which currently stands at about 25%. That means if you sell all of your assets, 25% goes towards taxes, with the other 75% remaining for distribution when the sale completes.

On the surface, that seems like you’re sacrificing a huge chunk of money. But think about this from the buyer’s perspective.

Let’s say you bought the business for $1 million and then sell it for $1.1 million. That’ll create a $100,000 capital gain, of which you pay $25,000 in taxes.

Your buyer gets access to assets and equipment that depreciate. That depreciation can be anywhere from 5% to 30%, depending on the age and nature of the asset. Depreciation creates what we call a “tax shield” for the buyer, where they get to claim back against the assets they’ve bought each year.

That’s an attractive proposition for any buyer.

Not only do they get direct asset ownership but they also get to save money on their taxes.

So, selling assets will cost you more in terms of capital gains tax. However, the upside of doing it is that you’re likely to attract more potential buyers, especially those who understand how the tax system works.

Selling Shares

If you have a Canadian-controlled private corporation, which is a small business based in Canada and controlled by a Canadian resident, you access a capital gains exemption.

This means that you don’t pay any taxes on the first $850,000 of capital gains you make from selling the shares. 

It’s a super great perk of owning and selling a small business in Canada. However, the perk does present some downsides to the person buying the business.

Let’s revisit our example about the million-dollar business purchase and the $1.1 million sale. In this situation, you have capital gains of $100,000, meaning you get to take home all of the money from the sale.

That sounds great.

But again, look at it from the buyer’s perspective. 

A share sale does not give the buyer the same control over the business’s equipment and land that an asset sale would. 

And as a result, they don’t enjoy the same depreciation benefits, meaning they lose the “tax shield” that makes your business so attractive from an asset sale perspective.

Which Type of Sale Should You Choose?

Choosing the type of sale to go for typically comes down to your negotiations. 

While selling shares means you keep a larger chunk of the profit, it also makes the business less attractive to buyers. 

By contrast, an asset sale means you pay 25% in taxes. But you may be able to ask for more money based on the depreciation benefits the buyer experiences.

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