Can I gift part of my business to my children and sell them the rest?

Giving a child part of a business and selling them the rest is a common way to hand over a family firm, and nothing in the Income Tax Act forbids it. What the Act does is look through the price. A child is a related person, and related persons are deemed not to deal at arm’s length, so the tax result is measured against fair market value rather than against what changed hands.

How the gifted part is taxed

Except as the Act expressly provides otherwise, when you dispose of property by way of gift, the Act deems you to have received proceeds equal to its fair market value. The child is deemed to acquire a gifted property at that value. The gifted portion can therefore produce a capital gain for you in the year of the gift, even though no money arrives to pay the tax on it.

How the sold part is taxed

If you sell to a person you do not deal with at arm’s length for less than fair market value, you are deemed to have received fair market value. Where a related buyer pays more than fair market value, the buyer’s cost is limited to that value. A valuation therefore matters for both parts of the plan, and a low price does not lower your tax. The wider rules are covered in transferring a business to your children.

What can soften the result

Two features may help where conditions are met. If part of the price is paid over time, the CRA explains that a capital gains reserve can spread the gain over several years, and it lists transfers to a child of qualified small business corporation shares and family farm or fishing property among those that qualify for a longer reserve period. If the shares qualify, the lifetime capital gains deduction may also reduce the taxable gain.

Settle these questions first

• Which shares or assets are gifted, which are sold, and what valuation date applies to each.
• Whether the shares are likely to qualify for the capital gains deduction at that date.
• How your child will fund the price, and what security you will hold for any balance.