There’s a special sense of pride when your child decides to follow in your footsteps and pursue the same career path as you. For dentists whose children are in dental school or are considering pursuing a career in dentistry, there is also another significant benefit: you get to leave your legacy in the hands of your children.
From a practical perspective selling your practice to your child can be an ideal situation. You get to work side by side with your child prior to, during and after the transition which reduces the rate of patient attrition. Your staff have probably watched your children grow up right in front of their eyes and are at ease with the idea of your child taking over which reduces staff turnover. You do not have to look for a buyer or really go through the process of selling your practice. Your ideal successor was already waiting in the wings the day they were born. The entire situation would appear to be a win-win for the family.
The tax laws however take a different view and failing to plan appropriately for this sale could result in a financial nightmare for both you and your child. The Canada Revenue Agency (CRA) have very specific rules when it comes to related party transactions (i.e. purchases and sales among family members). Tax rules which would not apply if you were to sell your practice to an unrelated third party find a way to rear their ugly heads into situations when the buyer and seller are related. In general, the following two scenarios could occur:
1) Parent wins, child loses
2) Child wins, parent loses
Parent Wins, Child Loses
In this scenario, the parent would sell the shares of their corporation the same way as if the buyer was a stranger. Assuming the parent and the shares qualified, they would be able to claim the Capital Gains Exemption (CGE) on their shares and potentially save up to $220,000 in taxes for each equity shareholder that was holding the shares.
While there’s nothing out of the ordinary for the parent as a seller, on the flip side, the child as the buyer is now restricted in how they can buy the shares. In order for the parent to qualify for the CGE, the child must purchase the shares personally. In other words, the buyer cannot be the child’s corporation. There is an important distinction when a buyer is an individual versus a corporation. When the buyer is an individual, the loans used to fund the purchase are personal
and must be repaid out of personal after-tax dollars. When the buyer is a corporation, the loans can be repaid from corporate afier-tax profits. Since personal taxes can be as high as 53.53 per cent versus corporate taxes of 15 per cent, this puts an immense financial burden on the child. On a two million dollar loan, the additional cost to repay the loan for the child would be 1.95 million dollars.
Child Wins, Parent Loses
In the reverse situation where the child was able to buy the shares using a corporation, each parent would not be able to claim the CGE and therefore would each be paying up to $220,000 in additional taxes on the sale of their practice shares. On a sale of two minion dollar practice with two equity shareholders (both parents), this would be about $440,000 in additional taxes,. The benefit is your child would be able to use cheap after-tax corporate dollars to pay back
the bank loan which would reduce the cost by 1.95 million dollars.
Is there a win-win situation?
This will depend a lot on specific details of your family’s financial situation. Several key questions to consider are as follows:
- How much does your child need to borrow from the bank to buy the practice?
- Does the parent have multiple dental practices?
- Has the parent already used their CGE?
- How many equity shareholders are there?
- Is the child already a shareholder of the parent’s corporation?
- Does the parent want to relinquish 100 per cent of the corporation or only a portion to the child?
- Will the parent forgive the proceeds?
- Will the parent stay as shareholder after the transition?
In many cases, there may not be a 100 per cent win-win situation for both parent and child due to the tax rules surrounding related parties. However, there may be a better solution involving tax maneuvers and tax reorganization provided the family is flexible and compromises can be made. Most importantly, you also need time. We have said it many times before: you need to plan several years in advance before you sell your practice. Selling your practice to your child is no
different. Despite not having to locate a buyer and having your child ready to take over, it may take longer for the entire transaction to unfold than if you were to sell to a stranger. This is not a process that should be rushed. Planning for the sale of your practice is critical; in the case of selling to your child, your family’s legacy and overall tax bill depends on it.
This article was prepared by David Chong Yen*, CPA, CA, CFP, Louise Wong*, CPA, CA, TEP and Eugene Chu, BAFM, MAcc,CPA, CA of DCY Professional Corporation Chartered Accountants who are tax specialists* and have been advising dentists for decades. Additional information can be obtained by phone (416) 510-8888, fax (416) 510-2699, or e-mail firstname.lastname@example.orgemail@example.comfirstname.lastname@example.org. Visit our website at www.dcy.ca. This article is intended to present tax saving and planning ideas, and is not intended to replace professional advice.