How to Transfer Your Small Business to Your Children Tax-Free: A Smart Tax Planning Guide

Passing on your business to your children is more than a transaction it’s a legacy. It represents your years of effort, sacrifices, and the dream of seeing your family carry the torch forward. But without proper planning, this emotional and financial transition can come at a steep cost potentially losing 30% to 50% of the business's value to taxes.

Thankfully, with well-structured tax strategies and a deep understanding of Canadian tax regulations, you can pass your business to the next generation without triggering unnecessary tax liabilities. Here’s how to do it right.

Why Planning is Essential When Handing Over Your Business

Many entrepreneurs believe transferring their business to their children is straightforward. But in practice, failing to plan can lead to unexpected capital gains and dividend taxes, eating into the value you've worked hard to build.

Capital Gains Tax

If your business has grown in value over time, that growth is considered a capital gain when transferred or sold. In Canada, capital gains are taxable and could result in up to 35% of the gain going to the CRA.

Dividend Tax

When your children inherit your business through a holding company, earnings distributed as dividends might also face tax. While corporate-to-corporate dividends (from an operating company to a holding company) can be tax-free in some cases, a poorly designed structure can result in avoidable taxes.

However, with the proper use of the Lifetime Capital Gains Exemption (LCGE) and ensuring your business qualifies as a Qualified Small Business Corporation (QSBC), you can reduce or eliminate tax entirely.

How to Transfer Your Business Tax-Free: Step-by-Step

If your company meets the QSBC criteria, you may be eligible to transfer the business tax-free. Here’s a breakdown of how that works:

Step 1: Confirm QSBC Share Qualification

To benefit from the LCGE (up to $971,190 in 2024), your business shares must qualify as QSBC shares. The criteria include:

• Your business must be a Canadian-Controlled Private Corporation (CCPC).
• At least 90% of assets should be used for active business in Canada.
• Shares must be held by you or a close relative for at least 24 months.

Meeting these conditions unlocks access to the LCGE, allowing a significant portion of capital gains to be exempt from tax.

Step 2: Transfer Shares to a Holding Company

Instead of gifting or selling shares directly to your children, you transfer them to a holding company (Holdco) that they own. If the shares qualify for the LCGE, you can use the exemption to eliminate capital gains tax.

Step 3: Receive a Promissory Note

In exchange for your business shares, Holdco issues a promissory note (an IOU) for the fair market value. This provides you with legal compensation without immediate tax consequences.

Step 4: Repay the Note with Tax-Free Dividends

After the transfer, your operating company (Opco) can pay intercorporate dividends to Holdco, which then uses the funds to pay down the promissory note. These dividends are tax-free under Section 112(1) of the Income Tax Act, allowing you to access the business’s value without a tax hit.

Example: Saving $375,000 in Taxes

Let’s say your business is worth $500,000, and your cost base is just $1. Without any planning:

• Capital Gains Tax: $499,999 × 66.67% × 45% = $150,000
• Dividend Tax: $500,000 × 45% = $225,000
• Total Tax Bill: $375,000

With strategic planning:

• Capital Gains Tax: $0 (thanks to LCGE)
• Dividend Tax: $0 (due to intercorporate tax-free treatment)

That’s the difference between losing most of your business’s value to tax and preserving it fully for your family.

Be Aware of the Alternative Minimum Tax (AMT)

Even with the LCGE, the Alternative Minimum Tax (AMT) may apply. It’s a separate calculation that ensures high-income earners pay a minimum amount of tax. Fortunately, any AMT paid may be recovered over the next seven years, making it more of a timing issue than a permanent loss.

Why Work with Dexado Accounting and Tax?

At Dexado, we specialize in helping Small Business Accounting execute tax-free business transfers. Here’s why clients choose us:

✅ CRA Experience You Can Trust With over 13 years as a former CRA auditor, we know exactly what the tax authorities are looking for—and how to stay compliant.

✅ Small Business and Succession Experts We tailor our strategies to the unique challenges of small businesses and family transitions, helping you avoid costly mistakes.

✅ Custom Tax Planning No two businesses or families are the same. We take a personalized approach to meet your goals and minimize tax exposure.

✅ Proven Results Our clients regularly save up to $375,000 in taxes on a $500,000 business transfer—legally and efficiently.

What Does Tax Planning Cost?

The investment depends on your business’s complexity:

• Basic Setup (1 Opco + 1 Holdco): $5,000 – $7,500
• Moderate Planning (Valuations, Trusts, Multiple Entities): $7,500 – $10,000
• Complex Structures (Restructuring, Multi-owner): $10,000 – $15,000
• Optional Audit Protection: From $1,500

Compared to the potential tax savings, this is an excellent return on investment.

Closing Thoughts: Plan Ahead and Protect Your Business

Transferring your business to your children is about securing your legacy. Without a clear tax strategy, you risk losing a major portion of your company’s value. But with expert guidance and proper planning, the entire process can be tax-free and stress-free.

At Dexado Accounting and Tax, we’re passionate about helping small business owners transition their companies successfully to the next generation.

👉 Start planning your tax-free business handover today. Contact Dexado to schedule a consultation and secure your family’s financial future.