Q: I want to sell our Dairy Queen (DQ) to my oldest daughter. The profit year after year is $56,000.00 to $76,000.00 but sales are about $1.5 million. We do not own the building—we lease it from a large company. We only own the equipment inside and the signage. I would like to sell the DQ to her at fair market value which it’s at right now so that the Canada Revenue Agency (CRA) will not come back later requesting more capital gains tax from me. I assess it to be worth between $340,000 to $360,000. The transfer to my daughter of DQ rights is free from DQ and the equipment is about $189,000. Will the CRA consider that or will there be problems?
A: One of the first questions to be considered is whether you are selling shares that qualify for the Lifetime Capital Gains Exemption, or not. The sale of shares to a related party can invoke some very complicated rules, currently under review by the Finance Department. Specifically, Section 84.1 could deem the proceeds to be a dividend rather than a capital gain. You will want to get some professional advice on that front.
Next, you must consider what the fair market value really is, especially since you are selling this to your daughter.
Business valuation usually comes down to a number of factors: what other similar businesses are selling for, a multiple of gross revenues, a multiple of net revenues, how much of the income is recurrent, the value of the equipment (before and after depreciation), the tax attributes (will assets be sold or shares acquired?), what liabilities will remain with the original owner (severance, tax bills outstanding, etc.), all culminating in what a willing buyer will pay a willing seller. So, your first line of defense is to do the research on these matters to decide on a fair market valuation.
Assuming this company is unincorporated, based on your estimates, if you sell for $350,000, and $189,000 will be allocated to the purchase of the equipment, that leaves the remaining $161,000 to be allocated towards the franchise fee and for goodwill. How does that compare with the value of other like franchises in your area?
Depending on what you paid for the purchased equipment and how much you depreciated it for tax purposes, you may have to pay tax on recapture of Capital Cost Allowance (depreciation) or you may be able to claim a terminal loss on the equipment. Again, professional help should be sought before the disposition to clarify your tax cost.
The taxation of the additional $161,000 will depend on whether you’ve claimed deductions over the years for the cost of the franchise. The taxation of eligible capital properties (which includes goodwill and franchise fees, unless they are for a limited term) is changing this year so make sure you get professional assistance from someone well versed in the changes.
With those precautionary steps, you should be in good shape if the CRA comes knocking in the future.
Evelyn Jacks is a tax expert, author, and founder and of Knowledge Bureau in Winnipeg
MORE FROM A TAX EXPERT:
- Will gifting a home avoid U.S. capital gains tax?
- Pay less tax on rental properties
- What taxes do my LIRA beneficiaries have to pay?
- Paying taxes on an inheritance
- How can my stock losses be used to lower taxes?
- How to invest your money in Canada as a U.S. citizen
- Inheriting cottage capital gains
- When two people are on a condo title, who pays capital gains?