The auto dealership landscape is changing. There is an unlimited supply of information discussing the coming changes in the automotive industry, from manufacturers, car magazines, think tanks and consulting firms. Everywhere you look, something is telling you to act now before it is too late.
Although there are undeniable technological advancements on the automotive horizon, the most pressing concern in the industry is far more basic. How can auto dealers successfully transfer ownership of their dealership to a family member or management team? The most common questions regarding such transfers are:
- How do I do transfer ownership of my dealership and still fund my retirement?
- How do I maintain legal say in the management of the dealership?
- How do I avoid paying capital gains?
The answer to all of the questions is the same – implement an estate freeze. In simple terms, an estate freeze transfers the future growth in value of business assets to another person, typically to the next generation. Implementing a freeze on an auto dealership means you freeze the value of the business at that specific point in time and transfer ownership to a newly created, appreciating class of shares to a family member or management team. In doing so, you transfer some ownership while deferring paying tax on the unrealized capital gain.
The estate freeze consists of five important steps:
There are many cases where a transition has taken place without consulting the family and the situation degenerates into litigation and restructuring costs after the fact. For this reason, consider involving a Business Transition professional with a Family Enterprise Advisor (FEA) designation. These professionals are specially trained to conduct individual family interviews and put together a strategic plan for the future of the business. They are often lawyers, accountants or both, and are well equipped to design a restructuring of the business, that if done at the outset of the transition, can save thousands in professional fees down the road.
Consider this: you own a dealership and have valued it at $2 million. You freeze the dealership and pass all appreciating common shares to the next generation. Then, Canada Revenue Agency (CRA) takes the position that your dealership is actually worth $3 million. You would now be taxable on that additional $1 million as opposed to being in a position to defer that tax into the future. The cost of having a valuation done is minimal when compared to the value of your dealership.
In addition, a Chartered Business Valuator (CBV) can provide you with specific steps to increase the value of your business, thereby allowing you to maximize the value of your interest in the dealership at the time of the freeze. For this reason, it is important to have a valuation done up to a year in advance of the transition to give you time to implement the valuator's recommended steps.
The characteristics of the shares can be structured in a variety of ways to maintain a legal say, or voting rights in the business, and a good accountant can walk you through all of the various options.
Once the freeze is implemented, an agreement for the systematic redemption of the preferred shares can be drawn up. In many of the cases, a significant portion of the current owner's retirement funding is wrapped up in the value of the dealership. The current owner needs to redeem his shares to fund his retirement but, at the same time, the dealership needs to retain sufficient cash flow to pay the operating costs and grow. Therefore, the current owner and the new owner need to come to an agreement that will ensure the cash flow requirements are met on both sides. Note that the existing owner will pay tax as his preferred shares are redeemed.
John is transferring his dealership, valued at $5 million, to his son, Brian. John freezes his dealership by exchanging his common shares for 5,000 redeemable preferred shares each with a $1,000 redemption value. Brian then purchases 100 new common shares for a nominal amount of $100. The CRA finds this transaction acceptable because essentially nothing has happened. John still has all the value of the dealership captured in his preferred shares and Brian bought and paid for his common shares. However, John has now successfully transferred his dealership to his son and has deferred paying tax on the capital gain. The tax will be paid in the future, as John's preferred shares are redeemed or are otherwise disposed of.
Conclusion
Upon implementing an estate freeze, you have effectively fixed the tax liability on the value of your dealership. You can now make plans to fund your future estate tax liability by purchasing adequate life insurance or setting aside funds to pay the cost of the tax liability. This will ensure your beneficiaries are not left with a tax bill that can only be paid by liquidating business assets. You have successfully transferred your assets to the next generation while deferring tax on the capital gain, and addressed the immediate needs of funding your retirement through an agreement with the new owner for the systematic redemption of the preferred shares.
An estate freeze can have substantial monetary benefits when transitioning business assets to the next generation. If you are planning to transition your business, ensure you ask your professional service provider if an estate freeze is right for you.