Separation or divorce is the outcome of many relationships and it can be a very difficult experience. If there is a breakdown in your marriage, you and your partner will need to determine how to divide your assets in accordance with the laws that apply in your province.
As a business owner, your most valuable asset may very well be your company, which will add complexities to the process—from an operational perspective, and from a valuation and tax perspective. You should carefully consider your options before moving forward with a plan for the business. It is important to consider the approach and timing for dividing the company and/or its assets, as they can have significant long-term tax implications for you, your former partner, and your business.
What is the definition of a spouse and a common-law partner for tax purposes?
For tax purposes, the definitions of a spouse and a common-law partner, as well as the length of time required to dissolve a formal partnership, need to be kept in mind throughout the process of separating business assets.
Under Canadian tax law, a spouse is a person to whom you are legally married. A marriage is ended only through legal divorce, regardless of the length or distance of your separation. This means that even if you have been separated from your spouse for years and live on opposite sides of the country you cannot be considered to be at ‘arm's length’ for tax purposes—until a divorce is finalized. (That said, there may be circumstances under which you do not deal at arm's length, even after divorce.) ‘arm's length’ and ‘non-arm's length’ are important concepts for income tax purposes—particularly when there is a transfer of property that is not considered to be at arm's length.
In contrast, a common-law partner is someone you are not legally married to, but with whom you live in a conjugal relationship, and at least one of three scenarios applies:
- you have been living together for the last twelve continuous months, with no separation periods of more than 90 days due to breakdown of the relationship during that time;
- they are the parent of your child, either by birth or adoption; and/or
- they have custody and control of your child, and your child is wholly dependent on them for support.
Ending a common-law partnership is less complicated than ending a marriage. A common-law partnership is deemed to be terminated once partners have been separated for 90 days or more.
However, if you are getting out of a common-law relationship, the 90-day rule may mean that you are racing against the clock when it comes to splitting your business assets. This time restriction may also limit your available planning alternatives.
It is often best to reach out to a tax professional before a formal separation or divorce, if possible, as the most tax-effective way of dividing your assets may require you to be separated, divorced, or still legally married to your partner.
Key tax rules to consider during separation or divorce
There are several tax areas business owners need to be especially cognizant of when tax planning for the division of business assets during or following a marital breakdown.