If you are a business owner going through a separation or divorce, the tax implications can be more complex than they are for employees. Your business may be part of the family property discussion, and decisions about shares, corporate assets, support payments, dividends, shareholder loans, and ownership changes can have long-term tax consequences.
Before transferring assets, changing share ownership, withdrawing funds from the corporation, or restructuring the business, it is important to speak with both a family lawyer and a tax professional. The right plan can help reduce tax surprises and protect the business during an already difficult time.
Update Your Marital Status with the CRA
For tax purposes, the Canada Revenue Agency generally considers you separated once you have lived separate and apart from your spouse or common-law partner for at least 90 days because of a relationship breakdown. Once the 90-day period is met, the effective date of your separation is the day you started living apart.
You must tell the CRA when your marital status changes. If you separate, you should wait until you have been separated for more than 90 days before updating your status. A marital status change may affect benefit and credit payments, including the Canada child benefit, GST/HST credit, Canada Carbon Rebate, and related provincial or territorial benefits.
For business owners, this change may also affect personal tax planning, compensation planning, household cash flow, and the way income-tested benefits are calculated.
Your Business May Need to Be Valued
If you own shares of a corporation, an interest in a partnership, or a sole proprietorship, the value of your business may become relevant during separation or divorce. The value may affect equalization, settlement negotiations, buyout arrangements, support calculations, or estate planning.
A business valuation may consider factors such as:
- corporate assets and liabilities;
- goodwill;
- retained earnings;
- shareholder loans;
- business debts;
- future earning potential;
- marketability of shares;
- tax liabilities; and
- whether the business depends heavily on the owner’s personal services.
The tax treatment of a settlement can differ depending on whether you transfer personal assets, corporate shares, corporate property, cash, or income-producing property. Do not assume that all transfers are tax-free.
Spousal Rollover Rules
A spousal rollover can allow certain capital property to transfer between spouses or common-law partners on a tax-deferred basis. In a separation or divorce context, this may also apply to certain transfers to a former spouse, or in some cases a former common-law partner, if the transfer is made to settle rights arising from the marriage or common-law relationship.
In general, a rollover means the transfer may occur at the transferor’s adjusted cost base, or ACB, for capital property, or at the undepreciated capital cost, or UCC, for depreciable property. This can defer immediate capital gains or recapture that might otherwise arise on the transfer.
However, the rollover rules are technical. They may depend on factors such as Canadian residency, the type of property, the relationship between the parties, and whether the transfer is made as part of a settlement. In some situations, a taxpayer may elect out of rollover treatment and transfer property at fair market value instead.
For business owners, this can matter when transferring private company shares, investment accounts, real estate, equipment, or other capital property.
Spousal Attribution Rules
Spousal attribution rules can apply when property is transferred or loaned to a spouse or common-law partner. In some situations, income or capital gains earned from the transferred property may be attributed back to the person who transferred the property.
Separation and divorce can change how attribution applies, but the rules are not automatic in every situation. For example, CRA guidance states that, for certain transfers, separated spouses or common-law partners may file a joint election so that the capital gains attribution rule does not apply while they are living separate and apart because of a relationship breakdown.
This matters if one spouse transfers income-producing property, investments, corporate shares, or other assets to the other spouse as part of a settlement. If the attribution rules are not reviewed properly, the transferor may remain taxable on income or gains they did not expect to report.
Tax on Split Income Rules
The tax on split income rules, commonly called TOSI, can apply to certain income received by individuals from a related private corporation, partnership, or trust. When TOSI applies, the income may be taxed at the highest marginal tax rate rather than at the recipient’s regular graduated rates.
For business owners, TOSI may be relevant if a spouse or former spouse receives dividends, shareholder benefits, trust allocations, or other amounts connected to a private corporation. Separation or divorce may affect whether certain exclusions or relieving provisions are available, but this requires careful analysis of the facts.
Do not assume that payments to a spouse or former spouse from a corporation will automatically avoid TOSI. The tax treatment can depend on the type of income, the person’s involvement in the business, their age, the ownership structure, and whether the parties are living separate and apart because of a relationship breakdown.
Support Payments and Business Income
Support payments can also affect tax planning for business owners.
Generally, child support paid under a court order or written agreement dated after April 1997 is not deductible by the payer and is not taxable to the recipient. Spousal support is generally taxable to the recipient and deductible by the payer if CRA’s requirements are met, including that the support is paid under a court order or written agreement.
For business owners, support calculations may involve more than salary. Dividends, shareholder loans, retained corporate earnings, management fees, personal expenses paid by the corporation, and non-recurring corporate transactions may all become relevant in family law and tax discussions.
If you own a corporation, make sure your compensation is properly documented. Poor records can create problems when determining income for support, tax filings, and corporate compliance.
Shareholder Loans and Corporate Withdrawals
During separation or divorce, business owners may be tempted to withdraw funds from the corporation to pay legal fees, equalization payments, support, or personal expenses. This should be handled carefully.
Withdrawals from a corporation can create taxable shareholder benefits, shareholder loan issues, dividends, salary, or other tax consequences. If the corporation pays personal expenses, the CRA may treat the amount as a taxable benefit or income inclusion unless it is properly recorded and supported.
Before using corporate funds for settlement or personal obligations, speak with your accountant to determine whether the payment should be treated as salary, dividends, a shareholder loan, repayment of an existing loan, or another type of transaction.
Lifetime Capital Gains Exemption
The lifetime capital gains exemption, or LCGE, may be available when an individual disposes of qualified small business corporation shares, qualified farm or fishing property, or other qualifying property, provided the conditions are met.
For business owners, the LCGE can be an important tax planning tool if shares are sold or transferred as part of a separation or divorce plan. However, eligibility is not automatic. The shares must meet strict tests, including asset-use and holding-period requirements.
Care is also needed where spouses, former spouses, holding companies, or related corporations are involved. Transactions between non-arm’s length parties can trigger complex tax rules, and poor planning may reduce or eliminate access to the LCGE or create unexpected taxable dividends or capital gains.
Before transferring shares or arranging a corporate buyout, get tax advice on whether the shares qualify, whether purification planning is needed, and whether the transaction structure could affect the exemption.
Dividing Corporate Assets and Butterfly Transactions
In some separations or divorces, both spouses may own shares in the same corporation or may need to divide corporate assets. One possible tax-planning method is a divisive corporate reorganization, often called a butterfly transaction.
A butterfly transaction may allow corporate assets to be divided among separate corporations on a tax-deferred basis if strict Income Tax Act requirements are met. These transactions are highly technical and should not be attempted without experienced legal and tax advisors.
There are different types of divisive reorganizations, and the rules can differ depending on whether the parties are related or dealing at arm’s length. A related-party butterfly may provide more flexibility in some family situations, while an unrelated-party butterfly is generally more restrictive and may require each party to receive proportionate shares of different types of assets.
These transactions also need to be reviewed for anti-avoidance rules, shareholder benefit issues, valuation concerns, creditor issues, and future sale plans. A mistake can create significant tax costs.
Protecting the Business During Separation or Divorce
A separation or divorce can affect the business even if only one spouse is actively involved in operations. Business owners should review:
- corporate minute books;
- shareholder agreements;
- buy-sell provisions;
- unanimous shareholder agreements;
- director and officer roles;
- banking authorities;
- shareholder loan balances;
- dividend history;
- salary and bonus planning;
- retained earnings;
- business debts;
- GST/HST and payroll accounts;
- personal expenses paid by the corporation;
- life insurance or key-person insurance; and
- succession and estate planning documents.
If the business has outdated records or undocumented transactions, these issues should be addressed before negotiating or completing a settlement.
Work with the Right Advisors
Divorce or separation can have major tax implications for business owners. A poorly structured transfer, buyout, corporate withdrawal, or asset division can create unexpected tax, cash-flow problems, or disputes with the CRA.
Before finalizing a settlement, work with a family lawyer, corporate lawyer, accountant, and tax advisor. A coordinated approach can help you understand the value of the business, divide assets properly, document transactions, and reduce tax risk.
E&E Professional Accountants can help business owners review corporate records, compensation, shareholder loans, tax filings, and potential tax consequences during separation or divorce. Contact us for guidance with tax planning, CRA compliance, bookkeeping, and business accounting.
Visit our blog for more articles, news and updates about small business accounting, tax planning, CRA audits and bookkeeping.