This article was updated on July 20, 2021
Bill C-208 includes changes to Section 84.1 of the Income Tax Act (ITA) that will allow a business owner to sell or transfer his or her shares in a small business, family farm or fishing corporation to a corporation owned by the taxpayer’s child or grandchild without the adverse tax consequences that currently apply.
Current rules on intergenerational transfers of a business
There are various ways for a business owner (Parent) to pass on their business to the next generation (Child). However, it is often most desirable for Child to buy the shares of Parent’s operating corporation (Opco) through a holding company (Holdco). Not only does this make it easier for Child to finance the sale with corporate funds, but it is also beneficial for Parent to sell the shares (as opposed to the business assets) to shelter all or a portion of the capital gain on those shares through the capital gains exemption, where applicable.
Unfortunately, under existing rules, were Parent to sell his or her shares of the business to a family member’s (i.e., non-arm’s length) corporation, such as Child’s Holdco, what would normally be a capital gain is recharacterized as a dividend due to the application of section 84.1 of the ITA. Depending on the province, this translates to an additional tax burden of over 20 percent. In addition, Parent can no longer use his or her capital gains exemption (CGE) to offset what would have been a capital gain.
Although Parent does have alternatives—for example, they could effect the sale of the business through a disposition of the business assets to Child—these alternatives are often not plausible, or they are much less tax-efficient due to the inability to use the capital gains exemption. As such, the better option for Parent, from a tax perspective, is often to sell the business to a third party. This rule clearly makes the transfer of a family business to the next generation much more costly than it needs to be.
Bill C-208 attempts to exempt certain intergenerational transfers from the punitive section 84.1 rules if the following conditions are met:
- The Opco shares are shares of a Qualified Small Business Corporations (QSBC), a family farm or a fishing corporation;
- The Holdco that purchases Opco’s shares is controlled by either Parent’s children or grandchildren, who are at least 18 years of age; and
- The Holdco does not dispose of the shares within 60 months of acquiring them (for any reason other than death).
Additional rules are included in Bill C-208 that add a bit of complexity and require careful consideration by the business owner who might be considering selling their business and taking advantage of these changes. For example, Bill C-208 includes a provision that intends to grind the CGE if the taxable capital employed in Canada exceeds $10 million. Furthermore, the rules also require the business owner to obtain an independent assessment of the value of the company. There appears to be some uncertainty in the wording of some of the rules, which may cause some confusion for taxpayers, so careful planning and consideration will be necessary to navigate these complex rules.
What do these changes mean for business owners?
Now that Bill C-208 has passed into law, it should make it easier and more tax-efficient for business owners to transfer their business to the next generation. At the very least, the changes should make it equivalent to selling the business to a child or an unrelated party. Nevertheless, there still remain some areas of uncertainty with this legislation. As such, taxpayers and their advisors should proceed with caution if they will be looking to implement an intergenerational transfer of a business that would be subject to the new rules.
Changes to section 55
The bill also includes a change to the anti-avoidance rule in section 55 of the ITA that would apply to certain transactions that result in a disposition of a corporation’s money or property. Under current rules, section 55 can convert what would otherwise be a tax free inter-corporate dividend into a capital gain in different circumstances. While section 55 went through substantial changes in 2015, requiring every dividend to be reviewed, there are still exceptions for inter-corporate dividends between related parties.
Section 55 is unique with respect to the related party carve-out as it treats siblings as though they are dealing with each other at arm’s length. This causes issues for family businesses on dividend payments, movement of assets with cross redemptions and certain other transactions—which ultimately requires business owners to undertake more complex, and more costly, alternatives. The amendments look to remove the carve-out of siblings and, consistent with the rest of the Act, treat siblings as related.
Although these changes would make it easier to effect transactions and/or dispositions involving siblings, we would still recommend that all inter-corporate dividends document any section 55 exposure, as the 2015 amendments have increased the risk that this anti-avoidance rule would apply.
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Bill C-208 offers significant benefits for family businesses. Our advisors can help you with a range of considerations—from determining optimal shareholding structures to determining if your business qualifies.
 An eligible individual is entitled to a cumulative lifetime CGE to shelter net gains realized on the disposition of qualified property. If a taxpayer has not claimed the CGE in prior years, they may be entitled to a CGE of up to $892,218 if they dispose of qualified small business corporation (QSBC) shares or a CGE of up to $1,000,000 if they dispose of qualified farm or fishing property in 2021.