Intergenerational business transfers: Proposed changes you should know

Businesses will need to meet additional requirements for the favourable Bill C-208 rules to apply to an intergenerational business transfer (IBT), under the latest proposed changes in Bill C-59.  

The federal government also proposes to expand the definition of ‘child’ under these rules to include adult nieces, nephews, grandnieces and grandnephews. The proposed amendments to Bill C-208, if enacted, will be effective for transactions occurring on or after January 1, 2024. 

Bill C-59, which includes the latest amendments to the intergenerational business transfer rules, was introduced on November 30, 2023. 

Background 

The current IBT rules, which were included in Bill C-208, took effect on June 29, 2021. These rules were implemented to treat the transfer of shares of a small business, family farm, or fishing corporation to a corporation controlled by the owner's child or grandchild similarly to a third-party sale. Consequently, the gain on the sale would be treated as capital gains (which are 50% taxable) rather than fully taxable dividends (as was the case before the legislation was introduced under the “surplus stripping” rules in section 84.1 of the Income Tax Act (ITA).  

Please refer to our tax alert for details about Bill C-208. 

Proposed changes to ensure genuine transfer of business 

The proposed changes to the IBT rules include new timing requirements to specify when the parent must give up control of the transferred business and when the adult child or grandchild (or a niece/nephew or grandniece/grandnephew for transactions on or after January 1, 2024) whose corporation acquires the shares of the business must have active involvement in the business. These changes, introduced in Budget 2023, are intended to ensure that the rules only apply to genuine IBTs and prevent “surplus stripping”. As a result, the new measures include two options for these types of transfers: 

1. an immediate IBT (three-year test) 
2. a gradual IBT (five-to-ten-year test) 

Both immediate and gradual IBTs must meet the following requirements: 

Before the transfer: 

• Parent has not previously implemented a post-2023 IBT plan to transfer shares that derived value from an active business of Opco. (Note that parents who executed Bill C-208 plans before 2024 to transfer a portion of their shares in Opco may still be able to benefit from the new rules to transfer the remaining ownership of the same business after 2023, if certain conditions are met.)   

At the time of the transfer: 

• OpCo is a qualified small business corporation (QSBC) or qualifying farm or fishing corporation (QFFC) 
• Parent transfers OpCo shares to AcquireCo (controlled by one or more adult children) 

After the transfer: 

• Parent must transfer the remaining balance of voting shares and common growth shares within 36 months of sale   
• Parent doesn’t legally control OpCo and AcquireCo and can’t own more than 50% of any OpCo shares other than non-voting preferred shares that meet the definition of “specified class” shares in subsection 256(1.1) of the ITA (e.g., freeze shares) 
• Parent and each Child must file a joint election in prescribed form 

In addition to the requirements common to both tests, the transfer must also meet the following conditions specific to each transfer option: 

In addition, Budget 2023 proposed relieving rules where the child or children subsequently sell shares to an arm’s length party, or upon the death or physical/mental impairment of a child, in certain situations.

Proposed capital gains reserve extension 

The rules would allow a parent to claim a capital gains reserve on the share transfer for a maximum of 10 years (rather than five years), provided that either the immediate or gradual IBT conditions have been satisfied.  

Other administrative changes 

For a business transfer to qualify as either an immediate or gradual IBT, the parent transferor and each adult child transferee must jointly elect in prescribed form, on or before the parent’s tax filing deadline for the year of the transfer. The child/children will be jointly and severally liable for any additional taxes payable by the parent if the transfer doesn’t meet the conditions as previously discussed. 

The CRA can monitor whether the conditions for these transfers are met over the years, as the limitation period for reassessing the parent transferor's tax liability will be extended three years for immediate IBTs, and 10 years for gradual IBTs. 

Takeaways 

The proposed changes broaden the scope of eligibility for IBTs to include transfers of ownership to nieces and nephews, as well as grandnieces and grandnephews, which may benefit more Canadian families. 

The two IBT options also offer business owners more flexibility to meet the conditions to exempt them from the “surplus stripping” rules. The immediate IBT option may have stricter requirements but offers finality sooner in the process with a shorter statute barred period. On the other hand, the gradual IBT option allows business owners more time to transition management and economic interest of their business to the next generation. However, both parties of a gradual IBT must closely monitor the transfer’s status over a longer period to ensure they’re compliant with all the tests. 

It’s important to note that the new rules are proposed to apply to transactions on or after January 1, 2024. Therefore, transfers completed in 2023 may still benefit from the current Bill C-208 rules, where the conditions are met.  

Have questions?  We can help. 

Transferring your business to the next generation can be complicated. Our advisors can help you with a range of considerations—from determining optimal shareholding structures to determining if your business qualifies for the IBT rules.