How Bill C-208 will effect tax on inter-generational business transfers
Family businesses are always faced with the most unique challenges – one of the main being transitioning and succession planning. As your business grows, so too does your legacy and you are left wondering, “who can I entrust my lifes’ work with?” Normally, your business grows into a legacy for your future generations, and existing practices and rules for private companies can make the taxation and succession of your business difficult to navigate. As if you don’t have enough on your plate already!
As an example, the sale of your businesses (if you have more than one) at fair market value to a relative is likely less advantageous from a tax perspective than selling to an arm’s length third-party due to our favourite section 84.1 of the Income Tax Act (hereafter referred to as ITA).
When your business meets the definition of a ‘Qualified Small Business Corporation’ (QSBC), whether it is a small business, a farm, or a franchise, the sale of the QSBC shares is generally eligible for up to $1M of lifetime capital gains exemption (LCGE). However, keep in mind that anti-avoidance rules contained in section 84.1 (and others) may prevent the use of this LCGE when the sale is made to a related party or relative.
Generally, section 84.1 of the ITA attempts to “limit surplus stripping through non-arm’s length sales or transfers”. With this provision in place, the proceeds of a sale may result in being treated as a dividend rather than a capital gain. Additionally, the dividends received by individuals are subject to a higher tax rate than a capital gain. Consequently, under this current legislation, a sale of QSBC shares to a related party, or relative, can result in less favourable tax treatment than a sale to an arm’s length party.
To reiterate: due to a provision that limits surplus stripping through non-arm’s length sales or transfers, the sale of your QSBC may lead to a larger tax bill than initially anticipated.
This is why Bill C-208 may be favourable. The proposed Bill intends to limit the application of section 84.1 in regards to the sale of inter-generational transfers of businesses. This Bill would exclude QSBC shares (including farmers and fishing corporations) from section 84.1 when sold to a related party, or relative, by the purchaser for a minimum of 60 months.
This is similar to legislative changes announced by Quebec in Budget 2021.
Ultimately, these seemingly small additions to the ITA have the potential to results in groundbreaking changes in how entrepreneurs, farmers and fishers transition their business to the next generation, and the reduced tax applicable thereafter.
It’s official: On June 29, 2021, Bill C-208 received Royal Assent.
As detailed above, 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.
Bill C-208 attempts to exempt certain intergenerational transfers from the Section 84.1 rules if the following conditions are met:
- The operating corporation shares are shares of a Qualified Small Business Corporations (QSBC), a family farm or a fishing corporation;
- The holding company that purchases operating corporation shares is controlled by either Parent’s children or grandchildren, who are at least 18 years of age; and
- The holding company 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. As an 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.
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.
When is it effective?
It appears that Bill C-208 would have been effective June 29, 2021, as there was no “coming into force date” requested.
However, on June 30, 2021, the Department of Finance issued a release indicating that legislation would be introduced to clarify that the amendments will become effective on January 1, 2022. This means that, while the changes are currently technically law, changes will be made which will eliminate the benefits of these provisions for any who undertook transactions to access them prior to January 1, 2022.