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 transition 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 future generations, but 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!
When your business meets the definition of a ‘Qualified Small Business Corporation’ (QSBC), whether it is a small business or a farm the sale of the shares is generally eligible for up to $1M of lifetime capital gains exemption (LCGE). However, the anti-avoidance provisions contained in the Income Tax Act (“ITA”) may prevent the use of the LCGE when the sale is made to a related party, typically the next generation. This can make a sale to children or grandchildren less tax advantageous than one to an unrelated third party.
This is why accountants, family business advisors and industry organizations are so excited about Bill C-208. The Bill, which received Royal Assent on June 29, 2021, limits the application of these anti-avoidance provisions with respect to the inter-generational sale of a business. This Bill will allow the sale of QSBC shares (including farming and fishing corporations) to be eligible for the capital gains exemption 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 adjustments to the ITA have the potential to result in ground-breaking changes in how entrepreneurs and farmers transition their business to the next generation.
Bill C-208 attempts to exempt certain intergenerational transfers from Section 84.1 of the ITA 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 the Bill 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 LCGE 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 equalize the tax treatment of selling the business to a child versus 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 in the legislation but the Department of Finance pushed back on the effective date. On July 19, 2021, Minister Freeland confirmed that the Bill was law as of the date of Royal Assent – June 29, 2021.
MORE changes coming
The Department of Finance also stated that it would introduce prospective legislative amendments by way of a new bill. The amendments will allow for legitimate transactions to occur but at the same time limit potential areas of deficiency in the original legislation. The amendments are expected to include:
- The requirement to transfer legal and factual control of the corporation carrying on the business from the parent/grandparent to their child or grandchild;
- The requirements and timelines for the parent/grandparent to transition involvement in the business to the buyers;
- Limiting the level of ownership the parent/grandparent can maintain in the corporation and the timeline for such ownership after the sale; and
- Determining the appropriate level of involvement in the business by the child or grandchild after the purchase.
The Department of Finance will be publishing final legislative proposals once feedback has been gathered and considered. The amendments are expected to be effective the latter of November 1, 2021, and the date of publication of the final draft legislation. This means that, while the Bill is currently law, changes will be made which may alter the benefits of these provisions from November 1, 2021, onwards.
The Department has committed to maintaining the spirit of the original legislation whereby legitimate intergenerational transfers can occur with the intended income tax benefits, however, caution should be taken where the sole intent of a transaction is the income tax savings.
What should a business owner do now?
If a potential sale to the next generation is on the horizon, it may be beneficial to enter into the transaction sooner than later. With the expectation of changes coming November 1, 2021, it would be prudent to have a discussion with your KBH partner as soon as possible to consider your options and the possible benefits of taking advantage of the provisions in Bill C-208.
With amendments on the horizon, KBH will endeavour to keep you up to date as information is released and planning opportunities arise.