Until recently, it was more financially beneficial to sell a business to a third party in Canada, rather than passing it along to children or grandchildren through an intergenerational business transfer. This had been a longstanding bone of contention among entrepreneurs. Bill C-208, An Act to amend the Income Tax Act (transfer of small business or family farm or fishing corporation), was designed to right that perceived tax wrong, providing greater succession flexibility through the intergenerational transfer of specific business shares.
But the private member’s bill—which received royal assent last month—was not supported by the current Liberal government. Moreover, the Grits planned to delay its implementation until January 1st, 2022, before eventually conceding that it was officially law and came into force when it received royal assent on June 30th. The primary reason for wanting the delay is that the legislation, as currently worded, allows for significant abuse that would go against the spirit of the provision. Legislative amendments are therefore in the works that are expected to come into force no earlier than November 1st that the government promises will “… honour the spirit of Bill C-208, while safeguarding against any unintended tax avoidance loopholes that may have been created by Bill C-208.” The Department of Finance has stated that eventual changes will not be made retroactive, and will focus on several key components of the legislation:
- “The requirement to transfer legal and factual control of the corporation carrying on the business from the parent to their child or grandchild;
- The level of ownership in the corporation carrying on the business that the parent can maintain for a reasonable time after the transfer;
- The requirements and timeline for the parent to transition their involvement in the business to the next generation; and
- The level of involvement of the child or grandchild in the business after the transfer”
There’s little doubt that there are challenges with the legislation as written, which as noted was the government’s prime reason for not supporting the bill. Specifically, Bill C-208 could open the door to overly-aggressive tax manoeuvering in the form of ‘surplus stripping.’ The practice involves converting dividends to capital gains at a lower tax rate, even if a business transfer fails to occur. Doing so could raise the ire of the Canada Revenue Agency and result in a challenge under the general anti-avoidance rule (GAAR)—a measure that Ottawa deploys if it feels that an individual or corporation is acting in a way that contravenes the implied intent of a piece of tax legislation. It’s questionable that such a challenge would be successful given the way the legislation is drafted, but it’s likely to be on the CRA’s radar nonetheless.
While the Liberals intend to tighten up the law, a federal election is looming and could be called in September or October, which means that in that scenario, the current legislation is unlikely to be amended until late fall or even early next year.
It’s important to note that for business owners, Bill C-208 provides a welcome change. The new law extends capital gains tax treatment to the sale of shares in a qualified small business corporation, or a farm or fishery corporation to a child or a grandchild where certain conditions are met. Doing so also allows the seller to use their lifetime capital gains exemption to tax shelter up to $892,218 (in 2021) on small business shares, or as much as $1 million in capital gains on the sale of shares in their farm or fishery corporation.
Until recently, the sale of qualified small business corporation shares to a child’s, or grandchild’s, corporation was deemed to be a dividend to the seller if any consideration other than shares was taken back on the transfer (i.e. cash or a promissory note). If those shares were sold to a third party individual’s corporation, however, the sale was treated as a capital gain. In other words, small business owners, farmers and fishers had a greater financial incentive to sell their businesses to purchasers outside of their families, thus making it more difficult to build and transfer businesses across generations.
The rules were widely criticized as being overly broad and restrictive. They were put in place to prevent a family member from using a non-arm’s length sale of shares to a purchaser corporation (potentially run by a family member) to extract surplus capital—the aforementioned practice of surplus stripping—from their corporation at a lower tax rate. But in cases where a business owner (a parent, for example) aimed to retire and transfer the shares they held in their wholly-owned small business corporation to a corporation controlled by their adult child (or children), the deemed dividend taxation could have had a negative financial impact on the family.
Bill C-208 amends the law by redefining such a transaction as being at arm’s length if certain conditions are met. For example, the purchaser corporation must be controlled by the taxpayer’s child or grandchild, who must be at least 18 years of age, while the shares must be held by the purchaser corporation for a minimum of 60 months.
In addition to the changes made to intergenerational transfers, Bill C-208 also introduced a change to another anti-avoidance provision in the Act that now makes it easier to involve siblings in the division of corporate assets. This change is very narrow in scope and will be addressed in a separate blog.
The bottom line is that if the law is leveraged as a tool by business owners to facilitate a genuine intergenerational transfer of a family small business, they have little cause for concern. But aggressive tax-planning tactics—those intended to extract capital from a corporation with little or no tax—are a likely red flag to CRA and should be avoided.
If your organization requires assistance with any aspect of succession planning and intergenerational wealth transfer structuring, please contact a member of our team.
Armando Iannuzzi, Co-Managing Partner