Reduction of tax on inter-generational business transfers
Bill C-208 awaits Royal Assent today, the last formality in becoming part of the Income Tax Act (ITA), after being approved by the Senate on Tuesday, June 22, 2021. The Bill allows the inter-generational transfer of certain family businesses to receive the same tax treatment as businesses sold to a third party. The implications of this Bill will take effect immediately upon receiving Royal Assent. Many small businesses, farms and fisheries meet the definition of ‘Qualified Small Business Corporations’ (QSBC). The sale of QSBC shares is generally eligible for up to $1,000,000 of lifetime capital gains exemption (LCGE) to individuals. Previous to Bill C-208, anti-avoidance rules contained in section 84.1 of the ITA, among others, prevented the use of this LCGE when the sale was made to a related party.
Very generally, section 84.1 of the ITA used to limit “surplus stripping” – the extraction of corporate value via capital gain – through non-arm’s length sales or transfers. This provision resulted in the proceeds of sale being treated as a dividend rather than a capital gain. In addition to limiting access to the LCGE, dividends received by individuals were subject to a higher tax rate than a capital gain. Prior to Bill C-208, a sale of QSBC shares to a related party resulted in less favourable tax treatment than a sale to an arm’s length party.
Bill C-208 limits the application of section 84.1 in the case of inter-generational transfers of incorporated businesses. The Bill would exclude the gain on QSBC shares (including farm and fishing corporations) from section 84.1 when sold to a child or grandchild and held by the purchaser for a minimum of 60 months. These relatively small additions to the ITA results in ground-breaking changes in how entrepreneurs, farmers and fishers transition their business to the next generation, as well as reduce the tax applicable thereon.
Note that the taxpayer must provide Canada Revenue Agency with an independent assessment of the fair market value of the subject shares and an affidavit signed by the taxpayer and by a third party attesting to the disposal of the shares. There is also a reduction in the availability of the LCGE that the parent(s) can claim on these transfers if the taxable capital employed in Canada is in excess of $10 million for the corporate group.
Simplification of the restructure of certain family business involving siblings
In certain circumstances section 55 of the ITA will convert transactions that would otherwise create a tax-free intercorporate dividend into a taxable capital gain unless the parties are related. Currently, under this provision siblings are considered not to be related. This can result in complex and costly transactions where a division of a business takes place among siblings.
Bill C-208 removes the carve-out of siblings and treats siblings as related parties where the transaction involves a QSBC. This change will allow for restructuring and succession planning for a family business involving brothers and sisters, reducing tax and compliance burden in these situations.