Are you looking for help with Intergenerational Business Transfers? On June 29, 2021, Bill C-208, An Act to Amend the Income Tax Act (transfer of small business or family farm or fishing corporation), received royal assent and became effective.

The purpose of the amendment is to level the tax-playing field on the sales of shares of a small business, farm or fishing corporation to a company owned by the next generation by limiting the application of section 84.1 of the Income Tax Act (the “Act”).

Although such changes are essential for business owners to keep their operations in the family, there are also concerns that the new rules may be too broad and apply to intergenerational transfers that are not genuine.

Section 84.1 generally treats the transfer of shares to a non-arm’s length purchaser corporation as dividends instead of capital gains

Section 84.1 of the Act is a specific anti-avoidance rule that intends to prevent “earnings stripping” transactions from taking advantage of lower capital gain tax rates.

Before Bill C-208, when an individual sells shares of a corporation to another corporation controlled by a family member (non-arm’s length), section 84.1 generally deems the proceeds of disposition as dividends.

However, whereas an individual sells these shares to an arm’s length party, the proceeds of disposition would receive a more favourable treatment as capital gains and the seller may claim the lifetime capital gains exemption if eligible. Therefore, section 84.1 has the effect of penalizing intergenerational business compared with arm’s length transfers.

Bill C-208 carves out intergenerational transfers from section 84.1

The amendments in Bill C-208 address this problem by carving out from section 84.1 for sales of “qualified small business corporation shares” (QSBC shares) and “shares of the capital stock of a family farm or fishing corporation” if the following conditions in the new paragraph 84.1(2)(e) are met:

1. The exchanged shares are QSBC shares or shares of a family farm or fishing corporation,

2. The shares are transferred to a purchaser corporation that is controlled by one or more of the owner-managers children or grandchildren who are 18 years of age or older, and

3. The purchaser corporation does not dispose of the exchanged shares within 60 months of acquiring them.

New subsection 84.1(2.3) sets out rules to support new paragraph 84.1(2)(e)

i. Paragraph (a) sets out consequences if the purchaser corporation disposes of the exchanged shares within 60 months of the purchase.

ii. Paragraph (b) will reduce the amount of the lifetime capital gains exemption when the subject corporation has taxable capital employed in Canada of more than 10 million.

iii. Paragraph (c) requires the taxpayer who disposed of the shares to the Canada Revenue Agency (CRA) with an independent assessment of the fair market value of

the subject shares (shares of the subjection corporation that were disposed of) and an affidavit signed by the taxpayers and a third party attesting to the disposal of the shares.

In addition, the amendments also include a small but beneficial change to section 55 of the Act, which is another anti-avoidance rule to prevent the conversion of an amount that is normally taxable capital gain into a tax-free intercorporate dividend by deeming siblings not to be related for purposes of subsection 55(2).

The amendments provide an exception to this deeming rule so that siblings will be related in order to facilitate tax-deferred reorganizations of family-owned businesses and farms which involve sibling ownership.

Concerns about the amendments

Although the changes in Bill C-208 are intended to apply to “bona fide” intergenerational transfers of shares of corporations with taxable capital not exceeding 10 million, the actual effect of the legislation seems to allow a broader range of transfers to avoid the unfavourable tax treatment under section 84.1. For example:

i. The condition that the purchaser corporation is controlled by children or grandchildren over the age of 18 does not require them to be involved in the business or provide any significant investment or capital contributions to the purchaser corporation.

Moreover, although the purchaser corporation is required to hold the shares for no less than 60 months, the shares could be preferred shares with a fixed value on which no dividend is required to be paid. Therefore, the parent corporation can continue to control the subject corporation and participate in the future growth of the business.

ii. The supporting new provision in 84.1(2.3) is only applicable to new paragraph 84.1(2)(e) which is too narrow. For this provision to be fully effective, it should also apply to many other provisions of the Act.

Intergenerational Business Transfers

iii. Due to the inadequacy of subsection 84.1(2.3), there is no mechanism to force a taxpayer to provide an evaluation of the shares of the subjection corporation, nor any consequences if a taxpayer fails to do so. In addition, there is no guidance regarding what constitutes an independent assessment and when or how such information should be provided to the CRA.

Overall, the amendment in Bill C-208 is a step in the right direction. It allows more business owners to keep their operations in the family without suffering an unfair tax penalty. Since the wording is broader than it intends to be, future legislation might be released later.

If you have a family business and want to know how this new amendment may affect you and your family, contact our law office to speak with an experienced Canadian lawyer for a consultation.

Jack Wang

Counsel at Barrett Tax Law