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Intergenerational Transfers – New Rules…For Now

September 9, 2021

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Historically, intergenerational business transfers were taxed punitively compared to an arm’s length sale. That is, a business owner selling shares to a buyer corporation[1] would generally realize a capital gain, 50% of which would be taxable. Assuming the shares sold are qualified small business corporation (“QSBC”) shares, the business owner may also be able to shelter all or a portion of the resulting capital gain using their available lifetime capital gains exemption (“LCGE”). However, where the buyer corporation is controlled by a person related[2] to the selling business owner, that capital gain may be recharacterized as a taxable dividend. This punitive tax result arises from the provisions under section 84.1, which is meant to prevent surplus stripping (i.e., extraction of corporate funds at a tax rate lower than the dividend rates). For 2021, the combined Federal and BC top marginal rate for capital gains is 26.75%, compared to 48.89% for non-eligible dividends.  Thus, where section 84.1 applies, the selling business owner will be taxed at higher dividend tax rates and lose the ability to claim their LCGE.

The recent Bill C-208 became law on June 29, 2021 and provides an exception to the application of section 84.1. However, given the unusual and hasty process under which this new legislation was passed, new legislation will be introduced to revise the Bill C-208 amendments. As such, there may be a small window to take advantage of these current rules before further changes are made, which will be effective on the later of November 1, 2021 or the date final draft legislation is published.

Bill C-208 also includes amendments to subsection 55(2), providing a potentially simpler and less costly approach to implementing a reorganization of a business among siblings.

SECTION 84.1 AMENDMENTS

Bill C-208 provides an exception from the application of section 84.1, which will allow a business owner (i.e., the parent) to sell their shares of a business (the “subject corporation”) to a child or grandchild’s corporation.

Where all of the following conditions are met, the current section 84.1 amendments would exempt certain intergenerational transfers from the punitive application of the section 84.1 rules, and potentially permit the parent to access their available LCGE on the sale of shares:

  • The shares being sold (the “subject shares”) are QSBC shares or shares of a family farm or a fishing corporation;
  • The purchaser corporation is controlled by one or more children or grandchildren of the selling shareholder, who are at least 18 years of age; and
  • The purchaser corporation does not dispose of the subject shares within 60 months of the purchase (other than by reason of death).

Under the new rules, if the purchaser corporation disposes of the subject shares within 60 months of the purchase, the above exemption from the application of section 84.1 does not apply and the selling shareholder is deemed to have disposed of the subject shares to the person who acquired them from the purchaser corporation.

Bill C-208 also includes a reduction to the amount of LCGE available to the selling shareholder if the taxable capital employed in Canada of the corporation being sold (and any associated corporations) exceeds $10 million and fully eliminates access to the LCGE where taxable capital employed in Canada reaches $15 million.

In order to qualify for this new exception to section 84.1, the selling shareholder must provide the Minister with “an independent assessment of the fair market value of the subject shares and an affidavit” signed by the selling shareholder and by a third party. Our Smythe Advisory team can assist with this independent assessment.

SECTION 55 AMENDMENTS

Under the old rules, siblings are deemed to be not related for purposes of subsection 55(2). As a result, certain corporate reorganizations involving the transfer of assets between corporations and otherwise tax-free intercorporate dividends among corporations controlled by siblings would be recharacterized as taxable capital gains. Bill C-208 provides an exception that deems sibling to be related for the purposes of subsection 55(2) in situations where the dividend was received or paid, as part of a series of transactions or events, by a QSBC, a family farm or a fishing corporation.

This new change allows for a simpler split-up (butterfly) transaction among siblings on a tax-deferred basis, which previously required a much more complex and costly reorganization to achieve.

WHAT’S NEXT?

Bill C-208 was intended to facilitate “genuine” intergenerational transfers.  However, as noted above, the Bill was passed hastily, despite concerns raised by Finance officials over the draft legislation and loopholes created.  Some anticipated changes we expect to see with the November 1, 2021 revisions include:

  1. Control of the subject corporation – The Bill C-208 amendments do not require the parent to relinquish control of subject corporation to the purchaser corporation. Thus, under the current rules, non-voting preferred shares can be sold to the purchaser corporation while allowing the parent to retain control.  We anticipate the revisions will require control (both legal and factual) of the subject corporation to pass to the purchaser corporation.
  2. “Genuine” business transfer – There are currently no requirements for the child/grandchild to be active in the business of the subject corporation, nor any requirement for the parent to transition out of the business of the subject corporation. We anticipate the revisions will include new restrictions to capture transactions carried out for surplus stripping purposes, rather than “genuine” business transfers.

Until the final legislative proposals are published, the current Bill C-208 stands.  The amendments outlined above may create a small window of opportunity for certain transfers or reorganizations, which may not be available after revisions are made.

Facilitating intergenerational transfers and reorganizing family business can be complex and should be discussed with your Smythe Advisor. For any questions or to discuss any planning opportunities that may be available, please contact your Smythe advisor.

[1] A buyer often prefers to purchase shares through a holding company, rather than personally, as the debt incurred for the purchase can be funded with corporate funds rather than with after-tax personal funds.

[2] A “related person” for this purpose includes common-law but excludes nieces/nephews and cousins.

 

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