Bill C-208 – New Rules for Intergenerational Wealth Transfers
On June 29, 2021, Bill C-208 received Royal Assent. It represents a significant change to the Income Tax Act (“ITA”) for intergenerational wealth transfers. The private member’s bill amended sections 84.1 and 55 of the ITA, providing more flexibility to intergenerational transfers of small businesses, family farms or fishing corporations. For business owners, Bill C-208 may allow access to new tax-efficient strategies when the time comes to pass down the torch to the next generation.
Basics of Wealth Transfer
There are two main ways for business owners to pay themselves out: by selling equity (capital gains) or issuing dividends. In Canada, taxpayers may obtain more favourable tax treatment on capital gains than on dividends. They may also be eligible to claim the lifetime capital gains exemption to reduce some or all the tax payable on the sale of qualified businesses.
Section 84.1 of the ITA is a specific anti-avoidance rule intended to prevent surplus stripping, a tax strategy where business owners pull out their earnings as capital gains rather than dividends. The law deems certain transactions involving related parties (a non-arm’s length transaction) as a dividend instead of a capital gain.
One popular method of passing on a business is through the use of a holding corporation. For example, parents sell their shares of a qualified small business corporation to a holding corporation owned by a child or a grandchild. Under the old rules, the transaction would be classified as a non-arm’s length transaction and would be captured by the s.84.1 anti-avoidance provision. The parents would have to pay dividends tax and lose the advantages associated with capital gains. In contrast, had the parents sold to a holding company owned by third parties, the sale would’ve been classified as an arm’s length (unrelated) transaction and deemed a capital gain.
The amendments in Bill C-208 intended to address the application of s. 84.1 on transactions between parents and their children or grandchildren. It effectively provides an exemption to section 84.1 of the ITA where three criteria are met:
- The business is a qualified small business corporation or a family farm or fishing corporation within the meaning of s. 110.6(1) of the ITA;
- The purchaser corporation is controlled by one or more children or grandchildren of the taxpayer who are 19 years of age or older; and
- The purchaser corporation does not dispose of the subject shares within 60 months of the transaction (other than for reasons due to death).
If the transaction meets the three criteria, the transaction would be assessed as a capital gain rather than a dividend and allow the parents to tap into significant tax savings.
Bill C-208 also include additional rules such as limiting a business owner’s access to the lifetime capital gains deductions for corporations with taxable capital employed in Canada over $10 million. Furthermore, the rules also require the business owner to obtain an independent assessment of the business’s fair market value. In the end, there remain many uncertainties in the wording of the new bill, and taxpayers should be vigilant when planning the sale of their family business.
Subsection 55(2) of the ITA is a specific anti-avoidance rule that would apply to certain transactions involving the transfer of a corporation’s cash or property. Before the amendment, the rule converts tax-free inter-corporate dividends into a capital gain in some circumstances. There were exceptions to this rule for related persons, but it did not apply to siblings. However, Bill C-208 effectively expanded the related person exception to provide additional tax savings to transactions involving siblings.
Bill C-208 introduced new amendments to the ITA to provide small business owners with new tax-efficient strategies for passing on their business to the next generation. Under the new rules, parents may be eligible to report the transaction as a capital gain, as opposed to the transaction being deemed a dividend under the old rules. Furthermore, the amendments relaxed transactions between siblings, adding greater flexibility for transactions within the family.
However, on July 29, 2021, the Department of Finance also indicated its intentions to release further legislative amendments that “honour the spirit of Bill C-208 while safeguarding against any unintended tax avoidance loopholes”. Taxpayers should be wary as these new amendments may change the applicability of Bill C-208.
Are you seeking to transfer your small business to your children? Contact us today to schedule an appointment with our team of experts! R&A Tax Law will provide you with the expert advice you need to minimize your tax exposure!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions, you should consult a lawyer.