Geoff McIntyre
On June 29, 2021, the Private Member’s Bill C-208 (the Bill), regarding the intergenerational transfer of small businesses and family farm or fishing corporations, received Royal Assent.
If you are the owner of a family business like a farm, the Bill is worth your attention as it represents a significant positive change in favour of family business succession in Canada.
Previously, a long-standing anti-avoidance rule in the Income Tax Act (ITA) treated intergenerational transfers of a business as a dividend rather than a capital gain.
This meant that if you were planning on selling your business, you would be better off from a tax standpoint selling it to an unrelated party rather than within your family. The Bill changes that rule to allow owners access to the lifetime capital gains exemption (LCGE) when selling to family members if certain conditions are met. The result aims to support intergenerational business transitions.
Access to the LCGE
When qualified farm property like orchards and vineyards are in play, the LCGE can represent up to $250,000 in tax savings per taxpayer.
For example, consider a husband and wife that own the shares of a company that operates a winery, and the shares are worth $3 million. If they sell the shares of the company to an unrelated party, they can shelter up to $1.78 million with their LCGE if certain conditions are met.
However, under the old rules, if they were to sell their shares to their children instead – and the selling price was to be funded from the company’s cashflow – the entire $3 million would be taxed as a dividend. Dividends are taxed at a higher tax rate than capital gains and the parents would not be able to use their LCGE on the sale.
The new legislation corrects this inequity, allowing the proceeds to be treated as a capital gain and the LCGE to be used.
Status of Bill C-208 Legislation
There has been significant activity surrounding the use of the Bill as currently written.
The Government announced their intention to bring forward legislative amendments to the ITA that honour the spirit of Bill C-208 while safeguarding against any unintended tax avoidance loopholes that may have been created by the Bill.
One loophole that the Bill may inadvertently permit is the opportunity for “surplus stripping” in which dividends are converted to capital gains to take advantage of the lower tax rate, without any genuine transfer of the business actually taking place, thereby compromising the integrity of the tax system.
It is important to note that the Canada Revenue Agency (CRA) has the tools and ability to reassess and apply anti-avoidance provisions where a transaction does not meet the object, spirit, and purpose of the ITA.
Clearly, the intent of the new legislation is to give intergenerational family business transfers the same tax treatment as arm’s length sales in situations where there is a legitimate transfer of operational and legal control of the company.
The government has indicated these forthcoming amendments to Bill C-208, which will address the following:
- 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.
- The level of involvement of the child or grandchild in the business after the transfer.
The draft legislative amendments will be brought forward for consultation. Final legislative proposals would be introduced in a bill and apply as of the later of either November 1, 2021, or the date of publication of the final draft legislation.
Noteworthy Items
Over the past few months since the legislation was announced, we have had time to do some analysis and discuss the new legislation with many of our family business clients. Here are some points to consider:
- Taxpayers must provide the CRA with an independent assessment of the fair market value of the shares transferred and an affidavit signed by the taxpayer and by a third party attesting to the disposal of the shares. Business owners planning to use this legislation to affect a sale of their business to a family member should be prepared to have the transaction reviewed by CRA. Comprehensive documentation will be critical.
- The company needs to be a qualified small business corporation as defined in the ITA. One of the conditions to meet this definition is substantially all the fair market value of the company’s assets are employed in an active business. Inactive assets like investments and excess cash can put the company offside.
Farming business owners often have a strong affinity for their land and a desire to transfer their businesses to the next generation. In fact, some of the oldest multi-generational businesses in the world are wineries.
In the past, the tax cost of selling within the family forced many business owners to look at a third-party sale, where the LCGE could be used. The introduction of Bill C-208 is a significant positive step towards making the intergenerational transfer of Canadian family farms a more affordable and viable option.
For more information contact Geoff McIntyre, Regional Leader, Agriculture Services at 250-979-2574 or geoff.mcintyre@mnp.ca
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