Canada:
Bill C-208: Long-awaited relief for family businesses and intergenerational transfers
June 28, 2021
McLennan Ross LLP
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An amendment that has just been made to the Income Tax Act (“ITA“) is likely to save families significant taxes by handing over their family businesses to the next generation.
Many families want to pass their business on to the next generation. At the moment, however, Sections 55 and 84.1 of the Income Tax Act often apply in order to prevent tax-efficient generational transfers. For a long time, those who hold skilled small businesses, farms and fishing companies have complained that it is unfair – that a transfer to a third party would have better tax results than an intergenerational transfer within the family.
Invoice C-208 (“the
invoice“) is intended to change this. The bill recently passed its third reading in the Senate and is expected to receive royal approval shortly. It provides for exceptions to Section 55 and Section 84.1.
For background, section 55 deals with “butterfly” reorganizations. This is the case when shareholders of a corporation attempt to divide the corporation’s assets between their respective holding companies. By redeeming shares in the reorganization, section 112 could effectively treat the transfer of assets as a tax-free dividend between companies. The anti-circumvention rule in Section 55 applies to most transactions with independent parties and will convert the tax-free corporate dividend into a capital gain.1 Section 55 (5) (e) also considers siblings to be independent persons, making it difficult for parents to run the family business on the respective Share their children’s (siblings) businesses.
Section 84.1 is an anti-circumvention rule regarding exemption from lifelong capital gains (“CGE“) .2 An individual / taxpayer who sells shares in qualifying small businesses or shares in a qualifying farming or fishing company to a buying company can cover the resulting capital gains tax with their CGE. The CGE is indexed each year and is currently $ 892,218. Those who run qualified farming or fishing businesses have an increased CGE of $ 1,000,000; however, Section 84.1 will treat the transfer to an off-market buying company as a dividend rather than a capital gain, effectively preventing the application of the CGE for becomes transfers to a family member’s corporation.
The bill changes Section 55 (5) (e) to include siblings as unrelated and traded on market terms if the dividend is “received or paid by as part of any transaction or event or series of transactions or events a corporation whose share in the share capital is a qualified small business owner’s share or a share in the share capital of a family business or a fishing company “. This enables siblings to make an independent butterfly of a qualified small business or a qualified agricultural or fishing company.
Section 84.1 (2) will also be amended if the acquiring company is controlled by the taxpayer’s children or grandchildren of legal age and the acquiring company has not held the shares for at least 60 months. This would exclude them from the application of Section 84.1 and the capital gains from the transfer could then be eligible for the CGE provided they meet all other criteria
While there are still many questions about the application of this law and anticipating some future changes, this bill provides a long-awaited relief for our customers with family businesses.
Footnotes
1. The bypass rule applies to most independent party butterflies because independent party butterflies must meet several difficult criteria to be excluded from the rule.
2. Section 110.6.
3. For example, the shares sold were in the capital of a qualified small business company or a qualified agricultural or fishing company. See Section 110.6 for other discrete criteria.
The content of this article is intended to provide general guidance on the subject. Expert advice should be sought regarding your specific circumstances.
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