Family business is the backbone of the Canadian economy. When a family business is passed down to the next generation, we see so many positive ripple effects in the economy:
- A new entrepreneur is given the opportunity to succeed
- New jobs are created
- Industry advancements are made
- Loyal customers maintain a trusted partner
- Communities entrench a source of personal pride
And yet, up until now, the process of transferring a business from a parent to a child has resulted in adverse taxation consequences. Thankfully, recently introduced Bill C-208 includes changes to Section 84.1 of the Income Tax Act (ITA) that will ease this tax burden.
Let’s take a closer look at what the bill’s proposed changes will entail:
The way it is today
Currently, the best way for a child to purchase a parent’s company is by purchasing the shares of the operating company (Opco) through a holding company (Holdco). This makes it easier for the child to make the purchase using corporate funds, while also allowing the parent to shelter some or all of the sale of their shares from Capital Gains.
That being said, under the current regulations, when a parent sells their shares to a non-arm’s length corporation, capital gains are recharacterized as a dividend, translating to an additional tax burden of more than 20%. Further, the parent is not able to use what would have been a capital gains exemption to offset the gain.
The parent could choose to dispose of the business assets to the child as an alternative, but this is often either not plausible, or not desirable given that they cannot use the capital gains exemption. This means that in many cases, it’s more financially beneficial for the parent to sell the business to a third party! A sad state of affairs indeed.
How Bill C-208 would ease this burden
Provided that the following provisions are met, Bill C-208 will make intergenerational transfers exempt from the adverse section 84.1 rules.
- Opco shares must be from a Qualified Small Business Corporation (QSBC), a family farm, or fishing corporation
- Holdco must be controlled by the parents’ children or grandchildren, and children and grandchildren must be over 18 years old
- Holdco must not dispose of the shares within 60 months of the time of acquisition (unless because of a death)
There are some additional rules that should be taken into consideration when determining whether to utilize the Bill C-208 changes to transfer a sale. The bill contains a provision that will grind the CGE if taxable capital employed within Canada is greater than $10 million. The business owner must have the value of the company independently assessed.
Bill C-208 also proposes a change to the anti-avoidance rules in Section 55 of the ITA. Currently in certain situations, a tax-free corporate dividend can be converted into capital gain. Section 55 treats siblings as if they are interacting with an arm’s length company – a carve-out. The proposed amendments would save business owners from the potentially costly and complex consequences of this section by removing the siblings carve-out.
How will this affect your family business intergenerational sale?
When these proposed changes take effect on November 1, 2021, the process of transferring a business from parent to child will become easier and more tax-efficient. With that said, it is important to note that the Department of Finance, may include additional amendments that could potentially impact possible planning.
For this reason, it makes sense to work with a skilled expert to navigate the changes when selling a business to the next generation. At Zeifmans, our team has more than 60 years assisting family run businesses. Not only that, we’re a family-run business ourselves, now in our third generation.
To learn more about how Zeifmans can help your family business, reach out to us today.