On June 29, 2021, Bill C-208, An Act to amend the Income Tax Act (transfer of small business or family farm or fishing corporation) received Royal Assent. The Bill amends the Income Tax Act (Canada) (the “ITA”) to make certain intergenerational transfers of certain small businesses, family farms, and fishing corporations more tax efficient. The Bill also contains amendments to the ITA to facilitate certain corporate reorganizations involving businesses owned by siblings.
Amendments to Section 84.1
Section 84.1 of the ITA is a specific anti-avoidance rule intended to prevent surplus stripping — a practice that aims to convert the accumulated surpluses of a corporation into capital gains. As currently drafted, section 84.1 can impose a significant barrier to tax-efficient intergenerational transfers of small businesses, family farms, and fishing corporations.
When an owner of a small business, family farm, or fishing corporation sells his or her shares to an arm’s length party, any profit from the sale is generally treated as a capital gain. Capital gains are subject to a more favorable rate of taxation and the business owner may be able to take advantage of the lifetime capital gains deduction to avoid paying any tax at all. However, when an owner of a small business, family farm, or fishing corporation sells his or her shares to a “non-arm’s length party”, which includes a corporation owned by a child or grandchild, section 84.1 may operate to deem the profit to be a dividend, rather than a capital gain.
Dividends are generally subject to a higher rate of taxation than capital gains and the owner will not be able to take advantage of the lifetime capital gains deduction. This different tax treatment essentially imposes a penalty on intergenerational transfers compared to sales to third-party purchasers.
The amendments to the ITA in Bill C-208 intend to address this different tax treatment by providing an exemption from the application of section 84.1. This exemption applies if three criteria are met:
- the business owner’s shares are “qualified small business corporation shares” or “shares of the capital stock of a family farm or fishing corporation” as defined in subsection 110.6(1) of the ITA;
- the shares are sold to a corporation controlled by one or more children or grandchildren of the business owner who are 18 years of age or older; and
- the purchaser corporation must not dispose of the subject shares within 60 months of their purchase.
The amendments in Bill C-208 do require the business owner to provide the Minister with an independent assessment of the fair market value of the subject shares and an affidavit signed by the taxpayer and by a third party attesting to the disposal of the shares. Further, the amendments limit a business owner’s access to the lifetime capital gains deduction for corporations with taxable capital employed in Canada in excess of $10 million and eliminate access to the lifetime capital gains deduction if the taxable capital employed in Canada of the corporation is greater than $15 million.
Amendments to Section 55
Subsection 55(2) of the ITA is a specific anti-avoidance rule that applies to certain transactions to turn what would otherwise be a tax-free intercorporate dividend into a capital gain to the extent the dividend exceeds “safe income.” Under certain conditions, an exception from subsection 55(2) applies for related persons. Historically, this related persons exception has not applied to siblings. The amendments to the ITA in Bill C-208 expand the related persons exception to include transactions involving siblings if the dividend is received or paid by a corporation of which a share of the capital stock is a “qualified small business corporation share” or a “share of the capital stock of a family farm or fishing corporation” within the meaning of subsection 110.6(1).
Coming into Force
After some confusion, the Department of Finance Canada issued a news release on July 19, 2021, clarifying that the amendments in Bill C-208 became part of the ITA upon the Bill receiving Royal Assent. The news release does note, however, that the government intends to bring forward further amendments to the ITA that “honour the spirit of Bill C-208 while safeguarding against any unintended tax avoidance loopholes.”
If you have questions about Bill C-208 or want to learn more about how the amendments to the ITA in Bill C-208 may be beneficial to you and your business, contact the Harrison Pensa Tax Law Group:
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