Tax Changes for Intergenerational Share Transfers

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 and consequently became law.

The purpose of Bill C-208 is to provide tax relief to families who wish to transfer shares of a small business or family farm or fishing corporation (herein collectively referred to as “small business”) to their children. Prior to Bill C-208, it was more tax advantageous for parents or grandparents to sell shares of a small business to a stranger than to their children or grandchildren.

On July 19, 2021, the Government of Canada issued a news release that clarified that Bill C-208 has become a part of Canada’s Income Tax Act. In this news release, it also clarified that it intends to bring forward amendments to the Income Tax Act “that honour the spirit of Bill C-208 while safeguarding against any unintended tax avoidance loopholes that may have been created by Bill C-208.”

Any amendments to Bill C-208 will apply as of the later of November 1, 2021 and the date of publication of the final draft legislation.

Intergenerational Share Transfers – Before Bill C-208 (And Where Bill C-208 Conditions Are Not Met)

When a parent is ready to sell shares of a small business, they can either sell to unrelated people or to their children. If the parent were to sell shares of the small business to a corporation owned by unrelated people, they would report a capital gain and potentially claim the capital gains exemption (the capital gains exemption would effectively eliminate the tax on up to $892,218 of capital gains for most businesses and $1,000,000 in the case of shares of a family farm or fishing corporation) to reduce the income tax on the resulting capital gain on the sale. However, if the shares were sold to a corporation owned by the parent’s or grandparent’s children, for cash or a promissory note, the parent would not have a capital gain and could not use the capital gains exemption. The parent would be deemed to have received a dividend, which is currently subject to a much higher rate of personal tax than a capital gain.

Even with proper tax planning, the trade-off in these situations is whether to structure the sale transaction such that the parent received access to capital gains exemption and the child would pay for the shares using after-tax personal funds, or structure such that the children were able to use an acquisition company to purchase the shares from their parent and pay for the shares using corporate funds resulting in the parents reporting dividend income. Regardless of which option is chosen, there is a significant tax cost to the family being the taxes on the dividends paid either by the parents or the child (depending on what approach is taken).

Intergenerational Share Transfers – Bill C-208 Change

Bill C-208 provides that the transfer of shares of a small business by a parent to a corporation controlled by one or more of the parent’s children or grandchildren who are at least 18 year of age is excluded from the application of the “deemed dividend” under the pre-Bill C208 rules noted above, provided that:

• The purchaser corporation does not dispose of the shares within 60 months of their purchase (except in certain cases involving a premature sale by reason of death)
• The parent must provide the Canada Revenue Agency both an independent assessment of the fair market value of the subject shares, and an affidavit signed by the parent and by a third party attesting to the disposal of the shares

It is important to note that the ability to use the capital gains exemption is reduced where the taxable capital of the small and its associated corporations exceeds $10 million and is eliminated at $15 million of taxable capital. There is no such restriction in respect of other unrelated sales of shares.

Some Issues that Have Been Noted with Bill C-208

There have been various technical issues raised with the Bill C-208 legislation. However, beyond these technical issues, the bigger concern is that the legislation is not restricted to genuine succession planning transfers. For example, there’s no requirement for the children to be involved in the family business or for the parent or grandparent to cease their involvement and control of the company.

Forthcoming Amendments to Address Issues with Bill C-208

In the July 19, 2021 news release, the Government of Canada provided the following illustrative list of the issues the amendments to Bill C-208 would address:

• 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; and
• The level of involvement of the child or grandchild in the business after the transfer.

Should you Take Action Before Amendments are Implemented?

The enactment of Bill C-208 is a welcomed change for small business owners. Despite the various issues with the Bill, it has become law and small business owners can start to plan for a tax effective intergenerational share transfer.

Under Bill C-208, there are very few conditions, as listed above, that need to be met to qualify for the tax relief provided by the Bill for international share transfers. The primary concern with the forthcoming amendments to the Bill is that it may become too restrictive to meet all the conditions to qualify for the intended tax relief.

Therefore, in our view, until such time as the amendments to Bill C-208 become effective there is an opportunity to execute intergenerational share transfers, as part of a succession plan for the business, with minimal conditions. This can either be part of a:

• Genuine intergenerational share transfers where the child acquires control of the small business and is actively involved in the business, or
• Intergeneration share transfers where the plan is for the child to eventually be involved and acquire control of the small business.

If in the foreseeable future you are considering a transfer of shares of your small business to your child/children, as part of a succession planning for the business, consider whether this transfer should be completed in advance of the updated legislation (i.e. in advance of November 1, 2021). Please contact your regular Ward & Uptigrove Accountant to discuss.