Private Members Bill Creates Unique (and Momentary) Tax Planning Opportunities
The Income Tax Act (Canada) (the "Act") was recently amended by private member's Bill C-208 (the "Bill") to address an inequity disadvantaging intergenerational transfers of businesses to family members. It is common for business owners to sell shares of their qualifying small business corporation to corporate purchasers. A transaction structured in this manner allows the business owner vendor to shield up to $892,218 of capital gains from tax using the lifetime capital gains exemption, and the corporate purchaser can fund the purchase using cash that has been taxed at the corporate level but not at the personal level.
Prior to the amendments introduced by the Bill, business owners could not sell their business to family members in this manner, as the anti-surplus stripping rule in section 84.1 would apply to reduce the paid-up capital of any shares acquired as consideration, and/or trigger a deemed dividend to the extent of any non-share consideration received, effectively denying the vendors of any benefit realized from claiming the lifetime capital gains exemption. The amendment addresses this inequity by preventing the application of section 84.1 on sales to holding corporations controlled by children or grandchildren of the business owner.
New paragraph 84.1(2)(e) deems a taxpayer and a purchaser corporation to be dealing at arm’s length, and thus not subject to the anti-avoidance rule in section 84.1, where the following conditions are met:
- The subject shares are qualified small business corporations shares or shares of the capital stock of a family farm or fishing corporation, as those terms are defined in subsection 110.6(1);
- The purchaser corporation is controlled by one or more children or grandchildren of the taxpayer who are 18 years of age or older; and
- The purchaser corporation does not dispose of the subject shares within 60 months of their purchase.
New subsection 84.1(2.3) adds other rules applicable for the purposes of paragraph 84.1(2)(e). Notably, taxpayers must provide “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” when relying on the new exception to section 84.1.
The Bill received Royal Assent in late June, but the Federal Government later announced plans to introduce additional amending legislation that is expected to take effect on November 1, 2021. The subsequent amendments are intended to "honour the spirit of Bill C-208 while safeguarding against any unintended tax avoidance loopholes that may have been created by Bill C-208". If the current Federal Government is re-elected, the November amendments may introduce restrictions and qualifications to the relaxed rules that may prevent planning that was previously unoffensive. Regardless of the looming amendments, the Federal Government has accepted that the changes introduced by the private members bill are now law, so any tax planning implemented with reliance on the current rules should be permissible, provided the planning does not otherwise offend the provisions of the Act, including the general anti-avoidance rule (the "GAAR").
This means there is a limited window of opportunity to implement valuable business succession planning that may no longer be available after the November amendments. We have identified the following planning opportunities that may be relevant for you or your clients.
- Intergenerational family business succession. Children or grandchildren of business owners can now buy shares of the family business from the parents or grandparents using their own holding companies without triggering the adverse tax consequences in section 84.1. This has two key advantages: first, the children or grandchildren can use cash taxed at the corporate rate (rather than the personal rate) to fund the purchase of shares from the parents or grandparents; and second, the parents or grandparents can now claim the lifetime capital gains exemption on a bona fide intergenerational sale of the business to their children or grandchildren as if they were selling to a third party.
- Sale of assets. Purchasers often insist on purchasing assets versus shares for a variety of legitimate commercial reasons. Planning can now be implemented prior to the asset sale to allow the business owner to realize on their lifetime capital gains exemption by first selling their shares of the business to a corporation controlled by their children or grandchildren, then selling the target assets to the purchaser. This strategy has further advantages of generating additions to the vendor's capital dividend account and potentially allowing for the controlling children or grandchildren to realize upon their lifetime capital gains exemption on a future sale of the business.
- Non-resident planning. U.S. citizens resident in Canada with Canadian resident children or grandchildren may structure an intergenerational transfer of their business by using a hybrid strategy taking advantage of their lifetime capital gains exemption for Canadian tax purposes and their U.S. gift tax exemption.
- Shareholder loan clean-up and other planning opportunities. When a shareholder borrows corporate funds from the business, the amount of the loan will result in an income inclusion for the shareholder if it isn't cleaned up as salary or dividends before the end of the corporate tax year following the year it was advanced. Planning may be available using the amendments to section 84.1 to eliminate shareholder loans before they result in an income inclusion, but there should be a legitimate commercial purpose for structuring a transaction in this manner.
Planning opportunities like these are now available until further legislative amendments are introduced in November, when the rules will need to be re-visited. As with all tax planning, the availability of any tax advantage or deferral will depend on the application of the provisions of the Act to the specific facts. All tax planning should always be implemented with careful consideration to any specific anti-avoidance rules and the GAAR.