On June 29, 2021, private members Bill C-208 received Royal Assent, amending the provisions of section 84.1 of the Income Tax Act (“the Act”) and allowing individuals capital gains treatment when selling shares of a corporation to another non-arm’s length corporation – specifically, parents/grandparents selling shares to a corporation controlled by their adult children or grandchildren. After some confusion about the timing of its implementation, the Minister of Finance announced that these amendments have in fact taken effect as of June 29, 2021. However, the government has indicated that it will introduce further amendments that are intended to address concerns it has with certain aspects of the recent amendments. It confirmed that any further amendments will take effect no earlier than November 1, 2021, providing a window of opportunity for some business owners before certain perceived loopholes are closed.
It is common for a purchaser to use a corporation to purchase the shares of a target corporation because it allows the purchaser to fund the acquisition using corporate profits, instead of using personal funds. Since corporate tax rates on business income are significantly lower than personal tax rates, using corporate funds provides a much more tax-efficient way of funding an acquisition. However, prior to Bill C-208 becoming law, where an individual sold shares of a corporation to another non-arm’s length corporation, section 84.1 of the Act applied to reclassify the vendor’s capital gain as a dividend instead. As a result, an individual selling shares to a child’s corporation could have been subject to tax on the gain at a rate of up to 47.7%, while an individual selling shares to an unrelated corporation could have realized approximately $892,000 of their gain on a tax-free basis (by virtue of the lifetime capital gains exemption) and been subject to tax on any remaining gain at a rate of up to 26.8%.
The amended rules now put the intergenerational transfer of a family business to adult children or grandchildren on equal footing as sales to unrelated parties. The rules now allow children/grandchildren to efficiently structure the purchase, and also allow the parents capital gains treatment on the sale (including the potential to claim the capital gains exemption). While these changes are welcome, they do contain certain limitations, including:
- the purchaser corporation must hold the acquired shares for at least 60 months after the purchase;
- CRA must be provided with “an independent assessment of the fair market value” of the shares (whatever that means); and
- the parents’ entitlement to claim the capital gains exemption in connection with the sale may be limited based on the taxable capital of the corporate group, with the capital gains exemption being only partially available if the group’s “taxable capital” is in the range of $10 million – $15 million, while there the capital gains exemption will not be available if taxable capital exceeds $15 million. Taxable capital of a corporation or a corporate group is basically its retained earnings, book value of capital stock, and debt, less the investments in and loans to other corporations.
Bill C-208 also contains an amendment to paragraph 55(5)(e) of the Act, which will facilitate the distribution of assets from corporations owned by siblings to other corporations owned by the siblings. This change greatly simplifies the ability to distribute dividends to siblings’ holding companies, or to split up a corporation’s business assets between siblings. This change only applies where the distributing corporation is a QSBC. While the government has not expressed concerns with this particular amendment, it is unknown whether further amendments will be introduced to this provision.
The changes introduce through Bill C-208 will benefit business owners looking to transfer a business to children or grandchildren, as well as distributions from corporations owned by siblings. Given the government’s concerns with certain aspects of these new rules and its intention to close what it sees as loopholes, taxpayers may want to take advantage of the current rules before further amendments are introduced. Please consult your Welch LLP trusted advisor to discuss how you might benefit from these changes.
Author:Edwin Ma, CPA
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