When assisting clients with succession planning, we typically have conversations about the costs and benefits of available options to achieve desired objectives. Sometimes, this includes discussions about technical roadblocks that need to be overcome.
Regarding the transfer or division of family businesses, recent amendments to the Income Tax Act (ITA) found in Bill C-208 provide expanded planning opportunities that historically were difficult or even impossible to implement. These provisions represent a significant and positive change – something the tax community has long lobbied for. These amendments simplify inefficiencies and complexities in the following scenarios:
- A parent/business owner wants to sell shares of the incorporated family business to a child or grandchild; or
- Siblings who co-own a business wish to divide the business assets and pursue separate interests
Sale of a business to a child or grandchild
For a parent or grandparent wishing to sell shares of their incorporated business to a corporation controlled by their child or grandchild, rules within Section 84.1 of the ITA converted what was otherwise a capital gain on the sale of shares into a deemed dividend. This meant the parent or grandparent could not claim the lifetime capital gains exemption on such a sale of their shares, translating to lost tax savings of approximately $240,000 (assuming top marginal tax rates apply).
Since such rules did not apply to a third party or “arm’s length” sale of shares, structuring a sale of a family business to a child was significantly more expensive from an income tax perspective than selling the business to a stranger.
Thanks to Bill C-208, via new paragraph 84.1(2)(e), the parent or grandparent is deemed to be at arm’s length from the child or grandchild. This means that the parent or grandparent vendor (or each of the parent or grandparent vendors if there are more than one) can potentially claim the $913,630 (tax year 2022) lifetime capital gains exemption for qualified small business corporation shares, or $1,000,000 exemption for shares of family farm or fishing businesses.
Several requirements must be met for the new paragraph to apply, including:
- The shares in question must meet the specific technical definitions of “qualified small business corporation” shares, or shares “of a family farm or fishing corporation.” Where the shares in question do not meet these definitions, we may be able to assist with pre-sale planning, enabling the shares to meet these definitions.
- The purchaser corporation must be controlled by a child or grandchild of the vendor, and that child or grandchild must be at least 18 years of age.
- The purchaser corporation may not dispose of the shares (by reason other than death) within 60 months of purchase.
Additionally, for the vendor to claim the full lifetime capital gains exemption on the sale, the “taxable capital” of the corporation being sold must be under $10 million (partial exemption may be available if taxable capital is below $15 million). An “independent assessment” of the fair market value of the shares must also be provided to the Canada Revenue Agency.
We can help you navigate these requirements, and we will closely monitor all matters relating to this legislation as they unfold. As of this writing, amendments to the legislation to clarify matters of technical interpretation have been announced, but not yet published.
Division of a business by siblings
For many years, tax deferred division of company assets amongst siblings has been the subject of some of the most technically challenging provisions in the ITA. The series of transactions required to divide assets between a single corporation jointly controlled by more than one sibling as well as corporations controlled by individual siblings generally resulted in taxable income, unless the transaction could rely on one of the exceptions in ITA subsection 55(3). These include exceptions for related parties, and a so-called “butterfly” exception where, pursuant to onerous technical requirements, arm’s length parties could also potentially be exempt from the requirement to include certain amounts in taxable income upon division.
It would follow that a division of company assets between siblings should be relatively simple, as siblings are usually considered related parties for most purposes. However, Section 55 of the ITA has long considered siblings to be dealing at arm’s length and therefore unable to use the related party exception. For this reason, the only avenue typically available to siblings seeking to divide on a tax-deferred basis has been the difficult, costly and time intensive “butterfly” exception. As a result, siblings who sought to divide a business faced substantial income tax or income tax risk, professional costs and potential delays to achieve the division.
The changes to Section 55 enacted by Bill C-208 stipulate that with respect to qualified small business corporation shares or shares of a family farm or fishing corporation, siblings are considered non-arm’s length – and therefore eligible for the related party exception. As a result, we may now be able to assist you with the division of business interests between siblings in a much more expedient manner than ever before. We can help determine your eligibility under these required definitions, as well as help with any necessary advanced planning.
If you have questions about these or other tax matters, simply consult any of our leading Melo LLP advisors.