On June 29, Bill C-208 received Royal Assent thereby amending the Income Tax Act («ITA»). This bill should facilitate the intergenerational transfer of shares of certain family business corporations.
The following summarizes the major changes to the ITA based on information available as of July 20, 2021.
Amendment of article 84.1 ITA (transfer to children)
Prior to the amendment, section 84.1 of the ITA generally prevented parents from realizing a capital gain and, under certain conditions, using their capital gains exemption («CGE»), when they sold their shares of a family business to a corporation controlled by their children. Instead, this section deemed the parents to realize a taxable dividend, which was taxed at a higher rate and was not eligible for the CGE. If the parents wanted to realize a capital gain, it was preferable for them to sell their shares to a third party or to the children themselves. In the latter case, the tax impact on the children was significant.
The amendments to section 84.1 of the ITA restore fairness by allowing substantially the same tax treatment when parents sell to a corporation controlled by their children as when they sell to a third party, i.e., the realization of a capital gain and the possibility of using the CGE.
However, certain criteria must be met. Thus, the corporation purchasing the shares must be controlled by one or more of the vendor’s children or grandchildren over the age of 18 and the corporation must not resell the shares within 60 months of purchase. In addition, the vendor must provide the Canada Revenue Agency with an independent appraisal of the fair market value of the shares sold and an affidavit signed by the vendor and a third party certifying to the sale of the shares.
Furthermore, it appears that the CGE available will be reduced if the corporation whose shares are sold has taxable capital employed in Canada in excess of $10,000,000, calculated on an associated group basis. The CGE will be reduced linearly and will become nil when the taxable capital reaches $15,000,000.
Amendment to section 55 ITA (transfer to siblings)
Section 55 of the ITA applies, under certain conditions, when a corporation receives a dividend from another corporation. In short, it prevents the conversion of a capital gain into a tax-free dividend. However, some relief was already provided when a corporate reorganization involved members of the same family, such as a parent and child.
The ITA has been amended so that these reliefs are also available where siblings are involved, but on the condition that the dividend is paid by a corporation whose shares are qualified small business shares or shares of family farms or fishing corporations.
Bill C-208 is in force, but the Ministry of Finance recently issued a press release stating that it intends to introduce a new bill to make further amendments targeting the following subjects :
- 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.
These changes would be effective on the later of November 1, 2021, or the date of publication of the bill could result in making the conditions for benefiting the new tax treatment more restrictive.
The Quebec Ministry of Finance has not yet taken a position on the harmonization of these amendments with the Taxation Act.
In this context, it will be necessary to analyze all the circumstances before carrying out a transaction based on the amendments currently in force or to come.
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