Family Business Transfers at Tax Risk

Unsure about transferring the family farming or fishing corporation or small business corporation to your child or grandchild under the current taxing environment?  There is good reason, considering a reprieve family businesses obtained with the passage of private members’ Bill C-208; has now ended effective November 1.

The Bill referred to ITA Section 84.1 and ensured that parents could use their Lifetime Capital Gains Exemption (LCGE) and capital gains treatment on the transfer of the family business to their children or grandchildren, who in turn could corporately finance the acquisition. 

Larry H. Frostiak, FCPA, FCA, CFP, TEP,  Managing Partner with Frostiak & Leslie Chartered Professional Accountants Inc. and Faculty Member of Knowledge Bureau. explained the following conditions must have been in place to take advantage of this opportunity:

• the exchanged shares are QSBC shares or shares of a family farm or fishing corporation
• the purchaser corporation is controlled by one or more children or grandchildren (aged 18 or older) of the vending taxpayer, and
• the purchaser corporation does not dispose of the exchanged shares within 60 months of the purchase

When those conditions are met, “new” paragraph 84.1(2)(e) would deem the taxpayer and the purchaser corporation to be dealing at arm’s length, so that “old” subsection 84.1(1) should not apply to the disposition; so long as it happened prior to November 1, 2021.

Here’s the problem:   Finance Canada and CRA have not been happy with this Bill, which received Royal Asset on June 29, 2021, and are already working on amendments.   They are concerned that it is too loosely written and could allow for “surplus stripping” (money is extracted out of the corporation as capital gains instead of dividends) and other tax avoidance transactions. 

“My understanding,” says Larry, “is that the next set of amendments will address certain issues, including:

• A 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 that the parent can maintain for a reasonable time after the sale of shares to the child’s corporation;
• the timeline for the parent to transition their involvement in the business to the next generation, and that generation’s level of involvement after the transfer. (This is generally taken to mean that they should be actively and continuously involved in the business that they are acquiring).

These draft legislative amendments will be subject to consultation, and the final amendments will be introduced in a legislative Bill to be in force the later of:

• November 1, 2021; and
• the date of publication of the final draft of the Bill

Because nothing has been released as of October 31, 2021, the amendments will have an “in force” date of November 1. 2021.

The next new rules will likely be retroactive to November 1 and, therefore practitioners and taxpayers will want to tread very carefully or wait until they see the new tax legislation released, cautions Larry, who also notes that some of the expected restrictions include requirements that the child is fully involved in the business, with lesser involvement and control (or potentially no control) by the parent who is selling.  But at this time, in the absence of guiding draft legislation, parties to these transactions are left to speculate.

That development puts an important spin on year end tax planning for family business owners who are ready for business succession to family members.

For more information:   Attend the CE Summits on November 10 for Advanced Year End Tax Planning for Investors and Small Business Owners.