This blog was originally published on June 15, 2021 and has been updated.
Update: On July 19, 2021, the Department of Finance clarified its position regarding the status of Bill C-208. The Department of Finance confirmed that Bill C-208 represents the current state of the law and forms part of the Income Tax Act (Canada). However, a re-elected Liberal government would intend to bring forward further amendments to ensure that the legislation facilitates “genuine intergenerational transfers,” and not “artificial tax planning.” The press release indicated that further amendments would apply as of the later of November 1, 2021 and the date of publication of the draft legislation.
The current rules, as set out in Bill C-208 and discussed below, create new planning opportunities. If you are considering a reorganization that would involve an intergenerational transfer of shares, MLT Aikins would be pleased to provide recommendations on the new transaction structures that may now be available.
Parliament has passed legislation amending the Income Tax Act which provide for greater flexibility and planning opportunities for tax-free intergenerational transfers of shares of qualified small business corporations and family farm or fishing corporations.
On May 12, 2021, the federal House of Commons passed Bill C-208, a private member’s bill that amends paragraph 55(5)(e) and section 84.1 of the Income Tax Act (Canada) (the “Act”). The amendments increase the options available to tax professionals who are assisting clients with intergenerational transfers of shares of a qualified small business corporation, or a family farm or fishing corporation (“Qualifying Shares”). Bill C-208 was passed by the Senate of Canada without amendment on June 22, 2021 and received Royal Assent on June 29, 2021.
Amendment: Section 84.1
Section 84.1 of the Act prevents an individual shareholder from accessing corporate surplus, which may otherwise be paid out as a tax-free return of capital, in a sale of shares to a corporation with whom the transferor does not deal at arm’s length (for example, a corporation owned by the transferor’s child).
Bill C-208 amends section 84.1 by adding a narrow exception in paragraph 84.1(2)(e). The exception would apply where:
- the transferred shares are Qualifying Shares;
- the purchaser corporation is controlled by an adult child or grandchild of the transferor; and
- the purchaser corporation does not dispose of the transferred shares within 60 months of the transaction.
In these circumstances, the purchaser corporation and the transferor would be deemed to be dealing at arm’s length so section 84.1 should not apply to the disposition. This change allows the transferor to realize a capital gain on the sale of shares to their child’s corporation, rather than being deemed to receive a dividend, as is the case where section 84.1 applies.
This change puts a narrow category of non-arm’s length transactions on equal footing from a tax perspective with transactions that occur between arm’s length parties. For example, an individual who owns Qualifying Shares that qualify for the lifetime capital gains exemption may be able to access the proceeds of disposition of the Qualifying Shares on a tax-free basis if they dispose of the Qualifying Shares to their child’s corporation (just like they would be able to do if they disposed of the Qualifying Shares to an arm’s length third party). In these circumstances, a parent may be able to access up to $892,218 (or $1,000,000 in the case of a qualified farm corporation) of proceeds from the share sale without paying any income tax.*
*Note: The potential impacts on Alternative Minimum Tax (AMT) and Old Age Security (OAS) should be reviewed before this planning is undertaken.
Amendment: Paragraph 55(5)(e)
In certain circumstances, subsection 55(2) of the Act will recharacterize transactions which would usually be treated as dividends as taxable capital gains. Corporations can avoid this recharacterization if they satisfy the rules set out in paragraph 55(3)(a) of the Act. In order for the rules to apply, no “unrelated person” can be involved in the re-organization transaction or series of transactions. An issue may arise, however, if siblings are involved, as paragraph 55(5)(e) of the Act deems siblings to be unrelated for the purposes of section 55.
Bill C-208 amends paragraph 55(5)(e) of Act so that the rule that deems siblings to be unrelated would not apply where the re-organization involves a qualified small business corporation or a family farm or fishing corporation (“Qualifying Corporations”). Under the amendments, dividends paid or received by Qualifying Corporations in which siblings have an ownership interest would fall within the exception set out in paragraph 55(3)(a) of the Act. This gives tax practitioners greater flexibility, for example, in situations where a parent desires to transfer the assets of a Qualifying Corporation to corporations owned by their individual children on a tax-deferred basis.
The changes to the Act discussed above came into force effective as of June 29, 2021 and appear likely to remain unchanged until at least November 1, 2021. A member of the MLT Aikins taxation group would be pleased to review your situation and provide our recommendations on the impact of Bill C-208 on the planning options available for your intergenerational transfer of the shares of small business and family and fishing corporations.
Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.