What Bill C-208 changes
Prior to the passing of Bill C-208, the Income Tax Act dictated that when parents sold shares of a business to a family member’s corporation, like a child or grandchild’s holding company, the proceeds would be taxed as dividends rather than capital gains.
That provision created something of a double-standard, as sales of business shares to a non-family member’s corporation were considered capital gains, which require only 50 per cent of the proceeds be taxed at the seller’s marginal tax rate.
Taxing those proceeds as dividends, which receive far more severe treatment from our friends at the Canada Revenue Agency, resulted in business owners taking an additional tax hit of over 20 per cent, says Jennifer Leve, partner at Dickson Wright LLP in Toronto.
“Basically, a company or holding company acquiring shares was fine, but your child or your grandchild's company acquiring the shares was not,” Leve says. She adds that the previous legislation was meant to prevent business owners from setting up new companies solely to buy shares in their old ones and avoid having to declare the proceeds as dividends.
Now that sales of company shares to family members receive capital gains treatment, sellers may also be able to take advantage of the lifetime capital gains exemption (LCGE), which allows them to realize tax-free capital gains on proceeds totalling up to $892,218 for the 2021 tax year, if the asset being sold qualifies.
Let’s say you sell shares of your company to your brilliant, successful daughter’s holding company for $1 million. If you’ve never tapped into your LCGE, you could use the entire exemption to shield almost $900,000 of the proceeds from being taxed. Of the amount left, only 50 per cent will be taxed as capital gains.
Things to keep in mind
Bill C-208 only extends to certain types of businesses: family farms, fishing corporations and “small business corporations”, which don’t necessarily need to be small, but they do need to be private and Canadian in order to receive the new tax treatment.
They also need to be active. A corporation that owns an investment portfolio or a collection of apartment buildings, for example, doesn’t qualify.
“For purposes of a sale just getting capital gains [treatment], you'd want to make sure that the corporation that is buying your shares is buying small business corporation shares, not publicly-traded entities, not U.S.-owned businesses,” Leve says.
There’s also a time threshold that needs to be considered. Launch a business today and sell it tomorrow and the proceeds will be taxed as dividends. To receive more favourable tax treatment, you must own your business for at least two years. During that two-year period, Leve notes, you’ll have to provide evidence that more than half of the assets you hope to sell have to been used actively by your company.
To ensure that those records — and any others your company keeps — are accurate, Leve says it’s important to secure some form of professional monitoring in the two years leading up to the date of sale. A little outside help can also prevent the sale of your business from being derailed by any less-than-best practices you may have established while doing your own books over the years.
Remember that part of the pre-sale planning will also need to include a valuation of your shares by an objective, professional third-party. Ballparking what they’re worth or trying to give your descendants a deal on your shares won’t cut it with the CRA.
Amendments could be on the way
Even though the bill is now law, the Department of Finance announced in July that Bill C-208 could be subject to at least some government tinkering in the form of amendments that remove the kinds of loopholes some business owners may be tempted to use to further reduce their tax bills.
Significant changes should not be expected.
“The amendments we intend to bring will honour the law passed by Parliament, make sure everyone pays their fair share, and support the families and small businesses that keep our economy, and our communities, strong,” Deputy Prime Minister and Minister of Finance Chrystia Freeland said in a statement.
The final version of the amendments has yet to be announced.
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