Bill C-208, which received royal assent on June 29, 2021, allows owners of qualifying small business corporations to benefit from a capital gains treatment when transferring their shares to the next generation and access their unused lifetime capital gains exemption (LCGE) to minimize taxation.
Prior to this legislation, certain anti-avoidance rules under the Income Tax Act could apply, which meant the difference between the value of the non-share consideration received (e.g., cash or promissory note) and the paid-up capital or adjusted cost basis of the shares (whichever is greater) would be taxed as a dividend. This typically results in a higher tax liability for the small business owner and doesn’t allow them to benefit from their LCGE, as the capital gains are recharacterized as dividends for tax purposes.
If your clients are planning for the succession of their business and thinking of using the new legislation to transfer the business to their children or grandchildren, there are a few important points to keep in mind. Also note that the government plans to introduce legislation this fall that may further affect business succession (more on this below).
Conditions to qualify
Based on the current legislation, your clients can benefit from the new rules if the following conditions are met:
- shares are of a qualified small business corporation, family farm or fishing corporation;
- shares are sold to a purchaser corporation controlled by one or more children/grandchildren who are at least 18 years of age; and
- the purchaser corporation doesn’t dispose of the shares within 60 months of acquisition (except if disposed due to death)
Your clients will also need to provide the Canada Revenue Agency (CRA) with an independent assessment of the fair market value of the shares being sold. The assessment must be completed by someone who is unrelated to the corporation and clients, has no financial interest in the transaction, and has sufficient knowledge and experience in valuation of similar businesses in the industry.
The assessment would typically include information such as the value calculations with accompanying explanation, appraisals of real property (if the company’s value is based on assets), and analysis (including assumptions) of shareholder agreements that may include rights and restrictions of the shares. The CRA has stated that a report completed as per the CBV [Chartered Business Valuators] Institute’s standards would meet the requirements. However, the client is not required to hire a chartered business valuator to complete the assessment.
Also required is an affidavit signed by the client and a commissioner of oaths or notary public attesting to the client’s disposition of shares. The CRA hasn’t provided a specific form for this affidavit, but guidelines state the affidavit must include information such as the name, address and social insurance number (SIN) of the client disposing of the shares; name and business number of the corporation and purchaser corporation; and the names and SINs of the children or grandchildren who control the purchaser corporation.
A detailed description of the fair market value assessment and affidavit requirements can be found on the CRA’s website.
If your clients will be filing their income tax returns by paper, the affidavit and valuation report should be included with the returns for the year of sale. If they will be filing electronically, they should keep the affidavit and valuation report in their records, as the CRA may ask for these documents if their tax returns are selected for review.
The Department of Finance indicated that revised legislation would be introduced to support only “genuine” intergenerational business transfers and safeguard against unintended tax loopholes caused by this bill. Finance originally stated that the revised legislation would apply as of the later of Nov. 1, 2021, or the revised legislation’s publication date.
The consultation process announced in the 2022 federal budget to review these rules and allow all stakeholders to provide their comments to Finance ended on June 17, 2022. It is expected that the government will introduce the revised legislation this fall. The revisions could include additional requirements or restrictions that limit the situations in which these rules may be available. For example, it is anticipated that the revisions could address the level of ownership and involvement the client can have in the business after it has been transferred.
The new rules are complex and require your clients to meet several requirements. Therefore, it is important for clients to work with their tax advisors before relying on these rules as part of their business succession plans.