19 Jun Recent Changes that Impact Family Succession Planning
Historically, individuals selling shares in a private business to their children have been penalized by the Canadian tax system more than those selling their business to an unrelated third party. This was due to rules that prevented them from claiming a capital gain and therefore utilizing the lifetime capital gains exemption on transfers to non-arm’s length corporations. The lifetime capital gains exemption permits every Canadian to claim a substantial amount of a gain on a sale of a qualifying Canadian controlled private corporation tax-free, so the inability to claim this on a sale of the company to a child or other close relative was significant.
Reforms to these seemingly unfair rules occurred in June 2021 with the approval of Bill C-208, which makes the tax treatment of sales to close family members similar to sales to third parties by permitting the use of an individual’s lifetime capital gains exemption on these transactions.
However, the government has highlighted some issues in C-208 that they feel could be used to claim unfair tax advantages, which they have addressed as part of the 2023 budget. Once these changes are effective, there will be more requirements to qualify for the lifetime capital gains exemption on transactions with close family members.
2023 budget amendments
As part of the 2023 budget, the government of Canada has proposed several amendments to the rules introduced in Bill C-208. The amendments are designed to address loopholes in the original legislation that could allow business owners to convert dividends to capital gains without completing a genuine property transfer to family members. The changes are scheduled to take effect on Jan. 1, 2024, giving taxpayers a limited opportunity to take advantage of the C-208 rules before these additional requirements come into effect.
Ahead of a transfer, the new rules require a parent to control the business, either alone or with a spouse. Further, the acquiring company must be controlled by at least one individual who is either a child, stepchild, child-in-law, grandchild, niece, nephew, grandniece or grandnephew.
In the initial transaction, the parents’ company must transfer a majority of voting shares, as well as at least half of the common participating shares. The remaining shares must follow within three years of the sale.
Further requirements depend on which of two available options are selected
The transaction may be deemed an immediate transfer or a gradual transfer of the business.
- Immediate Transfer Option
Under this option, parents cannot hold legal or factual control of the business after the sale has occurred. They then have three years to transfer management to their children, who must remain actively involved in the business for this entire period of time.
- Gradual Transfer Option
The gradual option only requires parents to give up legal control, not factual control, at the time of the transaction. This allows them to exercise factual or economic influence over the business after the sale. Within ten years of the transaction, the parents must reduce their debt and equity interests to at most 30% of the value of their interest on the date of the initial sale (50% for fishing and farming corporations). Meanwhile, the deadline to transfer management and the minimum time during which at least one child must remain actively involved are each extended to 60 months.
Business owners who have previously executed an estate freeze or who own their business with a larger group of family members may fall short of legal control and should consider an early transaction under the current C-208 rules before January 1, 2024.
Owners of private companies who want to keep their business in the family now have an incentive to accelerate succession planning as the window closes on the current rules for the capital gains treatment of intergenerational business transfers.
For those owners who are not ready to transition their business at this stage, they should still consider whether their current structure is adequate to take advantage of these benefits in the future.
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