Important tax update – Intergenerational transfers

Prepared by Andersen in Canada, Montreal Partner Patrick Coutu, Tax Director Danny Guérin and Tax Manager Omar Yassine.

The tax community has been asking the Canadian government for several years for legislative changes to address the fact that it is currently impossible for Canadians to benefit from their capital gains deduction (“CGD”) when disposing of their qualified small business corporation’s (“QSBC”) shares to a non-arm’s length corporation. Since the CGD is equivalent to a tax exemption on the first $ 892,218 of capital gains realized on the sale of such shares, this situation forces some taxpayers to sell their business to a third party instead of family members such as their children.   

On June 22, 2021, the House of Commons passed Bill C-208 by a majority vote. The purpose of this bill is to amend section 84.1 of the ITA (“Income Tax act”), which limits the possibility for Canadian taxpayers to make intergenerational transfers while benefiting from their CGD. The Bill also amends section 55 of the ITA to facilitate certain corporate reorganizations that involve siblings. These amendments will be discussed in detail in the following paragraphs. 

It should be noted that Bill C-208 received Royal Assent on June 29, 2021. However, the Department of Finance Canada has announced its intention to delay the implementation date of Bill C-208 until January 1, 2022. This announcement is likely due to the fact that the government intends to make additional amendments to the current legislative changes. One of the concerns raised by the Liberal Party of Canada was that the changes to the current tax provisions did not provide sufficient controls to ensure that the new rules only apply to genuine intergenerational transfers. Several tax practitioners also raised issues with the proposed changes. These issues will be discussed at the end of this article.

Section 84.1 of the ITA

The proposed amendments will add new paragraph 84.1(2)(e) of the ITA and subsection 84.1(2.3) of the ITA which can currently be read as follows:

84.1(2)(e) of the ITA: “ if the subject shares are qualified small business corporation shares or “shares of the capital stock of a family farm or fishing corporation” within the meaning of subsection 110.6(1), the taxpayer and the purchaser corporation are deemed to be dealing at arm’s length if the purchaser corporation is controlled by one or more children or grandchildren of the taxpayer who are 18 years of age or older and if the purchaser corporation does not dispose of the subject shares within 60 months of their purchase.”

84.1(2.3) of the ITA: “For the purposes of paragraph (2)(e),

(a)if, otherwise than by reason of death, the purchaser corporation disposes of the subject shares within 60 months of their purchase:

(i)paragraph (2)(e) is deemed never to have applied,

(ii)the taxpayer is deemed, for the purposes of this section, to have disposed of the subject shares to the person who acquired them from the purchaser corporation, and

(iii)the period of 60 months applicable to the operation that is deemed to have taken place under subparagraph (ii) is deemed to have begun when the taxpayer disposed of the subject shares to the purchaser corporation;

(b)the deduction referred to in subsection 110.6(2) or (2.1) is, for a particular taxation year, the amount, if any, by which that deduction exceeds the amount determined by the formula:

A × B / $11,250

where

A is the amount that would, but for this subsection, be the capital gains deduction referred to in subsection 110.6(2) or (2.1) for the particular taxation year; and

B is the amount determined by the formula

0.00225 × (D – $10 million)

where

D is

(a)if, in both the particular taxation year and the preceding taxation year, the corporation is not associated with any corporation, the taxable capital employed in Canada (within the meaning assigned by subsection 181.2(1) or 181.3(1) or section 181.4, as the case may be) of the corporation for the preceding taxation year,

(b)if, in the particular taxation year, the corporation is not associated with any corporation but was associated with one or more corporations in the preceding taxation year, the taxable capital employed in Canada (within the meaning assigned by subsection 181.2(1) or 181.3(1) or section 181.4, as the case may be) of the corporation for the particular taxation year, or

(c)if, in the particular taxation year, the corporation is associated with one or more particular corporations, the total of all amounts each of which is the taxable capital employed in Canada (within the meaning assigned by subsection 181.2(1) or 181.3(1) or section 181.4, as the case may be) of the corporation or of any of the particular corporations for its last taxation year that ended in the preceding calendar year; and

(c)the taxpayer must provide the Minister with an independent assessment of the fair market value of the subject shares and an affidavit signed by the taxpayer and by a third party attesting to the disposal of the shares. “

Paragraph 84.1(2)(e) of the ITA will deem the vendor and the purchaser to be dealing at arm’s length with each other in the context of an intergenerational transfer when certain conditions are met. In particular, the purchaser will have to be controlled by the vendor’s children or grandchildren who have reached the age of majority, and the purchaser will not be able to dispose of its acquired shares within 60 months of the purchase.

Moreover, new subsection 84.1(2.3) of the ITA clarifies certain rules in relation to new paragraph 84.1(2)(e) of the ITA. If the acquired shares are sold by the purchaser within 60 months of purchase, paragraph 84.1(2)(e) of the ITA would be deemed never to have applied. Furthermore, according to paragraph 84.1(2.3)(b) of the ITA, only intergenerational transfers for corporations with less than $10 million of taxable capital employed in Canada will allow the vendors to benefit fully from their CGD. In the situation where the corporation has more than $15 million of taxable capital employed in Canada, no CGD can be claimed by the vendors. Finally, in order to benefit from the application of new paragraph 84.1(2)(e) of the ITA, the vendor will have to provide an independent appraisal of the fair market value of the shares sold and an affidavit signed by the vendor and a third party to the Minister, attesting of the disposition of the shares in question.

Section 55 of the ITA

The proposed amendments will result in an amendment to subparagraph 55(5)(e)(i) of the ITA. These amendments may be read as follows:

55(5)(e)(i) of the ITA: “in determining whether 2 or more persons are related to each other, in determining whether a person is at any time a specified shareholder of a corporation and in determining whether control of a corporation has been acquired by a person or group of persons,

(i)a person shall be deemed to be dealing with another person at arm’s length and not to be related to the other person if the person is the brother or sister of the other person, except in the case where the dividend was received or paid, as part of a transaction or event or a series of transactions or events, by a corporation of which a share of the capital stock is a qualified small business corporation share or a “share of the capital stock of a family farm or fishing corporation” within the meaning of subsection 110.6(1)” (our underlining)

The amendments to subparagraph 55(5)(e)(i) of the ITA will provide Canadian taxpayers with the ability to implement certain tax restructurings involving corporations controlled by their siblings without triggering the application of subsection 55(2) of the ITA[1]. In order for siblings to be deemed related for purposes of new paragraph 55(5)(e)(i) of the ITA, the shares of the corporations involved in the restructuring will have to qualify as QSBC shares.

Conclusion

The new tax rules in force should allow Canadian taxpayers to make intergenerational transfers while benefiting from their CGD. However, because of the “overly broad” nature of these rules, it would not be surprising if additional amendments were proposed and even adopted in the future. In this regard, the following points can be made:

• Paragraph 84.1(2)(e) of the ITA does not require that the purchaser be controlled by the vendor’s children or grandchildren as a result of the sale of the vendor’s shares. This requirement is currently only applicable upon the disposition of the vendors shares.
• Paragraph 84.1(2)(e) of the ITA does not require that the vendor’s children or grandchildren be actively involved in the business carried on by the corporation.
• Subsection 84.1(3) of the ITA applies where shares acquired in an intergenerational transfer are disposed of within 60 months of purchase for reasons other than death. However, it is not specified whether this is the death of the purchaser or the vendor.

Finally, given the uncertainty associated with the “imperfect” nature of the tax rules adopted by the Royal Assent of Bill C-208, and since Parliament was recently dissolved and that general election has been called, we do not yet know the outcome of that election or the intentions of the other political parties with respect to these tax provisions. We therefore wish to advise the reader to be cautious with respect to these new tax rules, especially since we are aware of the intentions of the Ministry of Finance of the outgoing government to postpone the effective date of Bill C-208.

[1] Subsection 55(2) of the ITA deems certain inter-company dividends that are normally non-taxable to be capital gains.