AMENDMENTS FOR NON-ARM’S LENGTH TRANSFERS OF PRIVATE CORPORATE SHARES
When you sell shares in your corporation, any resulting gain is normally a capital gain, half of which is included in your income as a taxable capital gain. Furthermore, if the shares are qualified small business corporation shares, or shares in a family farm or fishing corporation, you can claim the lifetime capital gains exemption in respect of the gain. The lifetime exemption is $892,218 for 2021 for qualified small business corporation shares and indexed annually for inflation. For family farm and fishing corporations, the exempt amount is currently $1 million. The exempt amounts of the gains are generally tax-free.
However, if you sell your shares to a family member’s corporation (“purchaser corporation”), the tax consequences could differ, or at least they did differ before the changes discussed below.
In general terms, if you sell the shares in your corporation to your family member’s corporation (“purchaser corporation”), the consideration you receive (other than shares in the purchaser corporation) in excess of the cost of your shares in your corporation may be deemed to be a dividend rather than a capital gain. (Technically, it is the consideration in excess of your cost and the “paid-up capital” of your shares, with other possible adjustments.) These rules can apply if the family member is non-arm’s length with you, which includes people like your children and grandchildren.
So what’s the problem?
Under the Act, dividends are taxed more heavily than capital gains if you are in a high tax bracket. In addition, dividends do not qualify for the capital gains exemption.
The rules, and the recent amendments to those rules, are found in section 84.1 of the Act and are very technical in nature. The discussion here is more general.
Section 84.1 is meant to be an anti-avoidance rule. As noted, it can turn capital gains into deemed dividends on certain non-arm’s length transfers. The provision does not apply to transfers to an arm’s length corporation – for example, a corporation that is not related to the transferor or controlled by the transferor’s family members.
Small-business lobby groups have argued that section 84.1 discriminates against individuals in terms of inter-generational transfers – for example, where they wish to sell to their children or grandchildren. A member of the federal Conservative Party decided to take action and proposed a private member’s bill, which was passed with a majority of Parliament votes (the governing Liberal Party has a minority government).
The bill, Bill C-208, passed into law on June 29, 2021. It has amended section 84.1. The amendments apply where the shares sold by the transferor are qualified small business corporation shares or shares in a family farm or fishing corporation, if the purchaser corporation is controlled by the transferor’s children or grandchildren who are 18 years old or older. As long as the purchaser corporation does not dispose of the shares within 60 months of the purchase, the deemed dividend rule will not apply. As a result, the gain on the initial sale by the transferor will be a capital gain and eligible for the capital gains exemption.
However, the Bill seems to reduce the capital gain exemption in such case if the qualified small business corporation (or family farm or fishing corporation) has taxable capital in excess of $10 million. Unfortunately, the wording in the Bill is unclear at this point, and it may need further amendments.
There are other technical changes under the Bill, not discussed here, which are beneficial for the purchasing corporation and / or children or grandchildren who control that corporation. All the changes are meant to treat these inter-generational transfers similar to transfers to unrelated third parties.
As enacted, and based on the provisions of the Interpretation Act, the Bill C-208 amendments are effective as of June 29, 2021. However, the Department of Finance announced that it intends to introduce new legislation that will delay the implementation of the amendments until January 1, 2022. Whether the Department is successful in this regard remains to be seen. It appears that Finance, which opposed the bill when it was considered by the House of Commons Finance Committee, is going to propose further amendments that may undermine or limit the effects of Bill C-208.