Tax tricks for selling the shop, part 3

Changes to intergenerational transfer rules

In my previous articles, I focused on some tax-planning strategies and options when selling your business. So the coincidence was uncanny when the 2023 federal budget, which was announced on March 28, 2023, included some significant changes that made me think that Part 1 and Part 2 in my series needed a Part 3 and 4.

While there were more issues covered in the budget, in this article and the next I will focus on two specific proposals that will be of interest for those looking to sell their business. The first is proposed changes to the Inter-Generational transfer rules. These changes apply to the disposition of shares that occur on or after January 1, 2024.

The issue

At a high level, Section 84.1 of the Income Tax Act applies where an individual or trust disposes of shares of a Canadian-resident corporation to another corporation that the vendor does not deal at arm’s length. Secondly, if immediately after the disposition, the corporations are “connected,” i.e., one company owns more than 10% of the other company, or one company, together with other related entities, owns more than 50% of the voting shares. When this happens, capital gains that would have been recognized on the transfer are recharacterized as a taxable dividend. This typically results in a higher tax rate and the loss of the lifetime capital gains exemption.

The amendment

Bill C- 208 (introduced in 2021) provided an exception to the above rule where an individual (Vendor) disposed of “qualified small business corporation shares” (QSBC shares). I discussed these shares in last month’s article on the sale of Targetco to a Purchaseco that was controlled by an adult, child or grandchild of the vendor.

The change

With Budget 2023, the following requirements in Bill C-208 were removed:

A requirement that Purchaseco cannot dispose of shares of Targetco within 60 months.
A purported reduction in the availability of lifetime capital gains exemption in certain situations relating to Targetco’s taxable capital; and
A requirement to obtain an independent assessment re. FMV (Fair Market Value) of the Targetco shares.

The scope of “child” is also expanded to include niece/nephew of the vendor or their spouse/common-law partner, or spouse/common-law partner or child of such person It is also important to note that if a trust is involved in the structure, the proposed rules deem, for the purposes of these rules, that each beneficiary of the trust owns everything owned by the trust.

The rules today

Budget 2023 now requires that the parties involved meet one of two transfer options:

1. The Immediate Intergenerational Business Transfer (the “Immediate Transfer”); or

2. The Gradual Intergenerational Business Transfer (the “Gradual Transfer”)

Immediate transfer vs. gradual transfer

The pros of the Gradual Transfer are that (i) it is not required that the vendor (and spouse, if applicable) give up factual control immediately after disposition and (ii) the vendor has up to 60 months (as opposed to 36 under Immediate Transfer) to take steps to transition management to active children.

However, there are significant cons associated with the Gradual Transfer. For vendors with outstanding shareholder loan receivables and preferred shares (that do not satisfy certain prescribed conditions), the Gradual Transfer requires that they must decrease such interests down to the 30% (assuming QSBC Shares) within 10 years from the time of disposition. It could also create a cashflow issue on the operating companies with significant dividend income taxation to the vendor (the threshold is increased to 50% for shares of the family farm or fishing corporations). As well, the active business test must continue until the latter of 60 months and the time the vendors reduce their interests to 30% as per above.

Note that the current proposal also contemplates extending the limitation period for reassessing the vendor’s liability for tax from such business transfers by an additional three years for Immediate Transfers, and by 10 years for Gradual Transfers.

Next time: Details on the new Employee Ownership Trust coming into force in 2024.

Samantha Prasad, LL.B., is a Partner with Toronto law firm Minden Gross LLP, a Meritas Law Firm Worldwide affiliate, and specializes in corporate, estate, and international tax planning. She writes frequently on tax issues, and is the co-author of Tax and Family Business Succession Planning, 3^rd Edition. She is also co-editor of various Wolters Kluwer Ltd. tax publications. A version of this article first appeared in The TaxLetter, © 2023 by MPL Communications Ltd. Used with permission.

Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.