Canadian tax legislation is changing on January 1st, 2024, and there are huge implications for those who are looking to transfer their business to a family member. In 2021, Bill C-208 was enacted to create more equitable tax treatment for the sale of a family business to a third party compared to a family member. While the amendments under Bill C-208 were welcomed by many entrepreneurs looking to keep their business in the family, the Department of Finance had concerns that some were abusing the changes.
This included the act of “surplus stripping”, where owners electing to take cash out of a business could recognize capital gains instead of dividends without a genuine family business transfer taking place. This method allowed owners to realize a significantly lower tax rate on those payouts compared to increasing their salary or receiving the payout as a dividend. To address these concerns, the 2023 Federal Budget proposed modifications to the Income Tax Act that work to ensure that family business transfers are genuine.
The Notable Changes
1. The scope of family members who are eligible for intergenerational transfers has been expanded. Children, grandchildren, stepchildren, children-in-law, nieces and nephews, and grandnieces and grandnephews will be eligible under the new legislation.
2. Assessment conditions for a genuine transaction include transferring legal and factual control of the company, the transfer of economic interests, the transfer of management to the children, the length of time the next generation must retain control of the business, and the required time a child must be involved in the business following share transfers.
3. The introduction of immediate and gradual options for a genuine business transfer. The immediate option offers more stringent transfer rules but comes with an earlier resolution and a shorter CRA monitoring period. The gradual transfer option allows for additional flexibility during the transfer but is subject to a much longer CRA monitoring period.
4. Under the immediate option, the Transferor cannot hold legal or factual control of the business after the sale. Management of the business must be transferred to their children within 36 months. Under the gradual option, the Transferor is only required to give up legal control at the time of sale and may continue to exercise economic influence over the business for up to 60 months.
5. During the monitoring period, the actions of the child could cause the parent to fail the genuine transfer conditions. This would lead to a reassessment of the Transferor’s tax liability, and the child would be jointly and severally liable for any additional taxes payable by the Transferor.
Those considering a family business transfer should consult with a tax advisor to determine which legislation best meets your unique situation and transfer objectives.