According to the old tax law in Canada, if a business owner sold off their business or shares to their kids, there were larger tax implications.
But recently Canada’s Income Tax Act (ITA) saw some changes which could lessen the tax implications that came as a consequence of selling off shares to one of the family members.
Bill C-208 brought some significant tax relief when it got royal approval and became a Canadian law in June 2021. Now owners of family farms, fishing corporations or other small businesses can easily transfer shares to their kids or grandkids.
Bill C-208 Changes:
Previously, according to the Income Tax Act, when shares were sold off to the holding company of a child or grandchild, the proceeds were taxed as dividends and not capital gains.
This created a confusion and duplicity of standards, as when shares were sold to a non-family member’s corporation they were considered as capital gains, under which only half of the proceeds are taxed at the seller’s marginal tax rate.
When these proceeds were taxed as dividends, the business owners had to pay significantly more in taxes, at an additional tax of over 20%.
The old legislation was in place to prevent business owners from avoiding to pay taxes at real rates by owning shares in old companies by setting up new corporations and not having to report the proceeds as dividends.
Through this new legislation, sellers can now utilize the lifetime capital gains exemption (LCGE), under which they can realize tax-free capital gains on proceeds of up to $892,181 for the 2021 tax year, if the asset that is being sold off is eligible for this.
For instance, you sell your company’s shares to your son’s holding company for $1 million. If you did not utilize your LCGE previously, you may utilize the full exemption amount to shield almost $900,000 of the proceeds from taxes. From the amount left only half will be taxed as capital gains.
Points to remember:
Bill C-208 only covers some types of business like family farms, fishing corporations and small business corporations, which need to be private and Canadian to be eligible for the new tax rules.
The business should be an active one and not only be used to hold other businesses or investments such as investment property or an investment portfolio.
The corporation that is used to buy the business’ shares should be buying shares of a small business, and not publicly traded entities or US-owned businesses in order to qualify for capital gains treatment.
Further, in order to receive favorable tax treatment, the business must have been owned for at least two years where more than at least half of the assets that you wish to sell have been actively used by the company.
In order to keep the company records accurate, the time leading up to the sale should be professionally monitored. A help from a professional can help avoid any practices that may not be favorable to the company in the selling off of the assets.
The pre-sale planning phase also requires an expert’s opinion in valuation of the shares. Overstating or understating the value might create troubles for you with the CRA.
Further Amendments in the Bill:
Although the bill has now passed to become a law, the Department of Finance announced that some further amendments might be required to get rid of any loopholes that some may use to seek further reduction in the tax bills. However no major changes will be made.
“The amendments we intend to bring will honour the law passed by Parliament, make sure everyone pays their fair share, and support the families and small businesses that keep our economy, and our communities, strong,” Deputy Prime Minister and Minister of Finance Chrystia Freeland said in a statement.
The final version of the amendments has not been announced yet.