Private Members Act creates unique (and momentary) tax planning opportunities
September 02, 2021
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The Income Tax Act (Canada) (the “law“) was recently changed by Private Member Law C-208 (the”invoice“) to address an injustice that prejudices the transfer of businesses between generations to family members. It is common for business owners to sell shares in their qualifying small business company to business buyers. A transaction structured in this manner allows the business owner to raise up to $ 892,218 hedge capital gains from taxation using the lifelong capital gains exemption, and the business buyer can finance the purchase with cash that has been taxed at the company level but not at the personal level.
Prior to the changes introduced by the bill, entrepreneurs could not sell their business to family members this way, as the anti-excess stripping rule in Section 84.1 would apply to reducing the paid-up capital of shares acquired in return and / or an assumed dividend in the amount of the non-share consideration received, effectively denying the sellers any benefit that is realized by claiming the lifelong capital gain exemption. The amendment addresses this inequality by preventing the application of Section 84.1 on sales to holding companies controlled by the children or grandchildren of the business owner.
The new paragraph 84.1 (2) (e) assumes that a taxpayer and a buying company are acting on market terms and are not subject to the anti-circumvention rule in paragraph 84.1 if the following conditions are met:
- The relevant shares are qualified small business shares or shares in the share capital of a family business or a fishing company, as these terms are defined in subsection 110.6 paragraph 1;
- The acquiring company is controlled by one or more children or grandchildren of the taxpayer who have reached the age of 18; and
- The acquiring company does not sell the shares concerned within 60 months of their acquisition.
The new sub-section 84.1 (2.3) adds additional rules that apply for the purposes of section 84.1 (2) (e). In particular, taxpayers must provide “an independent assessment of the market value of the relevant shares and an affidavit signed by the taxpayer and a third party” when invoking the new exception in Section 84.1.
The bill received royal approval in late June, but the federal government later announced plans to introduce additional amending laws, expected to come into effect November 1, 2021, addressing unintended tax avoidance loopholes that may have been created by Bill C-208 ” In the event that the incumbent federal government is re-elected, the November amendments may result in restrictions and restrictions on the relaxed rules, which can prevent previously unobjectionable planning. Regardless of the changes that are emerging, the federal government has accepted that the changes introduced by the private members’ draft law are now law so any tax planning conducted in reliance on the current rules should be permissible, unless the planning otherwise violates the provisions of the law, including the general anti-circumvention rule (the “GAAR“).
This means there is a limited window of time to implement valuable corporate succession planning that may no longer be available after the November changes. We have identified the following planning options that may be relevant to you or your customers.
- Cross-generational succession in family businesses.
Children or grandchildren of entrepreneurs can now buy shares in the family business from their parents or grandparents via their own holding company without the tax disadvantages in Section 84.1. This has two key advantages: one, the children or grandchildren can use cash taxed at the corporate tax rate (rather than the personal tax rate) to fund the purchase of shares from their parents or grandparents; and second, parents or grandparents can now claim lifelong capital gains exemption in the event of a bona fide intergenerational sale of the company to their children or grandchildren as if they were selling to a third party.
- Sale of assets. Buyers often insist on buying assets versus stocks for a variety of legitimate commercial reasons. Planning can now be done prior to the sale of assets that will allow the business owner to realize a lifetime capital gain exemption by first selling his business shares to a company controlled by their children or grandchildren and then selling the target assets to the buyer . There are additional benefits to this strategy as it provides additional benefits to the seller’s capital dividend account and potentially allows the controlling children or grandchildren to realize after-life capital gains exemption in a future sale of the business.
- Planning for non-residents. US residents resident in Canada with Canadian resident children or grandchildren can structure an intergenerational transfer of their business by employing a hybrid strategy that leverages their lifetime capital gains exemption for Canadian tax purposes and their US gift tax exemption.
- Rehabilitation of shareholder loans and other planning options. When a shareholder borrows corporate funds from the company, the loan amount will result in an income credit for the shareholder if it is not adjusted as a salary or dividend before the end of the corporate tax year following the year in which it was preferred. Using the changes to Section 84.1, a plan to eliminate shareholder loans may be available before they result in income taking, but there should be a legitimate commercial purpose in structuring a transaction in this way.
Planning options like this are now available until further legislative changes are introduced in November when the rules need to be re-examined. As with any tax planning, the availability of a tax benefit or tax deferral depends on the application of the provisions of the law to the specific case. All tax planning should always be conducted with careful consideration of any specific anti-circumvention regulations and the GAAR.
The content of this article is intended to provide general guidance on the subject. Expert advice should be sought regarding your specific circumstances.
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