Following decades of attempting to change the rules surrounding business transitioning to family members, the business community may finally see positive developments within the next few months.
Many business owners are discouraged from selling their business to family members because of the adverse tax impact. In effect, the Income Tax Act penalizes the sale of a business to family members.
While family farm owners have been leading the charge on change with the introduction of Bill C-208 by Conservative MP Larry McGuire, the issues apply equally to any family business.
The Current Rules
Counterintuitively, it is significantly more expensive to sell a business to a family member than it is to a third party because of an anti-avoidance rule known as section 84.1.
This rule deems the sale proceeds of the business to be a dividend instead of a capital gain and does not allow an individual to claim the lifetime capital gains exemption (“LCGE”) when selling their shares to a corporation controlled by a related party.
In effect, Sec 84.1 changes what otherwise would be a capital gain taxed at 27%, or possibly a tax-free capital gain with the LCGE, to a fully taxable dividend, which is currently taxed up to 48%.
Some More Details
While an individual can sell the shares of their family business to another individual and claim the LCGE, it is significantly more expensive for the buyer to finance the purchase. This is because the individual will be paying back the seller with personal after-tax dollars (up to 54%) rather than corporate after-tax dollars (as low as 12%).
The result is that business owners will have to sell their business to a family member at a significant premium to get the same after-tax effect as selling to a third party.
While these anti-avoidance rules were implemented to prevent abuse of the lifetime capital gains exemption, they also made bonafide sales of businesses to family significantly more expensive.
The Proposed Changes
The current bill proposes that qualified shares of small business corporations and family farm and fishing corporations to be excluded under the anti-avoidance rules of section 84.1 if:
- The shares were sold to a Corporation controlled by a child or grandchild over the age 18 years, and
- The Corporation does not dispose of the shares within 60 months of the purchase.
Clearly missing from the proposed bill are sales to other family members, such as siblings.
Will Bill C-208 become law?
This issue has support across the political spectrum. In the past, all parties have introduced private members bills to change the rules on intergenerational business transfers. Bills have been introduced at various points by Liberal MP Emanuel Dubourg, NDP MP Guy Carron, and BQ MP Xavier Duval. Finance has been studying these issues for years.
Currently, Bill C-208 has passed the third reading and is off to the Senate for final approval. If the Senate approves the bill before parliament is dissolved, we will have new rules before the summer. If not, the result will be more waiting for family farms and businesses.
Contact Sloan Partners LLP in Toronto for Strategic Tax Planning Advice for Business Owners
Tax rules governing business transition and lifetime capital gains exemption are very complex and require planning long in advance of any purchase and sale. Speak to one of the experienced tax practitioners at Sloan Partners LLP before transitioning your business to a family member or third party.
At Sloan Partners LLP, we are experts at corporate reorganization and tax advisory. We work directly with business owners as well as small and medium accounting Firms to implement tax planning strategies and achieve the most favourable tax results for small business owners and their families. If you would like to discuss how you can make a tax plan that will better benefit your family and/or business, contact us to schedule a consultation. Please reach out to us online, or by phone at 416-665-7735.
Disclaimer: This article is intended for educational and informational purposes only. It is not intended in any way whatsoever to provide tax advice. The reader should be aware that legislation and administrative policy are subject to change at any time. None of the persons involved in the preparation of this article accepts any responsibility for its contents or the consequences that arise from its use.