New amendments to Bill C-59: strengthening genuine intergenerational transfers and tackling surplus stripping
Background
When undertaking transactions that involve the transfer of shares to the next generation, taxpayers historically needed to navigate special rules that would otherwise apply to convert what would have been a capital gain on the sale of shares into fully taxable dividends. Taxable dividends, for individual taxpayers, are taxed less favourably than capital gains, which are typically included in the taxpayer’s income based on a smaller inclusion rate (starting on or after June 25, 2024, the inclusion rates for certain capital gains will increase from 50% to 66.67%). These special rules are referred to as the “surplus stripping” provisions and are contained within section 84.1 of the Income Tax Act (ITA). Bill C-208, which came into effect on June 29, 2021, offered a special exception from the application of the “surplus stripping” rules. These intergenerational business transfer (IBT) rules were designed to ensure that the transfer of shares of a small business, family farm, or fishing corporation to a corporation controlled by the owner's child or grandchild would be treated similarly to a third-party sale and therefore the tax implication retain their status as capital gains.
Bill C-59, introduced on Nov. 30, 2023, encompasses the latest amendments to the IBT rules. These new IBT rules have received Royal Assent on June 20, 2024 and override the old IBT rules originally set out in Bill C-208. As discussed in Budget 2023, the new IBT rules aim to better accommodate the goal of encouraging intergenerational transfers and introduce safeguards that were not in place under the old IBT rules.
Introduction of the new IBT rules:
The new measures include two alternatives to access the exemption from the surplus stripping rules:
a. Immediate IBT: The immediate IBT option is useful for business transfers that are expedited and are based on arm’s length sale terms, with a compressed timeline of three years.
b. Gradual IBT: The gradual IBT option allows for a more protracted transition period, spanning five to ten years, providing greater flexibility for both parties involved in the transfer.
At a high level, the conditions that must be met for both options can be very generally summarized as follows:
Criteria
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Immediate business transfer
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Gradual business transfer
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No duplicate planning test
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Parents could not have previously sought the immediate/gradual IBT exception related to the business of the operating company
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Purchaser control test
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Children must control the purchaser corporation and be at least 18 years of age or older.
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Share condition test
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Operating company shares must be qualified small business corporation (QSBC) shares or family farm or fishing corporation (QFFC) shares.
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Transfer of control test
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Parents immediately and permanently transfer both legal and factual/effective control.
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Parents immediately and permanently transfer only legal control.
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Transfer of voting shares test
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Immediate transfer of majority of voting shares.
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Remaining share ownership test
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Parents must not own any shares, other than non-voting preferred shares, within 36 months after the disposition.
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Transfer of management test
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Parents transfer management of the business within 36 months after the disposition.
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Parents transfer management of the business within 60 months after the disposition.
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Remaining economic interest limitation test
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N/A
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Within 10 years after the disposition, the fair market value of all debt and equity previously owned by the parents is reduced below either 30% or 50% of their original amount, depending on whether the shares disposed of were QSBC shares or QFFC shares, respectively
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Retention of control test
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Children retain legal control of the purchaser corporation for a 36-month period following the initial disposition time.
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Children retain legal control of the purchaser corporation for a 60-month period following the initial disposition time
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Child works in the business test
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At least one child remains actively involved in the business for the 36-month period following the share transfer.
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At least one child remains actively involved in the business for a 60-month period following the initial disposition time.
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Administration and special rules of application
In order to be eligible for the new IBT rules, both the parents and the children must file a joint election in prescribed form by the parents’ filing deadline for the year of transfer.
The Canada Revenue Agency (CRA) will have the power to monitor whether the above conditions are met over a period of time and subsequently reassess the original year of transfer when the conditions fail to be met. Both the parents and the children will be jointly and severally liable for any additional taxes payable.
Additionally, certain special rules and treatments will apply for purposes of the new IBT rules, including:
- Nieces/nephews or grandniece/grandnephews are included in the scope of “child”.
- Certain criteria can be deemed to met if the time periods are cut short for various reasons, such as in situations where the children sell the shares to an arm’s length party, a child experiences a prolonged impairment or dies, or if the business ceases.
- Parents will be able to claim an extended capital gains reserve from the ordinary five years to a maximum of ten years.
Navigating the challenges and tax benefits under IBT rules for business transfers
While the criteria of the new IBT rules from Bill C-59 are perhaps stricter than the old IBT rules under Bill C-208, this represents a new planning opportunity for taxpayers that are looking to transfer their businesses to the next generation. While the costs of non-compliance can leave some taxpayers feeling uneasy, allowing taxpayers to be afforded the same tax treatment had they sold to an arm’s length party is a highly beneficial. The ability to gain the same benefit under either the immediate or gradual options, depending on taxpayer circumstance, offers some meaningful flexibility.
