CANADIAN BUSINESS OWNERS: – Deadline Approaching for Intergenerational Transfer

Gold’s Legal Minute*GLM*

By Allan Gold, lawyer Montreal and elder law attorney

Vol. 14, #7 – August 31, 2023

OPENING
Let’s get back to business! You’re a Canadian entrepreneur. You were observant and saw an unfulfilled demand in the market place. You launched your company. You worked hard. You were intuitive, saw further openings and grew the enterprise to what it is today. You’re also the parent of adult children; and they already play an active operational role in the day-to-day. You’re still the owner, but it’s always been your plan that the next generation would carry on the family business. Such does lay out in broad strokes your future intergenerational business transfer. Although you’re aware that a quality of leadership is having a succession plan, you haven’t as of yet, gotten around to it. Here’s the point – if you now advance succession, you can take advantage of the current looser C-208 rules! You see, you’re now less constrained. You have until December 31^st 2023 after which, you’ll have to jump through a lot more hoops and dot more i’s and cross more t’s. And potentially, it could cost you more…much more. . . and it’s not chump change! If you want to learn more – read on!

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“The hardest thing in the world to understand is the income tax.” – Albert Einstein
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What Is Generational Wealth? Generational wealth refers to financial assets passed by one generation of a family to another. Those assets can include cash, stocks, bonds, and other investments, as well as real estate and family businesses.3
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CONTEXT
Do you like working with really big numbers? Here’s one. “The Great Wealth Transfer refers to an intergenerational wealth transfer that is underway in the United States, among other nations, with the baby boomer generation leaving significant wealth to their heirs. Baby boomers and the silent generation will bequest a total of $84.4 trillion in assets through to 2045, with $72.6 trillion going directly to heirs. The transfer of wealth from baby boomers will account for $53 trillion or 63% of all transfers, while the Silent Generation will hand down $15.8 trillion.” 4 Indeed, the phenomenon of ‘Generational Wealth Transfer’ is now having a huge impact.

QUICK BACKGROUNDER

Do you want to know how we got here? It happened as follows. Reference is made to Section 84.1, Income Tax Act 5 – that’s the anti-surplus stripping rule/ It’s designed to stop the extraction of corporate surplus as a capital gain.
This provision of the ITA made it difficult for children to use a corporation to buy shares of a small business, family farm, or fishing corporation from their parents, this whilst parents claimed the lifetime capital gains exemption on the sale of shares. If selling shares to an arm’s length (unrelated) corporation, vendors were able to use the capital gains exemption to reduce the income tax on the resulting capital gain on the transaction. But if the shares were sold to a non-arm’s length (related) corporation, such as one owned by the parent’s children, for cash or a promissory note, the parents would not have a capital gain and could not use the capital gains exemption. The result would be substantial income tax consequences.
In 2021, Bill C-208 was last introduced. It was titled, “An Act to amend the Income Tax Act (transfer of small business or family farm or fishing corporation).” This was a private member’s bill. The sponsor was Larry Maguire, Conservative MP.
On June 29, 2021, Bill C-208 received Royal Assent. The idea was “to facilitate the transfer of small businesses or family farms or fishing corporations.”
In essence, “This enactment amends the Income Tax Act in order to provide that, in the case of qualified small business corporation shares and shares of the capital stock of a family farm or fishing corporation, siblings are deemed not to be dealing at arm’s length and to be related, and that, under certain conditions, the transfer of those shares by a taxpayer to the taxpayer’s child or grandchild who is 18 years of age or older is to be excluded from the anti-avoidance rule of section 84.‍1.” 6
It’s noteworthy that the rules allowed a sale of shares to non-arm’s length purchasers, such resulting in a capital gain where a taxpayer could use the capital gains exemption in order to reduce the income tax.
On 28 March 2023 came the 2023 Federal Budget. The government needed to tighten Bill C-208 rules due to “insufficient safeguards.” Criteria was added to require a more comprehensive transfer of ownership from a parent to adult child. The changes were targeting bogus transfers of business between family members taking place. The intent was to prevent “surplus stripping.” (N.B. The “capital gains strip,” otherwise known as “surplus stripping” refers to tax strategies that let you distribute cash from your corporation as a capital gain instead of pulling the cash out as dividends, which are more highly taxed.)

LET’S GET DOWN TO BRASS RACKS

Technically, here’s a rundown.

An intergenerational share transfer would continue to be considered genuine where: * each share of the transferred corporation is a qualified small business corporation share or a share of the capital stock of a family farm or fishing corporation at the time of the transfer; and * the purchaser corporation is controlled by a person or persons who are all adult children (including grandchildren, nieces and nephews, and grandnieces and nephews) of the transferor.

Nota Bene!

There are new conditions for a transfer to qualify as being genuine. Such relate to transfer of control, economic interest and management of the business, the degree of involvement of adult child in the control and running of the business.
There’s a choice between two options: “immediate” or “gradual.” The former is based on an arm’s-length sale term (with a three-year test). It “would provide finality earlier in the process,” but come with more stringent conditions than the gradual transfer. The latter is gradual, based on traditional estate freeze characteristics (with a five-to-10 year test).
There’s a 10-year capital gains reserve for genuine intergenerational share transfers that satisfy the above proposed conditions.
Caution: There’s an extension of the limitation period for reassessing the transferor’s liability for tax by three years for an immediate business transfer and by 10 years for a gradual business transfer.
The proposed measures would apply to transfers on or after Jan. 1, 2024.

QUEBEC SITUATION

Speaking of intergenerational business transfers, please note:

That on August 12, 2021, for purposes of reconciling objectives pursued by Québec’s tax policy and those set out in Bill C-208, amendments were made to Québec tax legislation, such that the Québec integrity rule announced in 2015 and 2016 could apply despite the coming into force of Bill C-208.
That following the 2023 federal budget, considering the substantial changes made to the conditions and rules for intergenerational business transfers, these changes were incorporated into the Québec tax system. Such amendments are to apply to dispositions made after December 31, 2023. The provision easing the Québec integrity rule will thusly be abolished.

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“The early bird gets the worm.” – William Camden
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“An intergenerational business transfer isn’t like instant coffee. It’s not check a box and you’re done. There’s a lot of preparations – start today!” – Allan Gold

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HOLD OR SELL

There are factors to consider when deciding whether to hold or sell an asset. Several are your age, risk tolerance and time horizon. There are a number of ideal times to sell an asset and those you shouldn’t. When it comes to your business, there are pros and cons about selling out and it’s complicated. At any given time, there are advantages and disadvantages. A sunset provision situation, such as this, is a major reason for making a divestiture. Of course, it’s your call. Know that business is sometimes like poker – there’s a time to cash out. Be informed that if the time is right to sell but the buyer is not very liquid, you could exchange shares for a price part in cash and part in installments.

CONCLUSION: Countdown you only have four months to the deadline!

As you can see hereinabove, conditions and rules concerning intergenerational business transfers shall be made more stringent subsequent to December 31^st 2023. This means it will be more difficult thereafter to qualify for the Bill C-208 tax breaks. And in all likelihood, the tax bill shall then be higher! So the takeaway message of this blog post is clear. This is a need and an opportunity thing! And there’s a best before date – because the looser C-208 rules will end at the end of this year. So if an entrepreneur, ready to retire or not, consider this your personal wake-up call! If the time is right for you, then hurry –it’s late…but not too late. You really need to get moving – time is short!

P.S. “A person doesn’t know how much he has to be thankful for until he has to pay taxes on it.” – Anonymous

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NOTICE – CAUTION –DISCLAIMER. The material provided herein is of a general nature, strictly for informational purposes. The interpretation and analysis is not to be misapplied to a personal situation with a particular set of facts. Under no circumstances, are the herein suggestions and tips, intended to bring a reader to the point of acting or not acting, but instead, the hope is that they are to be a cause for pause and reflection. It is specifically declared that this content is not to be a replacement of, or a substitution for, legal or any other appropriate advice. To the contrary, for more information on these presents, related subjects or any other questions, it is the express recommendation of the author that everyone seek out and consult a qualified professional or competent adviser.

1. Image by Gerd Altmann from Pixabay

2. Image by Myriams-Fotos from Pixabay

3. https://www.investopedia.com/generational-wealth-definition-5189580

4. https://en.wikipedia.org/wiki/The_Great_Wealth_Transfer_(United_States)

5. RSC , 1985, c. 1 (5th Supp.)

6. https://openparliament.ca/bills/43-2/C-208/

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