Good News for Family Business Transfers: New Tax Measures Now in Effect

Transferring a Family Business: Understanding the Tax Rules 

What is set out in section 84.1 of the Income Tax Act? 

In general terms, section 84.1 of the Income Tax Act (the “ITA”) applies when an individual or trust residing in Canada disposes of Canadian corporation shares to another corporation with which the taxpayer does not deal at arm’s length for consideration other than shares (cash or promissory note). When these conditions are met, the capital gain that would otherwise have been realized on the disposition of the shares is recharacterized as a taxable dividend, thereby preventing the seller from claiming the capital gains deduction. 

The application of section 84.1 of the ITA in its previous version resulted in a significant tax disadvantage for taxpayers who chose to sell their business to their children or grandchildren rather than to an arm’s-length third party. 

Stricter rules for genuine intergenerational transfers 

Bill C-208, in effect since June 29, 2021, was designed to mitigate this unfair situation by introducing an exception to the application of section 84.1 of the ITA in the case of an intergenerational transfer of a family business. Nevertheless, these measures had the potential of creating opportunities for stripping surpluses in situations where there was no actual business transfer. The rules applicable to dispositions made since January 1, 2024, have tightened these guidelines so that the exception applies only to genuine intergenerational business transfers. 

Accordingly, for dispositions made since that date, where the conditions listed below are met, a selling parent may claim the capital gains deduction on the disposition of shares of one corporation (“Corporation”) to another (“Purchaser”) controlled by one or more of their children, nephews or nieces aged 18 or more (“Child” or “Children”).

Transferring a Family Business: Two Possible Approaches 

The rules provide for two ways to structure an intergenerational business transfer: 

• An immediate intergenerational business transfer
• A gradual intergenerational business transfer 

The criteria to be met for either approach differ only as regards the conditions to be fulfilled subsequent to the transfer.

What Requirements Must Be Met for an Intergenerational Business Transfer?

The rules set forth a series of conditions that must be met before, during and after the transfer. 

Prior to the transfer 

• The selling parent must not have already claimed the exception to the application of section 84.1 of the ITA for the same business, except with respect to dispositions that occurred before January 1, 2024. 

At the time of the transfer 

• The seller must be an individual (other than a trust). If the shares are held by a trust, prior transactions must be carried out to transfer them to the selling parent prior to the sale.
• The Purchaser must be controlled by one or more Children.
• The shares sold must be qualified small business corporation shares. 

Subsequent to the transfer 

Surrender of control by the selling parent: 

• Under an immediate intergenerational business transfer, the selling parent must relinquish legal and factual control of the Corporation and the Purchaser.
• Under a gradual intergenerational business transfer, the selling parent must relinquish only legal control immediately. The selling parent may retain factual control for up to 10 years subsequent to the transfer. 

Transfer of business ownership: 

• At no time subsequent to the disposition may the selling parent own, directly or indirectly, 50% or more of the common shares of the Corporation or the Purchaser. Within 36 months of disposition, all ordinary shares must be transferred.
• Under a gradual intergenerational business transfer, within 10 years of the time of disposition, the selling parent must not hold, directly or indirectly, more than 30% of the fair market value of all interests (including any debt) in the Corporation or the Purchaser immediately prior to the time of disposition. 

Maintenance of control by the Child: 

• Under an immediate intergenerational business transfer, for a minimum period of 36 months, the Child must retain legal control of the Purchaser and take an active part in the business. Moreover, the business underlying the Corporation must continue as an active going concern.
• Under a gradual intergenerational business transfer, the minimum period is extended to 60 months. 

Transfer of business management to the Child: 

• Under an immediate intergenerational business transfer, the selling parent must, within 36 months of the disposition or whatever longer period is reasonable in the circumstances, transfer management of the active business carried on by the Corporation to the Child, thereby definitively ceasing to manage the business.
• Under a gradual intergenerational business transfer, the 36-month period is extended to 60 months. 

What Tax-Related Decisions Should Be Made During an Intergenerational Transfer? 

In addition to meeting the foregoing conditions, the selling parent and the Child must jointly elect to apply the exception to section 84.1 of the ITA with respect to the disposition of the shares. This choice must be filed no later than the filing due date for the tax return of the selling parent for the taxation year in which the disposition occurred. 

Furthermore, due to the periods during which certain conditions must continue to be met, the limitation period for an immediate intergenerational business transfer and a gradual intergenerational business transfer are extended by three and ten years, respectively. 

Certain relief measures are provided when the foregoing conditions are not met, in particular following the death or disability of the Child or the insolvency of the Corporation. 

How Can You Properly Plan a Family Business Transfer?

Successful planning requires a structure adapted to the reality of the business, the objectives of the selling parent, and those of the successor. The decision between an immediate or gradual transfer should be evaluated based on these factors and the applicable tax rules. 

BCF’s tax team regularly assists entrepreneurs with their business sales, intergenerational transfers and estate planning to establish a structure tailored to their business objectives and those of the next generation. 

To determine the best approach for your family business transfer and discuss your options, contact our family business succession tax planning team, or directly contact the author of this article, Mehrez Houacine, Partner and Tax Specialist at BCF. 

To learn more about the different stages of a transaction and better understand the challenges involved in selling a business, read our discussion on Demystifying Business Sales Transactions: A Step-by-Step Guide for Entrepreneurs.