The "GIST" Of Genuine Intergenerational Share Transfers: Important Proposed Legislative Changes

• Law Firm: Cox & Palmer
• Subject Matter: Tax, Income Tax, Tax Authorities
• Author: Matthew Peyton
• Published date: 31 May 2023

Business owners planning to transition their business to the next generation will need to consider further changes proposed to the rules for intergenerational business transfers in the 2023 Federal Budget. These changes were expected and much anticipated following the enactment of Bill C-208, a private member's bill that received Royal Assent on June 29, 2021 and became law as of that date.¹ Bill C-208 amended the Income Tax Act (Canada) (the "Act") with the main aim of creating fairness in Canada's tax system by placing genuine intergenerational share transfers on equal footing with arm's length share sales. This was welcome news to many business owners who intended to cede their business to their children or grandchildren.

Prior to Bill C-208, the transfer by an individual of shares of a Canadian corporation to a corporation controlled by that individual's adult child or grandchild resulted in the proceeds of the sale being treated as a deemed dividend, whereas a similar sale to a corporation controlled by an arm's length third party was treated as a capital gain. This difference in treatment was a significant disadvantage for intergenerational business transfers as a result of the loss of the 50% inclusion rate for capital gains and the loss of the ability to claim the lifetime capital gains exemption ("LCGE") in specific circumstances.

While the changes implemented by Bill C-208 were welcomed overall, the Department of Finance expressed concerns with the breadth of Bill C-208 and, in particular, certain gaps that could allow an individual to engage in surplus stripping through disingenuous intergenerational share transfers.² To address these concerns, further amendments have been proposed in the 2023 Federal Budget to ensure the spirit of Bill C-208 is honoured by only allowing for genuine intergenerational share transfers.

The GIST - A Brief Summary for Business Owners

A business owner that wishes to transition their business to the next generation (as opposed to selling to an arm's length third party) while maintaining capital gains treatment and ultimate access to the LCGE has a few options available to them. As was always the case, a business owner can sell the shares they personally own in a corporation (that either operates the business or directly/indirectly owns the shares of a corporation that operates the business) directly to the desired individuals of the next generation (i.e., adult child, grandchild, niece, nephew, etc.) in their personal capacities. Further, thanks to Bill C-208, a business owner's adult child(ren)/grandchild(ren) now has additional flexibility to use a corporation controlled by them to finance and facilitate the purchase of the shares from the business owner, while maintaining the seller's preferable tax treatment.

With the proposed changes in the 2023 Federal Budget, there will be two possible streams when using a corporation to facilitate the purchase: (1) an "immediate" intergenerational business transfer; and (2) a "gradual" intergenerational business transfer. Under both transfer streams, the shares being sold must qualify as a "qualified small business corporation share" or a "share of the capital stock of a family farm or fishing corporation" (as those terms are defined in the Act), and the shares must be owned by the business owner (either alone or together with their spouse) in their personal capacity. Further, under both transfer streams, the purchasing corporation must be controlled by one or more of certain specified individuals, which can include the business owner's (or their spouse's) children, grandchildren, great-grandchildren, nieces, nephews, grandnieces, grandnephews, or the spouse of any of the foregoing. There are then additional and differing conditions to be met for each transfer stream.

Under an "immediate" transfer, the following conditions must be satisfied:

1. the business owner must immediately (and permanently) transfer both legal and factual control of the corporation and a majority of all classes of shares (other than certain fixed-value preferred shares);
2. within 36 months of the initial transfer the business owner must transfer the balance of all classes of shares (other than certain fixed-value preferred shares);
3. the children (or other specified individuals) of the business owner must control the purchasing corporation for a period of 36 months after the initial transfer and at least one child (or other specified individual) must be actively engaged in the business (and the business must be carried on as an active business) during such period; and
4. within 36 months after the initial transfer (or a greater period of time if reasonable given the circumstances), the management of the business must be transferred to the child or children (or other specified individual(s)).

Under a "gradual" transfer, the following conditions must be satisfied:

1. the business owner must immediately (and permanently) transfer only legal control of the corporation and a majority of all classes of shares (other than certain fixed-value preferred shares);
2. within 36 months of the initial transfer the business owner must transfer the balance of all classes of shares (other than certain fixed-value preferred shares);
3. within 10 years of the initial transfer the business owner must reduce their debt and equity interest to a fair market value of not greater than 50% (in the case of a sale of a "share of the capital stock of a family farm or fishing corporation") or 30% (in the case of a sale of a...