Tax expert breaks down the narrowing window of opportunity for business owners – and why waiting could be better
With less than half a year to go before a slew of federal tax proposals on intergenerational business transfers take effect, family business owners across Canada are confronted with a narrowing window of opportunity to pass on their business to a family member under the current rules. And according to one tax expert for family enterprises, it’s a decision that shouldn’t be taken lightly.
“Private enterprise contributes in a significant way to the Canadian economy. Many family business owners dream of transferring their business to the next generation,” says Dino Infanti, partner and national leader, Enterprise Tax at KPMG in Canada. “Now we have additional clarity on specific issues the government was concerned about with respect to these transactions.”
Creating balance
The federal proposals revolve around specific provisions within Bill C-208, a private members’ bill which was enacted in 2021. Among other things, the bill sought to create equitable tax treatment between family business owners selling to third parties, and those transferring their businesses to a family member. More specifically, the bill granted the same tax benefits when selling corporate shares of a qualifying family business to a corporation owned by an adult child or grandchild as if sold to an unrelated person.
“Prior to the enactment of the existing rules, if a business owner transferred the business within the family unit to their adult children, that owner would not be able to claim their lifetime capital gains exemption (LCGE) towards that transaction,” Infanti explains. “Furthermore, instead of being treated as capital gains, which are broadly taxed at around 26%, the transfer of shares would generally be taxed as dividends at a rate close to 50%.”
When Bill C-208 found its way into the Income Tax Act in 2021, it was welcomed legislation for Canadian entrepreneurs who wanted to keep their business within the family.
But it also prompted a reaction from the Department of Finance, which raised concerns that the new rules could also be abused as a way for some owners to “extract corporate surplus” – claiming the equitable tax treatment that was meant for internal succession of family businesses, even though no genuine transfer of the business actually took place.
“After the enactment of the existing rules, Finance addressed some of the technical aspects they were concerned about, and highlighted what future amendments might look like,” Infanti says. “They indicated aspects such as legal and factual control of the corporation, the level of ownership, and timing of the transfers.”
With the federal budget in March, the government finally got to address those concerns. The proposed rules – which are set to take effect on January 1, 2024 – deal with immediate and gradual transfers of a family business, with several tests that must be satisfied for share transfers to be regarded as a bona fide passing of the torch.
“What we need to think about, ultimately, is the purpose, spirit, and intent of these rules that exist,” Infanti says. “Essentially, they’re meant to put the vendor of the shares of the business in the same or similar tax position had they sold the shares of the business to an arm’s-length third party.”
To rush or to wait
With the deadline for changes to Bill C-208 to take effect fast approaching, Infanti says entrepreneurial families who were already discussing an intergenerational handoff may want to consider accelerating their plans depending on numerous factors.
“In terms of planning, you want to think about whether the adult child or grandchildren are already involved in the business. That’s not a requirement in itself under the existing rule, though you also want to contemplate a family’s specific fact pattern in the context of the General Anti-avoidance Rule,” he says. “They also should consider how the purchase is being financed.”
The proposed rules, Infanti says, will also require business owners to immediately transfer legal control of the business within 36 months. For some first-generation owners who might prefer to keep some control, or gradually transfer control over a longer period, implementing the succession plan under the existing rules might make more sense.
In some scenarios, the changes to Bill C-208 could actually be beneficial. One of those changes, Infanti says, would resolve a “technical glitch” under the existing legislation as it relates to the computation of taxable capital and claiming the LCGE.
“If someone is concerned that they may end up not accessing their entire LCGE under the existing rules, they might want to wait until January 1, 2024,” Infanti says.
The federal budget proposals also expand the scope of second-generation family members eligible for intergenerational transfers. Starting January 1, the federal government will extend acceptable intergenerational transfers to include children, grandchildren, stepchildren, children-in-law, nieces and nephews and grandnieces and grandnephews.
Today, Infanti says KPMG in Canada is talking with clients to make sure they’re aware of the proposed rules, and their potential ramifications. For those already contemplating transitioning the business and aren’t entirely comfortable with the specific rules and conditions that would take effect on January 1, he anticipates some of those discussions will be accelerated in the coming months.
“At the end of the day, the business, the family dynamics, and the tax strategy to complement that – all those things are important,” Infanti says. “For clients who have been mulling over transitioning their private business within the family unit to the next generation, we encourage them to bring those discussions forward and look at those plans in a much deeper way to hopefully arrive at an optimal solution.”
