Selling a businessUnder the old tax laws in Canada, selling a business or its shares to family members resulted in significant tax implications for the business owner. However, recent amendments to the Income Tax Act (ITA) have alleviated this burden. The passing of Bill C-208 in June 2021 has provided substantial tax relief for owners of family farms, fishing corporations, and small businesses looking to transfer shares to their children or grandchildren.
Changes Brought About by Bill C-208
Bill C-208 brought about changes to the Income Tax Act regarding the taxation of proceeds from the sale of shares to a child or grandchild’s holding company.
Previously, these proceeds were considered dividends and not capital gains, resulting in confusion and inconsistency. Selling shares to a non-family member’s corporation, however, was considered a capital gain and only half of the proceeds were taxed at the seller’s marginal tax rate. The old legislation aimed to prevent tax avoidance, but it resulted in business owners paying more taxes, with an additional tax of over 20%.
With the new legislation, sellers can now utilize the lifetime capital gains exemption (LCGE), allowing them to realize tax-free capital gains on eligible assets of up to $892,181 for the 2021 tax year. For example, if you selling your company’s shares to your son’s holding company for $1 million and have not used your LCGE before, you can shield almost $900,000 of the proceeds from taxes. Only half of the remaining amount will be taxed as capital gains.
Here are some key points to keep in mind regarding Bill C-208:
- The new tax rules only apply to certain types of businesses, including family farms, fishing corporations, and small Canadian businesses that are private.
- The business should be an active one and not just used to hold other investments, such as investment property or an investment portfolio.
- The corporation buying the business’s shares must be purchasing shares of a small business, not publicly traded entities or US-owned businesses, to qualify for capital gains treatment.
- To receive favorable tax treatment, the business must have been owned for at least two years, and more than half of the assets to be sold must have been actively used by the company.
- It’s important to keep accurate company records leading up to the sale and seek professional help to avoid any unfavorable practices.
- An expert’s opinion is also required for the valuation of shares during the pre-sale planning phase, as overstating or understating the value could create issues with the Canada Revenue Agency (CRA).
Additional Amendments to Bill C-208:
While the bill has now become a law, the Department of Finance has announced that some further amendments may be necessary to eliminate any loopholes that individuals may use to seek additional reductions in their tax bills. However, no major changes are expected.
In a statement, Deputy Prime Minister and Minister of Finance Chrystia Freeland said, “The amendments we intend to bring will honor the law passed by Parliament, make sure everyone pays their fair share, and support the families and small businesses that keep our economy and communities strong.”
The final version of the amendments has not yet been announced.