Surplus Stripping on Intergenerational Transfers of Small Business Shares
Bill C-208 received Royal Assent on June 29, 2021 and as a result amended the Income Tax Act (Canada) (“Act”). If certain conditions are met, its provisions now allow for the extraction of corporate surplus on the intergenerational transfers of small business. These enacted amendments to the Act prevent the application of the surplus stripping rules already contained in section 84.1 of the Act, which would have otherwise recharacterized capital gains, including capital gains that qualify for the lifetime capital gains exemption, as taxable dividends.
In very simplified terms under the new provisions enacted by Bill C-208, if the seller disposes of all of his or her shares of the operating company (“subject shares”) to a corporation owned and controlled by his/her child/children and or grandchild/grandchildren, and has no further involvement with the operating company after the transfer, he or she should be able to use these new provisions in the Act to achieve his or her objectives. This would allow an entrepreneur to transfer his/her shares of a small business company to his/her children and grandchildren, claim the lifetime capital gains exemption, and extract corporate surplus by way of non-share consideration (such as a promissory note).
On July 19, 2021, the federal Department of Finance issued a press release stating that the government intends to introduce new proposals to clarify the application of the provisions of C-208. These proposals are intended to make sure that it facilitates "genuine intergenerational transfers and is not used for artificial tax planning purposes.” What would constitute a genuine transfer, and how it would be differentiated from artificial tax planning, is not known.
The federal government has stated that the proposed amendments to the provisions of C-208 would take effect the later of: November 1, 2021; or the date of publication of the final draft legislation. The outcome of the federal election should not be used as an opportunity to delay considering the implications, and possibly opportunities, under currently enacted provisions of C-208. It would be prudent to assume that Finance will propose amendments, which may reduce the attractiveness of the current provisions of C-208, for the government to consider regardless of which political party wins the 2021 federal election.
The potential savings for an individual Ontario resident from the 2021 lifetime capital gains exemption NOT being re-characterized as an other than eligible dividend would be $425,945 (= $892,218 LCGE limit for 2021 x 47.74% top marginal tax rate for other than eligible dividends).
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AUTHOR:
Santosh Prasad, CPA, CA
Senior Manager, International Expansion | Private Client Corporate Services
