What is Bill C-208 and what does it attempt to accomplish?
On June 29th, 2021, Bill C-208 ("C-208") received royal assent and amended section 84.1 and section 55 of the Income Tax Act ("ITA"). The objective of C-208 was, ostensibly, to facilitate fairness in our taxation system – previously, certain intergenerational transfers of small businesses would result in the loss of the transferor's ability to claim the Lifetime Capital Gains Exemption ("LCGE"). The objective of C-208 is to facilitate bona fide intergenerational transfers of a business while preventing tax avoidance that undermines the equity of our tax system.1 As a result of C-208, several anti-avoidance rules in the ITA were modified to provide specific exceptions that will facilitate the transfer of property between family members, to allow the transferor to claim the same benefits, or close to, that they would receive in an arm's-length sale.
Section 55 is a specific anti-avoidance rule that is meant to prevent capital gains stripping and has the effect of applying to intergenerational transfers. Amended section 55(2) allows for siblings to convert taxable capital gains into a tax-free intercorporate dividend.2 Section 84.1 is another anti-avoidance rule designed to prevent converting corporate surplus, which would otherwise be a taxable dividend, into a tax-free return of capital by using non-arm's length transactions. Now, section 84.1 provides tax relief to those who wish to transfer (sell) shares of their farm, fishing or small family business to their adult children or grandchildren and be treated equally to those who were passing on their businesses to an unrelated (arm's length) corporation.3 This means that parents or grandparents selling shares to a non-arm's length (related) corporation say a corporation owned by a child or grandchild, can now access the LCGE to reduce or eliminate the income tax on the resulting disposition so long as they meet certain specifically enumerated criteria.4
Concerns surrounding Bill C-208
Although C-208 is officially law, the government expressed its intentions on making changes to it due to the pitfalls and gaps surrounding it. In a press release on July 20th, 2021, the Department of Finance addressed its intention to bring forward amendments to C-208 that will clarify its vagueness and safeguard against tax avoidance loopholes, such as surplus stripping.
As an aside, to put it simply, surplus stripping is when retained earnings, which are normally treated as dividends under the Act are converted to capital gains by way of "incestuous" sale between related parties to take advantage of the lower tax rate without any genuine transfer of the business actually taking place. For example, a shareholder seeking to "surplus strip" may incorporate a new holding company and sell their shares of an operating company to realize a capital gain on the sale of shares, but remain the ultimate owner of the same. This allows the shareholder to extract corporate surplus by way of capital gain and results in significant tax savings. Such behaviour is the purpose of many of the anti-avoidance rules in the Act, including section 84.1.
With respect to the Department of Finance's concerns about the vagueness of the language in, C-208, after years of languishing in committees and at various points in the legislative process, it was ultimately passed into law without an "application date", presumably to prevent its application from the date of passing. However, according to section 5(2) and section 6(2) of the Interpretation Act, a statute or amendment that receives royal assent and does not have an application date is effectively the law and enforceable on an immediate basis. From a technical legal perspective, this means that C-208, including the "vague" language contained therein, is the law. This is a unique circumstance in that the Department of Finance has announced plans to amend the rules, but for now, the law remains as drafted. This type of grey area can lead to aggressive tax plans that could perhaps in some circumstances be "nullified" if the Department of Finance and Parliament choose to enact retroactive changes to C-208 and the ITA. Caution is thus advised for anyone considering utilizing the new rules in a "creative" manner without regard for the CRA's stated position that there is a "scheme" against surplus stripping inherent in the ITA. The Court to this point has explicitly repudiated CRA's statement, so some creative planning opportunities may in fact exist.
Upcoming amendments to Bill C-208
Evidently, the law hopes to achieve fairness for "genuine" intergenerational transfers, yet it lacks a genuineness test. Questions pertaining to legal control, factual control and duration of control over the company remain unanswered. The Department of Finance attempted to confront the abovementioned concerns in a press release by indicating that amendments would address the following issues:5
- The requirement to transfer legal and factual control of the corporation carrying on the business from the parent to their child or grandchild
- The level of ownership in the corporation carrying on the business that the parent can maintain for a reasonable time after the transfer
- The requirements and timeline for the parent to transition their involvement in the business to the next generation
- The level of involvement of the child or grandchild in the business after the transfer
The amendments should apply after Nov. 1, 2021, or "the date of publication of the final draft".6 Yet, to the date of this newsletter, the legislation has not been amended to reflect "genuine intergenerational transfers".
Overall, C-208 presents a valuable new opportunity for family businesses and is an improvement to the harsh treatment that small business owners were subject to when choosing to pass a business on to their children. There are now many tax planning opportunities for those businesses, farms or fishery owners that were historically unavailable. With the current state of the law, creative accounting mechanisms are available to gain a tax advantage through carefully planned sales. These opportunities are counterbalanced by the precariousness of C-208's future amendments and undoubtedly come with uncertainties. If you are interested in determining if you can take advantage of the new changes, proper legal advice is paramount before implementing any changes.
*This blog was co-authored by Katherine Berze*
1 "Government of Canada clarifies taxation for intergenerational transfers of small business shares" (July 19 2021), online: The Department of Finance (https://www.canada.ca/en/department-finance/news/2021/07/government-of-canada-clarifies-taxation-for-intergenerational-transfers-of-small-business-shares.html)
2 Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), s. 55
3 The Department of Finance, supra note 1.
4 Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), s. 84.1(2)
5 The Department of Finance, supra note 1.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.