BILL C-208 – Intergenerational Transfers of Small Businesses – Lifetime Capital Gains Exemptions

The Trudeau Government’s July 2017 Private Corporation Tax Proposal had three purposes:

1. Limit income splitting among family members – Result: 2018 – TOSI (Tax on Split Income);
2. Restricting corporate income tax deferral – Result:  2018 – Corporate Passive Income taxation; and
3. Mitigate the unfavorable tax treatment for intergenerational transfers of small businesses and eliminating surplus stripping – Result: 2021 – 29 June – Bill C-208

No changes were made to mitigate the unfavorable tax treatment for intergenerational transfers of small businesses or eliminate Surplus stripping until the enactment of Bill C-208 on 29 June 2021.

Prior to Bill C-208, Canadians who sold their business shares to family members rather than an unrelated third party, faced a heavy tax burden. To mitigate this issue, four years after announcing that they would fix the problem, the government enacted Bill C-208. It was intended to address the unfairness of the current rules and eliminate surplus stripping.

Unfortunately, Bill C-208 was poorly drafted, creating a supersized opportunity for surplus stripping, exactly what the Liberals wanted to eliminate in their 2017 Private Corporation Tax Proposal.

According to the rules prior to Bill C-208, individuals who sold QSB (Qualified Small Business) shares to a family member typically did so at dividend tax rates (Ontario – 48%, BC – 49%) versus selling to an unrelated party. When selling to an unrelated party, the Sellor would benefit from the capital gains treatment and could access his/her Lifetime Capital Gains Exemption (LGCE), (2021 – $892,218), the balance taxed at capital gain rates (Ontario – 27%, BC – 27%). To put numbers to this, an individual with a capital gain valued at $1M, wanting to transition the business to his/her child or grandchild, would be faced with a $480,000 tax bill (Ontario). If, on the other hand, the individual sold to an unrelated party, he/she would benefit from the capital gains treatment and have access to their LCGE ($892,218 of the gain tax free), the balance taxed at Capital Gain rates (27% in Ontario) resulting in approximately $30,000 tax bill. The result is a $450,000 tax cost for a business to transfer to the next generation rather than selling to an unrelated party.

Under the newly enacted Bill C-208, an individual who sells QSB shares to a corporation controlled by children or grandchildren who are at least 18 years of age will benefit from the capital gains treatment and be eligible for the LGCE (2021 – $892,218) resulting in the same taxes payable of $30,000. This eliminates the disparity that previously existed.

Bill C-208 does stipulate that:

1. the purchaser must be 18 years or older; and
2. the purchaser corporation (held by a child or grandchildren) would have to own the shares of the corporation for a minimum of 60 months subsequent to the transaction.

It all sounds great for individuals that are looking to transition their business to their children or grandchildren, however, this legislation appears to allow a much broader range of transfers that avoid this adverse tax treatment. More specifically Bill C-208 opened the flood gates to surplus stripping.

Under Bill C-208, a business owner can strip out his/her available lifetime capital gains exemption (a maximum of $892,218 in 2021) without paying any tax and continue to own and operate his/her business.

In addition to missing the mark on surplus stripping, the legislation does not interact well with several sections of the Income Tax Act, raising questions and uncertainties regarding how the new rules are to be applied. It therefore seemed inevitable that the Department of Finance would have to respond to these concerns. They issued a press release on 30 June 2021 (the day after Bill C-208 was enacted), announcing that they intend to repeal Bill C-208 stating that in effect, Bill C-208 was not law.

Amid a flurry of criticism, on 19 July 2021, in a sudden reversal of opinion, Minister Freeland announced that the government will not, after all, refuse to enforce Bill C-208. She did however reiterate that amendments to the Bill are forthcoming.

It is, however, unclear how quickly any proposed amendments will be released by the government. The target date is 1 November 2021.  Minister Freeland did not discuss retroactive application of the amendments, however, Liberal MP Rachel Bendayan, parliamentary secretary to the Minister of Small Business, said she “unequivocally” confirmed on behalf of the government that any amendments to C-208 will not be retroactive. Can we rely on her statement? No retroactive treatment?

The government has thrown out “anti-avoidance” legislation application in relation to Bill C-208, so, taxpayers should be cautious when considering the use of Bill C-208 to engage in surplus stripping.  They may find their transactions challenged by the Canada Revenue Agency under this legislation — even before the government introduces legislative amendments to the Bill. The Department of Finance has made it quite clear that they have a problem with Bill C-208, pointing out the issues they have with it and suggesting that the Bill as it reads today could provide opportunities for tax avoidance.  Minister Freeland commented that transactions that are not in the spirit of the intended legislation could therefore be challenged under anti-avoidance legislation.

Accordingly, taxpayers should be cautious in taking immediate action in reliance on the rules in Bill C-208.

Is there a better way? Stay tuned for my next blog