If you read agriculture news regularly, you probably saw the following at some point this week, “Farm groups welcome passage of bill to reduce the tax burden of selling a business to a family member” (RealAgriculture) and “MPs approve change to farm taxes” (Ontario Farmer). Both articles failed to report on Bill C-208 without some incomplete information. RealAgriculture has since updated their article for improved understanding which is good. They led the reader to believe that until now farm families (and small business owners) have been taxed unfairly when they want to transfer their farm or business to another immediate family member. This isn’t what the bill is about or even who is really impacted. So let’s find out what Bill C-208 is really about.
Bill C-208
This bill is a private member’s bill from MP Larry Maguire. It is approximately one page long, you can read it here. It seeks to change sections 55 and 84.1 of the Income Tax Act. The critical item missing in the media is that both sections target corporations only. The changes with this bill will only impact family business corporations (even Larry fails to mention that in his interview), not unincorporated family farms that already enjoy plenty of favourable tax deferrals for family transfers.
The Bill aims to provide exceptions to both Section 55 and 84.1 when dealing with shares that are qualified small business corporation shares or shares of the capital stock of a family farm or fishing corporation within the meaning of subsection 110.6(1) of the ITA. It proposes the following exceptions and changes:
Subparagraph 55(5)(e)(i), which currently deems siblings not related for purposes of section 55 will not apply; and
Paragraph 84.1(2)(e) will be added to deem the taxpayer and the purchaser corporation to be dealing at arm’s length in order to prevent the application of subsection 84.1(1). In order for paragraph 84.1(2)(e) to apply, the purchaser corporation must be controlled by one or more children or grandchildren of the taxpayer (who are 18 years of age or older) and the purchaser corporation cannot dispose of the subject shares within 60-months of their purchase.
It also contains an exception to the 60-month rule for paragraph 84.1(2)(e) in the event of a premature sale by reason of death, although the legislation does not define whose death would invoke this exception.
It reduces the lifetime capital gains exemption (“LCGE”) available for any taxpayer relying on paragraph 84.1(2)(e) if the taxable capital employed in Canada exceeds $10 million. Complete elimination of the LCGE occurs at $15 million of taxable capital.
These proposals also require a taxpayer to provide the CRA with an independent assessment of the subject shares' fair market value, and an affidavit signed by both the taxpayer and a third party attesting to the disposal of the shares.
This impacts more than just family farm corporations, it also impacts family businesses. Over 80% of the corporations in Canada are classified as family corporations. In contrast, roughly 22% of farm businesses are incorporated.
Not the first Bill
This is not the first time that there has been an attempt to change these sections. There were two attempts in 2015 which got lost due to the election that year. Another attempt was made in 2016 that the Liberals ultimately voted down because it does open a potential tax loophole. Bill C-208 has passed the third reading but it still has a ways to go.
Section 55 converts tax-free dividends issued from one corporation to another corporation that owns shares of the payor corporation into capital gains under specific scenarios which generally happen during a sale of shares. This turns a non-taxable dividend into taxable capital gains. Currently, it prevents the use of non-taxable intercompany dividends between siblings which Bill C-208 wants to change.
Section 84.1 applies when transferring shares to a holding company owned by a related party. It converts the proceeds of the sale into a dividend. This then disqualifies the business owner not only from the LCGE but also from the favourable tax treatment on capital gains. Dividend income doesn't qualify for the LCGE, and, unlike a capital gain, which is only half taxable, the deemed dividend is fully taxable.
Current impacts on succession planning
These sections complicate transactions where a business owner who wishes to retire from a wholly-owned small business corporation sells shares of the corporation to a corporation controlled by their children. Purchasing a business using a corporation is not uncommon because it is more tax-efficient for the purchaser and they can then borrow against the assets of the business to finance the purchase. Taxing the transfer as a dividend instead of capital gains currently costs more as it prevents using the LCGE and the lower tax rate on capital gains as a result of the 50% inclusion rate.
Section 84.1 has been around long enough though that there are other routes to making a family business transfer. The options include:
Some version a Section 85 rollover like an estate freeze or a holding company freeze. This involves issuing new shares to the next generation at a nominal amount while freezing the value of the company for the retiring shareholders. It does allow the retiring shareholder to use their LCGE.
A Section 86 internal freeze involves using preferred shares to freeze the value at the time of transfer. This option does not allow for the LCGE right away but there still favourable tax deferrals.
Setting up a family trust during an estate freeze to provide flexibility for distributions and LCGE utilization.
Overall, it’s not currently a black-and-white situation, it just involves a lot of planning. Adjusting section 84.1 would make certain situations a lot more straightforward.
Great for all Family Business Corporations
While Bill C-208 has the potential for good, it has not passed yet. Given that there are a lot more family business corporations than farm corporations, the real winners here would be qualifying small family business corporations. There are also pitfalls that might impact farms specifically:
If a farmer used their entire LCGE to incorporate their farm, they no longer have that benefit. As long as the current inclusion rate on capital gains remains at 50%, yes, there is an advantage compared to a dividend.
If the farm corporation has taxable capital of over $10 million, the capital gains exemption would be reduced or even right out eliminated. In a capital-intensive sector like agriculture, this is possible. Taxable capital consists of retained earnings, contributed surplus and all loans and advances to the corporation.
I hope this clears up those headlines. Farm families were never disadvantaged on a generational transfer unless they were incorporated and even then, there were ways to deal with it. And if farmers are going to care about tax changes currently in Parliament, I’d be a lot more concerned about the proposed changes to limit interest expense deductions.