Imagine yourself as an owner of Stephanie’s Electric, a company specializing in electrician services. Stephanie’s Electric started off small but is now an established company in the community. From the beginning, you taught your children the ways of Stephanie’s Electric, and they have managed to become really good at it. You’re now ready for retirement and to pass the business along to them. However, you weigh your options and realize you will pay less taxes if you sell it to a third-party buyer than to your children’s corporation. You will be taxed on the transfer to your children’s corporation, but you’re exempt from tax if you sell it to a third party. What do you do?  

This has been a common issue many family business owners have faced in the past few years. The tax system rewards you if you sell to a third party but penalizes you if you sell to a corporation owned by one of your children. That’s what gave rise to Bill C-208.  

What is Bill C-208? 

Bill C-208 received royal assent on June 29, 2021, and is now enacted. Before understanding Bill C-208, there are three tax concepts we like to highlight:  

1. Lifetime Capital Gains Exemption – The lifetime capital gains exemption (LCGE) exempts Canadians from paying tax on up to $892,218¹ of capital gains when they sell their small business corporation shares.  

2. Dividends vs. capital gains – In Canada, capital gains are taxed at a lower rate than dividends.  

3. Surplus Stripping – A tax maneuver for individuals to convert payments from the corporation –normally taxed as dividends – into capital gains. As a result of being structured as capital gains, it would be taxed more favourably and qualify for the LCGE. 

Section 84.1  

Bill C-208 proposes several amendments. It amends section 84.1, which, among other things, targets parents selling their shares to their children’s corporations. Before Bill C-208, section 84.1 made it more beneficial for parents to sell a corporation to a third party than their children. This was because (under the old section 84.1) if they sold their shares to a corporation owned by their children, the capital gain would be recategorized as a dividend. Meaning, it will not qualify for the LCGE and be taxed at the higher dividend rates.  

Legislation passed under Bill C-208 would allow parents to sell the shares of their corporation to a corporation owned by their children while getting capital gains treatment and qualify for the LCGE. 

It also proposes additional requirements, including: 

1. The new purchaser corporation must be controlled by one or more children or grandchildren aged 18 or older. 

2. Subject to certain limitations, the purchaser corporation cannot dispose of the shares within 60 months after the purchase.  

3. The availability of the LCGE will be reduced if the taxable capital of the company being sold exceeds $10 million and will be eliminated at $15 million.  

4. An independent assessment of the fair market value must be provided to the CRA. 

5. An affidavit must be signed by the seller and purchases attesting to the disposal of the shares. 

Case Scenario: Homer’s Juice Bar

Homer started Homer’s Juice Bar, and the business has taken off.  Homer is now ready to retire and would like to transition the business and sell it to Lisa for $800,000. Suppose the dividend tax rate is 48%. 

Lisa is excited to take over the business but has concerns about paying her dad for the business. She doesn’t have a lot of money personally but would still like to take over the business. Homer insists on using the LCGE to shelter any tax he would owe on the sale.  

Before Bill C-208 

To simplify, Lisa would have to buy Homer’s Juice Bar. Lisa would need to borrow money or pay her dad for the business over time. She needs to use money from Homer’s Juice Bar to pay herself, pay tax on the amount she receives, and then use the remaining proceeds to pay off her dad or the loan. She would incur personal tax of $384,000 ($800,000 x 48%).  

After Bill C-208 

Lisa can now use a corporation to buy Homer’s Juice Bar while her dad would still qualify for the LCGE. She would not have to buy it personally. When she makes money from Homer’s juice bar, she can pay a tax-free intercorporate dividend to her purchaser corporation. The purchaser corporation can then use the money to pay Homer and Lisa without any personal tax. The Simpson family saves $384,000 in taxes that could be reinvested in the business.  

Should I Start Planning the Transfer of My Business?

Not so fast, because there is a lot of political controversy over this Bill.  

The Political Turmoil Behind Bill C-208 

This Bill didn’t follow the normal process of drafting a tax bill. Generally, the Tax Policy Branch of Canada’s Department of Finance is responsible for developing tax policy. They conduct research, analysis, and review case law to develop tax policy. The Department of Finance would then draft legislation in consultation with the Department of Justice and the CRA. The minister of finance would introduce it to Parliament with the help of the Department of Justice. Parliament studies the proposed legislation in their committees before passing it.  

Liberals Kill Bill C-208

Bill C-208 was a private member’s Bill meaning a member of Parliament drafted the Bill and introduced it to Parliament. The Department of Finance did not analyze the Bill. The majority of the Liberals voted against it (including Justin Trudeau and Chrystia Freeland). In contrast, the NDP and Conservatives unanimously voted to pass the Bill. As a result, the Bill passed.  

Normally, a bill comes into full force under Canadian law – the day it receives royal assent. However, the Department of Finance released a statement to delay the implementation of this Bill to January 1, 2022. However, the Liberal government has since been criticized for this announcement, given that the Bill received royal assent and should already be in force. The Department of Finance has retracted its statement as a result.

Liberals Bring Back Bill C-208 to Life (Temporarily) 

In response, the Liberals have announced that they intend to present amendments that ‘honour the spirit of Bill C-208’, closing any loopholes that it may have created. One of the reasons for these amendments is that the Bill is poorly written and can potentially be exploited, eroding the tax base. The Liberals have announced that their amendments will clarify various issues by ensuring legitimate transfers of control from parents to (grand)children under reasonable timelines and reasonable ownership limits maintained by the parents. The draft amendments will be introduced in a parliamentary bill sometime on or after November 1^st, 2021.  The government commented that this new Bill will only apply as of November 1, 2021, or when the legislation passes. This means there is still a tiny window where taxpayers can rely on Bill C-208 as it currently reads and take advantage of the looser rules.  

What Now?

In short, it is good that the government is looking at facilitating genuine intergenerational share transfers. We hope that the amendments are reasonable and do not prevent small business owners – the lifeblood of our economy – to legitimately and reasonably transition their businesses to their children, who are committed to carrying it on. Until November 1^st, 2021, small businesses may be able to transition their businesses without additional restrictions that the Department of Finance intends to introduce.