The 2023 Federal Budget announced a number of key tax measures for businesses in Canada, including changes to Bill C-208, new clean energy investment tax credits, and details on a previously announced 2% tax on repurchase of equity.
Genuine intergenerational share transfers and Bill C-208
In 2021, a change was made to the Income Tax Act (ITA) to allow certain intergenerational transfers of closely held small businesses, including farming and fishing businesses, to be made in a tax-efficient manner when shares were transferred to the children or grandchildren of the owners. These changes were initially introduced in Bill C-208 and are generally referred to as the Bill C-208 changes.
However, the initial legislation was the result of a rushed process, and taxpayers and their advisors were left with many questions about the application of the rules. One particular concern was that the enacted legislation allowed a transfer of a family corporation in a way that took advantage of the new rules but did not restrict the ownership of that business adequately after such a transfer and did not ensure that a genuine intergenerational transfer had occurred.
Following a consultation process announced in Budget 2022, the government has brought forward changes to correct some of the concerns with the content of Bill C-208. The following is a summary of the significant changes proposed in Budget 2023 that would come into effect for transfers that occur on or after January 1, 2024.
To ensure a bona fide transfer of the business occurs, new conditions regarding the control of the business are proposed and one of two tests must be met. There must be either:
- an immediate transfer of both voting and economic control with a full transition of all voting shares within 36 months of the initial transaction; or
- an immediate transfer of voting control with a full transition of all voting shares within 36 months, along with transfer of certain economic control criteria within 10 years of the initial transaction.
The proposed rules also expand the qualifying recipients of the business to include grandchildren, stepchildren, children-in-law, nieces, nephews, grandnieces, and grandnephews. However, the new rules also provide for a joint election between the transferor and the transferee, making the transferee jointly and severely liable for any taxes resulting from the transfer that do not meet the future conditions.
Finally, the new rules also propose to provide a 10-year capital gains reserve for all share transfers that meet the 10-year conditions. For more information on Bill C-208, see our Tax Alert, Bill C-208 - Tax changes for intergenerational transfers now law.
Employee Ownership Trusts
An Employee Ownership Trust (EOT) is a trust that holds shares of a corporation for the benefit of the corporation's employees. An EOT can be used to facilitate a purchase of a corporation by its employees, as an additional option for business owners when planning for succession. To facilitate the use of EOTs, this budget proposes to amend the Income Tax Act (ITA) to:
- Extend the five-year capital gains reserve to a 10-year reserve for “qualifying business transfers” to an EOT, thereby allowing for an extension of the period that an individual may defer recognition of a capital gain realized on the disposition of shares in a qualifying business transfer by an additional five years. A minimum of 10% of the gain would be required to be brought into income each year.
- Introduce an exception that will allow an EOT to repay amounts borrowed from a qualifying business from one year of the qualifying business' year-end to 15 years, where the amounts were loaned from a qualifying business to an EOT to purchase shares in a qualifying business transfer.
- Exempt EOTs from the requirement to dispose of its capital property after 21 years (i.e., 'the 21-year rule') that generally applies to certain trusts. Where the EOT ceases to meet the conditions to be considered an EOT, the 21-year rule will be reinstated until the trust next meets the conditions required to be an EOT.
These amendments will apply as of Jan. 1, 2024.
Clean energy incentives
As promised, and consistent with the Budget 2023 environmental focus, the government introduced three new refundable investment tax credits related to clean energy and expands on previously announced measures.