Although there have been special tax rules to allow tax-deferred intergenerational transfer of farm properties for some time, these rules do not fit all circumstances.
In June 2021, a significant change was made to the law, which allowed, among other things, the opportunity for owners of qualified small business corporations and family farm or fishing corporation shares to transition their businesses to their child(ren) in a bona fide succession plan and enjoy similar tax treatment as if they had sold the shares sold to an unrelated party.
The purchasing child(ren) could now use corporate dollars to finance a buyout of mom and dad, while allowing mom and dad to use their capital gains exemption or pay lower rates than what they would have paid in previous planning arrangements.
Department of Finance's concerns with Bill C-208
The 2021 changes, called Bill C-208 at the time, were made in an unusual way in that they came from a private member's bill. Because of this, the new law was not subject to the same vetting process that a law proposed by the Department of Finance would be. As a result, the Department of Finance had significant issues with the bill and issued a statement soon after Bill C-208 became law that they intended to propose legislation to change this new law.
Originally, the government indicated that those changes would be addressed in November 2021; no changes came, although a consultation period was announced with the 2022 Federal Budget. Finally, changes were announced in the 2023 Federal Budget.
Updates to the intergenerational transfer tax rules
In general, under the current Bill C-208 rules, parents could still control and manage the business(es) of the corporation after the share transaction, as there was no requirement that the voting shares of the corporation be transferred nor that the children be involved in the business in any form. As long as the purchaser corporation was controlled by the child(ren), the conditions relating to control would be met.
This potential for abuse has been removed under the proposed rules, as under the new rules, a child or group of children must control both the purchaser company and the farm operating company immediately after the sale, and the child or group of children that control must also be involved in the active business.
A summary of the proposed changes can be found in the BDO article, 2023 budget proposes changes to the tax rules for intergenerational transfers. In this article, we focus more on considerations where there are significant differences between the 2021 legislation, which will be the law until December 31, 2023, and the 2023 proposals, which are proposed to become law as of January 1, 2024.
Changes under the new proposals
In addition to the new rules regarding changes in share ownership outlined in the above- referenced article, there are a few other things to note about the new proposals:
- A joint election needs to be made by both parents and the purchasing children, to elect that the new rules will apply to the sale transaction. By making that election, the selling parents and the purchasing children would be jointly and severally liable for the tax bill if the conditions for a capital gain on sale are unmet.
- The reassessment period for the tax year in which the sale takes place will be extended by three years for an immediate transfer and 10 years for a gradual transfer, given the increased time frames of the transitions.
- They will allow for a ten-year capital gain reserve to be an option in these sales; currently, the only option would be a maximum 5-year reserve. The increase to the reserve time can reduce taxes payable and aid in cash flow planning from the resulting taxes payable.
- They will also allow the purchaser corporation to be amalgamated with the operating corporation immediately after the sale, as is typically done in arm's length transactions, to simplify the structure and reduce annual compliance fees.
As well as the above additions, some provisions were also removed from the current legislation. According to the supplementary budget information, the following conditions will be eliminated:
- The requirement for an independent assessment of the fair market value of the shares
- This is a welcome change due to the added cost of such assessments. However, a word of caution should be noted. Related parties are deemed to transact at fair market value under the ITA, and if the CRA successfully challenges the value of the shares, double taxation can result. A third- party assessment or formal valuation can provide protection against the CRA challenging the purchase price of the shares and is still highly recommended.
- The requirement for a signed affidavit by the taxpayer and a third party attesting to the disposal of the shares
- A reduction to the amount of capital gains exemption allowed to be claimed on the shares tied to the taxable capital of the associated group.
- Depending on the taxable capital of an associated group of corporations (taxable capital being the collective equity and debt) there is the intention under current legislation, that the amount of capital gains exemption that could be claimed would be reduced or eliminated when it exceeds ten million dollars.
In contrast to the above positive changes, there are concerns and questions that arise.
- One such concern is the requirement that immediately before the sale, the operating company being purchased must only be controlled by the taxpayer or the taxpayer and their spouse (i.e., mom and dad). For example, if a corporation is owned equally by two brothers (dad and uncle to the children who will control the purchaser company), it appears the updated provisions would not apply to the sale because mom and dad (or just mom, or just dad) did not control the company being sold immediately before the sale.
- In the event that no party controls the corporation, would none of the owners be eligible for the provisions?
- What about situations where control has already been transferred to the child, but the parents still retain shares in the corporation? Would these sales also be excluded because the parents do not control the corporation immediately before the transfer?
These results seem unfair, given the purpose of the legislation. Steps could be taken to ensure the sellers do have control before the disposition, but would these actions come under scrutiny from the CRA, as they will have only been completed to meet the control conditions of the legislation? These are the types of questions that will need to be considered more closely when draft legislation is available.
The changes occur for transactions dated January 1, 2024, and later. The new rules will be more fixed and less flexible than the original and will have trade-offs specific to each taxpayer's' situation. If farm business owners have doubts about falling into the new rules, they should consider undertaking a transaction in 2023 while the old rules are still in effect.
Your BDO advisor can help you understand if these rules could help you and provide tax savings.