Recent Development in Succession Planning for Business Owners

Business owner clients who may be contemplating retirement frequently request our assistance in order to effectively structure and implement the transition of an incorporated business to a member of the family (such as an adult son’s or adult daughter’s corporation). Thankfully, a recent amendment to the Income Tax Act (the “ITA”) has facilitated a succession planning strategy which could make inter-generational business succession more favourable from a tax perspective than was formerly the case – since previously the “surplus stripping” provision in section 84.1 of the ITA could well have applied to treat any gain on such a non-arm’s length transfer of shares as a taxable dividend (taxed at up to 47.74 percent effective rate), rather than as a capital gain (taxed at lower effective rate of up to 26.76 percent).

Prior to this recent amendment (emanating from Bill C-208) to the ITA being enacted, section 84.1 of the ITA could have applied if a business owner sold his or her shares of a privately-held business corporation to a family member’s privately-held corporation for proceeds which included non-share consideration (such as a promissory note or cash) of an amount greater than the adjusted cost base (ACB) (i.e. the tax cost) of his or her transferred shares – resulting in both significantly greater tax payable (compared to a sale of such shares to an arm’s length purchaser) by the business owner and not enabling access to the capital gains exemption in section 110.6 of the ITA (of up to a maximum amount of $913,360 in 2022).

Following the enactment of this recent amendment to section 84.1 of the ITA, where a business owner sells shares of a privately-held business corporation (which shares constitute “qualifying small business corporation shares” within the meaning of the ITA) to a non-arm’s length private corporation (such as a corporation owned by an adult son or adult daughter) and the following conditions are satisfied, the purchaser corporation will be deemed to deal at arm’s length with the business owner – such that any gain on such a transfer of shares would be treated as a capital gain and access to the capital gains exemption would be allowed:

1. at time of the transfer, the business owner’s private corporation shares constitute “qualifying small business corporation shares”, and 
2. the purchaser corporation is controlled by one or more children or grandchildren of the business owner, and
3. the children or grandchildren of the business owner are at least 18 years of age, and
4. the purchaser corporation does not dispose of the transferred shares within 60 months of the transfer from the business owner, and
5. the business owner provides the CRA with an independent assessment of the fair market value (FMV) of the transferred shares, as well as with a signed affidavit of the business owner and a third party attesting to the transfer of the transferred shares.

As a result, the enactment of this recent amendment to section 84.1 of the ITA has, provided that the required conditions described above are satisfied, effectively “levelled the playing field” between arm’s length purchasers and non-arm’s length purchasers (who are children or grandchildren of the business owner) – and consequently enabled an inter-generational business succession strategy to facilitate such privately-held incorporated businesses to remain as family businesses.

The foregoing should not be considered to be legal advice and should not be relied upon as such. Please consult a lawyer to get advice and an opinion on your unique circumstances.