A majority of the House of Commons has voted on third reading in favour of private member's Bill C-208, An Act to amend the Income Tax Act (transfer of small business or family farm or fishing corporation), which aims to amend section 84.1 of the Income Tax Act (Act). Currently and in very general terms, when an individual sells shares of a corporation to a corporation controlled by a family member, section 84.1 of the Act may result in the proceeds from the sale being treated as a dividend, whereas such proceeds would receive more favourable capital gains treatment had the taxpayer sold these shares to an arm's-length party. If adopted, Bill C-208, which passed third reading on May 12, 2021, would limit the application of section 84.1 of the Act in cases of intergenerational transfers of a business. The Senate must now vote in favour of Bill C-208 for it to become law.
Section 84.1 of the Act is a specific anti-avoidance rule denying capital gains treatment on a wide range of transfers of shares of a corporation by an individual (the Taxpayer) to another corporation with which he or she does not deal at arm's length (the Purchaser Corporation). The purpose of the rule is to prevent "earning stripping" transactions taking advantage of lower capital gains tax rates. Where the rule applies, the individual is denied capital gains treatment and instead a deemed dividend is triggered, taxable at a higher rate. Importantly, the individual sellers cannot claim their lifetime capital gains exemption where they are disposing of shares of a qualified small business corporation, a family farm or fishing corporation. This means that individuals transferring their business to a corporation controlled by their children are taxed at a higher rate than those who sell their business to an arm's-length third-party. As currently drafted, section 84.1 of the Act thus has the effect of penalizing intergenerational business transfers as compared with arm's-length sales.
Bill C-208, if adopted, would carve out intergenerational transfers from the scope of section 84.1 by deeming the Taxpayer to operate at arm's length with the Purchaser Corporation when the corporation is controlled by one or more children or grandchildren of the Taxpayer who are 18 years of age or older, provided that the Purchaser Corporation does not dispose of the subject shares within 60 months of their purchase.
Though Bill C-208 was sponsored by Conservative MP Larry McGuire, all parties have long supported amending section 84.1 to limit its effects on intergenerational business transfers. In fact, similar bills have been introduced in prior parliamentary sessions by Liberal MP Emanuel Dubourg, NDP MP Guy Carron and Bloc Québecois MP Xavier Barsalou-Duval. On third reading, Bill C-208 received unanimous support from all parties except the Liberal Party (although as it was a free vote, certain Liberal members voted for the Bill), citing alleged concerns with the lack of adequate safeguards to ensure that the carve-out is restricted to true intergenerational transfers.
It is highly unusual for a private member's bill addressing tax matters to pass. It remains to be seen whether the Senate will take up Bill C-208 before Parliament is dissolved. The Department of Finance has been studying the issue of intergenerational business transfers for some time. It also remains to be seen if the passage of Bill C-208 in the House will be a spur to Finance putting forward its own proposals to address the inappropriate application of earnings stripping rules in cases of true intergenerational transfers.
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