Many small businesses are family-owned and plan to pass on the business to the next generation. For many years, the sale of the company to family members had been taxed less favourably than a sale to non-family members. Under the old rules, if you sold the shares of your business to a corporation that was owned or controlled by someone related to you, the proceeds on those shares would very likely be treated as a deemed dividend, and not a capital gain, which would result in higher taxes. . Recent updates to the legislation have attempted to correct this inequality.

What Changed in Intergenerational Business Transfer (IBT) Rules?

Bill C-208, which was introduced in 2021, put most inter-generational transfers on par with sales to third parties. If a business was sold to a corporation that was controlled by the seller’s adult child or adult grandchild, and the transaction met certain criteria, then the sale was exempted from the anti-avoidance rules that had previously been causing the unfavourable tax treatment.

This legislation was welcome news for those wanting to pass the torch to the next generation, but critics were concerned that it could be used to extract retained earnings on a tax-free basis without actually transferring ownership of the company.

The latest changes in Bill C-59 address these concerns by introducing criteria to ensure that only legitimate business transfers benefit from the new rules. This bill applies to transfers on or after January 1, 2024.  

How do the Intergenerational Business Transfer rules work?

The government has laid down a detailed list of criteria that intergenerational business transfers have to meet to prove they are genuine. A genuine IBT could avail itself of the same tax treatment as selling a business to a third party. This means that a genuine IBT can report the gain on sale as capital gain and not as a deemed dividend.

The new IBT rules have two timeline options for the complete transfer of the business to the child.

• Immediate transfers: The parent has to give up control and complete the business transfer within 36 months.
• Gradual transfers: The parent gives up control and completes the business transfer over 5 to 10 years.

The Criterion Businesses Should Meet to Qualify for IBT

There are specific conditions the businesses have to meet before, during, and after the transfer.

Before the transfer of shares

• No duplicate planning test: The parent should not have previously sought the immediate/gradual IBT exception related to the transfer of shares of the particular Operating Company (OpCo). Even if they have, they may use the new rules for transferring the remaining shares after 2023, subject to certain conditions.
• AcquireCo test: One or more adult children (age 18 years and above) must control the AcquireCo. Children comprise the business owner’s child or grandchild, nieces and nephews, and grandnieces and grandnephews.

During the transfer of shares

• Share condition test: The OpCo, whose shares will be transferred, should be a qualified small business corporation (QSBC) or qualifying farm or fishing corporation (QFFC).
• Transfer of voting shares test: The parent must transfer the majority of voting shares and common growth shares.

After the transfer of shares – 6 tests

1. Transfer of remaining share ownership: Parents must transfer the remaining voting shares and common growth shares within 36 months of sale. After 36 months, they may only own non-voting preferred shares.
   
2. Transfer of control test:
   • Immediate transfer option: The parent has to give up legal and factual control such as economic or other influence. 
   • Gradual transfer option: Parents immediately and permanently transfer only legal control. They transfer economic control and other influence over a longer time period.
     
3. Transfer of management test: Parents must transfer business management within 36 months umder the immediate transfer option or 60 months under the the gradual transfer option.
4. Remaining economic interest limitation test: No economic interest will be remaining for immediate transfers as the transfer happens right away. For gradual transfers, parents should reduce debt and equity interests in OpCo and AcquireCo to 30% of their value for QSBC and 50% for QFFC within 10 years after the share transfer.
   
5. Retention of control test (intended to prevent the children from immediately selling to someone else):
   • Immediate: Children must retain legal control of the business for at least 36 months after the share transfer.
   • Gradual: Children must retain legal control of the business for 60 months or until the business transfer is complete, whichever is greater.
     
6. Active involvement test:
   • Immediate: At least one child must be actively involved in the business for 36 months after the share transfer.
   • Gradual: At least one child must be actively involved in the business for 60 months or until the business transfer is complete, whichever is greater.

Election needed

To utilize the IBT provisions, the parent and each adult child must jointly elect in the prescribed form on or before the parent’s tax filing deadline for the year of the transfer. This way, the CRA can monitor whether these transfers meet the conditions over the years. If they find any discrepancy, both parents and children will be jointly and severally liable for any additional taxes payable. 

Contact McCay Duff LLP in Ottawa to Help You with Intergenerational Business Transfer (IBT)

The new intergenerational transfer rules are very complicated. Not every family business transfer situation may qualify. Given the long period of the transfer, it needs to be meticulously planned to ensure compliance with all requirements. That calls for tax expertise.

At McCay Duff LLP, our accountants and tax consultants can provide services such as tax planning, regular monitoring of IBT transactions, and tax filings. To learn more about how McCay Duff LLP can provide you with the best accounting and tax expertise, contact us online, or by telephone at 613-236-2367, or toll-free at 1-800-267-6551.