Tax rules changing for transfers of family businesses, farms

The federal government is moving to change the tax rules that govern the transfer of a small business or farm from parents to other members of the family.

Critics say they worry the new rules could be too restrictive

A tractor in a field.
Transferring the family farm or business is about to get a bit more complicated under new rules proposed in Tuesday's budget. (Charlotte Wasylik)

The federal government is moving to change the tax rules that govern the transfer of a small business or farm from parents to other members of the family.

The move — which observers say could affect tens of thousands of family businesses across Canada — is also meant to close a loophole created by Parliament in 2021 when it adopted legislation intended to facilitate intergenerational transfers.

The proposed changes to the way family businesses are taxed when they are transferred from one generation to another is the latest twist in a tale that has spanned years and crossed party lines.

For many years, there were complaints that tax rules made it more advantageous to transfer a farm, fishing business or small business to a stranger than to a member of one's own family.

Under previous rules, any difference between the original price and the sale price was considered a dividend. If, however, it was sold to a non-family member, the difference was considered a capital gain – which was taxed at a lower rate and eligible for the lifetime capital gains exemption. That made it more financially advantageous to sell a family business to a stranger.

Conservative MP Larry Maguire proposed Bill C-208, which was adopted in June 2021. The bill, like previous bills proposed by the Liberals and the NDP, was designed to address that discrepancy.

A loophole in the law

The legislation was adopted despite a warning from Department of Finance officials that the way it was drafted risked creating a loophole that could be exploited by tax planners to allow some people to avoid taxes.

In a document accompanying Tuesday's budget, the department said the legislation adopted by Parliament did not require that the parent no longer control the business of the corporation, did not require the child to have any involvement in the business, and did not require that the child retain an interest in the business after the transfer.

That meant a parent who wanted to reduce their tax bill could transfer a business to a child but still run the business — the child didn't have to even set foot on the premises.

Under the proposed changes, outlined in the tax measures guide that accompanied the budget, the corporation buying the business will have to be controlled by an adult family member of the seller if the seller wants to claim the transfer as a capital gain for tax purposes.

The government's definition of "adult child" includes grandchildren, step-children, children-in-aw, nieces, nephews, grandnieces and grandnephews.

The changes also provide for two different timelines to transfer a business. One option would provide for a more immediate transfer to take place within three years. The second option would see the transfer take place over five to 10 years.

"The immediate transfer rule would provide finality earlier in the process, though with more stringent conditions," the Department of Finance wrote in a document accompanying the budget.

"In recognition of the fact that not all business transfers are immediate, the gradual transfer rule would provide additional flexibility for those who choose that approach."

A picture of Dan Kelly.
Dan Kelly, president of the CFIB, is worried the proposed changes could be too restrictive. (Sue Goodspeed/CBC News)

Dan Kelly, president of the Canadian Federation of Independent Business, said the changes could affect tens of thousands of family businesses across the country. He said he fears the new rules could be too restrictive and make it harder for families to transfer a business between generations.

"I am worried that they are tightening the system too much, potentially preventing some legit business transfers from happening," Kelly said. "We need these kinds of rules in place because 70 per cent of small business owners tell us that they are planning to exit their business over the next decade.

"So, we need to make sure that this handled as smoothly and cleanly as possible and if Ottawa gums up the system too much, it could make it worse."

MP Maguire said the Liberal government tried to derail his private member's bill in 2021 and didn't consult him about the proposed changes contained in the budget.

A photo of Conservative MP Larry Maguire.
Conservative MP Larry Maguire, who introduced Bill C-208, says the Liberal government didn't consult him about proposed changes to the tax rules governing the transfer of family businesses from one generation to the next. (Trevor Hagan/Canadian Press)

"I will be reaching out to the stakeholders who appeared at the finance committee and other tax experts to get a better understanding of what the proposed amendments will do when families are trying to transfer their qualifying small business or farm to the next generation," Maguire said in a media statement to CBC News.

"It is imperative that the spirit of the bill is upheld and that families who want to transfer to the next generation can do so without facing unfair tax treatment."

Under the government's plan, outlined Tuesday, families who want to transfer a business swiftly would have to immediately and permanently surrender both legal and effective control by transferring a majority of voting shares right away and the balance of voting shares within 36 months.

Parents would have to transfer management of the business to their child within 36 months, the child or children would have to retain legal control for 36 months after the shares are transferred and at least one child has to remain actively involved in the business during that time period.

In the case of more gradual transfers, parents have to immediately transfer legal control and a majority of voting shares, but they don't have to transfer effective control and have 36 months to transfer the balance of the voting shares.

Over the 10 years after the initial sale, parents are supposed to reduce the economic value of their debt and equity interest in the business to 50 per cent in the case of farm or fishing corporations and to 30 percent of the value of their interest in a small business corporation.

Parents would have to transfer management of the business within 36 months. Children would have to retain legal control and at least one child has to remain actively involved in the business for 60 months or until the transfer is completed, whichever is greater.

The parents and the children have to agree on whether the transfer is to be immediate or gradual.

The proposed changes also provide for a 10-year capital gains reserve for genuine intergenerational transfers that meet the conditions laid out by the government.

The measure is to apply to transactions starting on Jan. 1, 2024. It is expected to increase federal government revenue by nearly a billion dollars over the coming five years by reducing the number of people who can take advantage of the intergenerational transfer provisions.

'I worry about their practicality'

While Department of Finance officials could not say how many families they estimate could be affected by the move, it is expected to have less of an impact in Quebec, where the province already has adopted rules regarding intergenerational transfers.

Kelly said he was glad the Department of Finance didn't opt to make the changes retroactive. He said some accountants have advised clients not to take advantage of the changes in C-208 for fear that Ottawa would make retroactive amendments to the law and they would be hit with a tax bill.

At the same time, Kelly acknowledged that those who want to take advantage of the loophole simply to lower taxes without actually transferring control of a business to members of their family could race to take advantage of it.

Kelly said his group will consult its members and analyze the proposed changes.

"I worry about their practicality. There are all sorts of things that can happen in the middle of a business transition that may mean that they have to change gears," said Kelly, pointing out that a parent could have a heart attack in the middle of a transition or a child's life could change.

"We need to make sure that whatever rules they put in place are flexible."

Kelly said the taxes should be the same, regardless of whether someone sells their business to a family member or a stranger.

Elizabeth Thompson can be reached at elizabeth.thompson@cbc.ca


Elizabeth Thompson

Senior reporter

Award-winning reporter Elizabeth Thompson covers Parliament Hill. A veteran of the Montreal Gazette, Sun Media and iPolitics, she currently works with the CBC's Ottawa bureau, specializing in investigative reporting and data journalism. She can be reached at: elizabeth.thompson@cbc.ca.