Bill C-208 was created to alleviate the financial disadvantage that typically arose for taxpayers who sold their business or family farm corporation to their children or grandchildren, as compared to selling to an arm’s length third party. This disadvantage was caused by certain tax rules. Specifically an anti-avoidance rule in section 84.1 of the Income Tax Act.
The disadvantage before the bill was passed
Before this bill was passed, the sale of qualified small business corporation shares or family farm corporation shares by an individual was generally eligible for the lifetime capital gains exemption. Currently the capital gains exemption for small business is $971,190 and $1 million for family farms. However, the anti-avoidance rules contained in section 84.1 prevented an individual from claiming their LCGE when they sold their corporation to a corporation controlled by family members. This increased the after-tax cost to family members of funding the acquisition of the shares when the individual claimed the LCGE, as the shares had to be purchased personally by family members.
For example, you have a corporation that is worth $1,000,000. And the adjusted cost base is $0. A third party comes along and pays $1,000,000 for your corporate shares. This would give you a capital gain of $1,000,000. Your capital gains exemption of $1,000,000 would bring your taxable income down to $0. Now if we trade out this third party for your child’s corporation, the $1,000,000 payment from your child’s corporation for your corporate shares would be deemed a dividend instead of a capital gain. Resulting in taxes owning of about $460,000.
Bill C-208, levels the playing. This bill allows parents to use their capital gains exemption on the sale of their corporate shares to their children’s corporation, essentially treating the transaction the same as if it were a third-party transaction.
That’s Bill C-208 in its purest form. Next week we will review how you can take advantage of this bill by going over a strategy that allows you to use your capital gains exemption while you are alive and withdraw money from your corporation tax preferred.