The Department of Finance’s stance on the conversion of dividends into capital gains is well-known. On July 18, 2017, it released “Tax Planning Using Private Corporations,” which states:
Individual shareholders with higher incomes can obtain a significant tax benefit if they successfully convert corporate surplus that should be taxable as dividends, or salary, into lower-taxed capital gains (such conversions are commonly referred to as "surplus stripping").
Section 84.1 is an important anti-avoidance rule in the private company context, which is used to prevent the conversion of corporate surplus from dividends into tax-free capital gains, but it does not work as well to stop the conversion of dividends into taxable capital gains. Given the increasing spread between dividend tax rates and capital gains tax rates, tax planning around 84.1 – converting dividends into taxable capital gains – has become a lot more common. This is why the Department of Finance introduced changes to 84.1 and new section 246.1 on July 18, 2017: to prevent this type of corporate surplus strip tax planning.
What the Department of Finance did not anticipate was the huge outcry from the business and professional community. As a result of this reaction, Minister Morneau announced the government would no longer be moving forward with these measures on Oct. 19, 2017. However, the minister did leave the door open for further discussions related to intergenerational transfers of businesses, which is a form of corporate surplus stripping. The problem with section 84.1 is the rules do not distinguish between legitimate intergenerational transfers and abusive surplus strips. As a result, in some situations, it can be more tax-efficient to sell your corporate business to a stranger than to your own child.
In the 2017 budget and the Oct. 19, 2017 announcement, the Department of Finance expressed an intention to continue outreach to farmers, fishers and other business owners. Its intention is to develop proposals that would better accommodate intergenerational transfers of businesses, while protecting the fairness of the tax system.
As we approach the 2019 federal budget, we know the Department of Finance held sessions with members and stakeholders of the Canadian Federation of Agriculture to discuss issues around intergenerational transfers and section 84.1. Given the recent explosion of surplus stripping (converting dividends into taxable capital gains and rendering section 84.1 ineffective), there is a good chance the Department of Finance is currently cooking up a potentially satisfying revision to section 84.1, in an effort to address this problem.
In Budget 2019, I predict we will see a significant revision to 84.1, stopping abusive surplus stripping. However, this time hopefully the rules will be designed to allow legitimate intergenerational transfers – something we have wanted for a long time.
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