Is Finance ready for intergenerational transfers?

A fundamental principle in tax policy is neutrality. Taxation should seek to be neutral, not influence activities or decisions. However, governments have a tendency to utilize tax legislation to incentivize or discourage taxpayer behaviours.

Private company owners have the ability to monetize the value of their company using capital gains rates instead of dividend rates. They can do this by selling shares of their company to a successor instead of extracting the company’s value via dividends. With a current average spread among provinces of 19 per cent in favour of capital gains, there can be a significant benefit to capital gains treatment on the sale of shares. If you also factor in the ability of a private company owner to access the lifetime capital gains exemption (LCGE), the spread between capital gains and dividends significantly widens.

Private company owners accessing this tax rate spread or extracting corporate funds on a tax-free basis using the LCGE are a big concern for the Department of Finance. There is currently a long-standing anti-avoidance rule in the Income Tax Act (ITA) that prevents individuals from extracting surplus funds from a corporation tax-free by recharacterizing certain proceeds of disposition received on the sale of shares into a dividend. This anti-avoidance provision is currently applied when the individual selling the shares is not dealing at arm’s length with the corporation acquiring the shares. Since immediate family members are deemed not dealing at arm’s length, intergenerational family succession plans of privately owned companies are put at a disadvantage. The tax results would be significantly better if a father and mother sold their company to a complete stranger than their own son or daughter. This suggests the ITA lacks neutrality when considering the succession of a private company.

In the July 2017 proposal “Tax Planning Using Private Corporations,” the Department of Finance appeared to be more concerned about the inappropriate access to this tax rate spread than legitimate private company succession plans. As a result, the July 2017 proposal enhanced the anti-avoidance provision to ensure no illegitimate access to this rate spread and possible tax-free extraction of corporate funds. This legislation was poorly drafted and resulted in a significant tax burden for certain legitimate situations. Due to an outcry from the public, the Department of Finance decided against this proposed enhancement of the anti-avoidance provision. In a news release from Oct. 29, 2017, Minister Morneau announced the government would not be moving forward with measures relating to the conversion of income into capital gains. In that same announcement, he stated the following:

“During the consultation period, the government heard from business owners, including many farmers and fishers that the measures could result in several unintended consequences, such as in respect of taxation upon death and potential challenges with intergenerational transfers of businesses. The government will work with family businesses, including farming and fishing businesses, to make it more efficient, or less difficult, to hand down their businesses to the next generation.”

Since this announcement, the Department of Finance has kept its promise and engaged in consultations with stakeholders. In 2018 alone, consultation sessions were held in Halifax, Montreal, Regina and Guelph. In the 2019 federal budget, the government reiterated its committed to continuing its outreach to farmers, fishers and other business owners throughout 2019 to develop new proposals to better accommodate intergenerational transfers of businesses while protecting the integrity and fairness of the tax system.

Interestingly, in the 2019 Liberal election platform “Forward – A real plan for the middle class,” the promise to consult with farmers, fishers and other business owners was truncated to “we will also continue to work with farmers on tax measures to facilitate the intergenerational transfer of farms, making it easier for farmers to transfer or sell family farms to family members or others.¹

As of today, we still don’t have any revisions to the anti-avoidance provision that currently results in a tax disadvantage for selling a privately owned company to the next generation. With the 2020 federal budget fast approaching, it could be possible that the government will introduce a rules-based approach that allows true intergenerational transfers. This approach could be similar to Quebec or the United States, or it could be something completely different. In any case, it will be interesting to see if the exclusion of fishers and other businesses from the wording in the 2019 Liberal election document was accidental or not.

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