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The latest federal budget outlined potential amendments to the tax rules that shape the way businesses are transferred from parents to children. The proposed changes are meant to ensure that an intergenerational transfer is genuine. Kim Parlee and Pierre Letourneau, Business Succession Advisor, TD Wealth, discuss what you should know about the proposed changes if you’re planning on passing your business down to family.
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The federal budget outlined potential changes to the tax rules that shape the way businesses are transferred from parents to children. So if you're a business owner and thinking about passing your business down to the family when you retire, you may want to have this on your radar.
Pierre Letourneau is a business succession advisor with TD Wealth. He joins me now to dig into the details. Thank goodness you're here to decipher some of these rules that came out. So, from what I understand, these are amendments to something that came out earlier, and it was a bill-- and you'll correct me here, C208, that was introduced in 2021. So maybe just give us a little background before we jump into actually what happened.
Sure. So Bill C208 was a private member's bill, actually, that was introduced, and it was meant to provide tax relief when a parent was transferring shares of a small business corporation to a child's corporation. So there's a few advantages to purchasing a corporation through a corporation. In the past, the rules were so that that type of transfer was treated as a dividend for the parent, instead of a capital gain. Normally, when you sell shares, you earn a capital gain on that sale.
Right. So it's taxed differently.
It's taxed differently, yeah. So a dividend is taxed at a higher effective tax rate, and, also, because it was a dividend, the lifetime capital gains exemption wasn't available on those types of transfers. So these new rules were introduced to sort of equalize the tax treatment when you sold your business to a corporation owned by your children, equalize that to the treatment that would occur if you sold to a third party.
Now, give us a little more detail on some of these perceived problems. I know there's something called "surplus stripping," which you can explain.
Right. So, with the first set of rules that were introduced and enacted, the government felt that they were a bit too broad, and provided opportunities to take money out of your business, what we call "surplus stripping," take the money out of the business and get capital gains treatment, instead of dividend treatment, when there wasn't a true transfer of the business. So that was the real issue with the initial form of the rules.
So they've made these changes now, and they talk about making sure that it is a genuine transfer. So they want to have that happen. So what are the conditions for this, and then what happens?
Right, so they amended the rules by adding these conditions that need to be met to get the proper treatment, the capital gains treatment. So they're looking for genuine transfers. So the rules state that the control of the business needs to be transferred to the child, any economic interest also needs to be transferred, management of the business needs to be transferred, and then there's some limitation in terms of what the child can do with the business. So the child needs to hold on to the business for a certain period at a time after the transfer. So they can't just flip it, and then, also, they need to remain involved in the business. So are some of the conditions that need to be met.
That's interesting. That's a lot, I mean, when you think about it, and the test for that--
It can be complicated, yeah. So there's a lot of new conditions, but genuine transfers should be able to meet those conditions.
Those conditions, and then, when that happens, then you get that new treatment, as capital gain versus dividend.
Exactly, and all the benefits that come with that.
And explain that a little bit, just so people, just, again, with a capital gain, you get what benefit, versus the dividend?
So you get a better tax treatment, just on the gain, and then, if the corporation qualifies as a small business corporation, you get the lifetime capital gains exemption, which is up to $970,000, roughly, per individual. So that could be a substantial tax savings on the transfer of the business.
Are you seeing a lot of families passing on the business right now? I mean, is this going to help that, I guess, because--
I think it may help that. That's one of the issues, is that I don't think there was as many as you'd think, because there was an incentive to actually sell to a third party. You know, there's other factors involved in that. But, certainly, that was a factor that you'd get a better tax treatment if you had a third party buy your business.
Yeah, you were disincentived to send it down to the family. I know they also came out with an introduction of something, the employee ownership trust, so if you want to actually, say, sell to your employees eventually, what is that?
So that's an arrangement that was promised in last year's budget, but they finally proposed some rules for this arrangement, and it's a trust that holds the shares of the private company for the benefit of the employees. So it's meant to facilitate the transfer to employees. There's a lot of roadblocks that present themselves as you try to transfer your business to the employees, financial roadblocks, also just practical roadblocks. So there are incentives attached with this arrangement that provide some financial relief for the employees to help them purchase the business, and also a bit of tax relief as well, too, for the business owner. So those incentives are meant to facilitate that transfer.
It's interesting, because there's a lot of, I guess, things here, which are very positive for business owners in terms of helping them, you know, either somehow crystallize some of that gain they've made with building their business over the years. With all of those things in mind, what are the things that a business owner needs to start thinking about? You don't sell your business in five minutes. Obviously, it takes time to get it ready and do everything, so how do you start that process?
Well, I think you need to have the right people around you that will provide you with the right advice, and I always say, it's never too early to start planning. Even if you're just starting a business, you know, doing some planning today could provide you flexibility down the road. So it's important to work with a trusted advisor, somebody that has experience with these types of situations and can help guide you through the process.
Give me a little window into that. So if I decide that I have a business, and I want to sell it, let's say, five years from now, when you say, do the planning today, what are the kinds of things that will get highlighted, maybe, in the planning that I may or may not have thought about?
Well, start thinking about who that potential successor may be, right? And once you've identified that, how should you structure your corporation to be able to make that transfer more efficient? If you haven't identified that successor, then maybe there's a specific, sort of, I guess, structure that you want to put in place to help with that process.
That's great, Pierre. Always great to have you on. Thanks so much.
Thanks for having me. [AUDIO LOGO]
[INSTRUMENTAL MUSIC PLAYING]
The federal budget outlined potential changes to the tax rules that shape the way businesses are transferred from parents to children. So if you're a business owner and thinking about passing your business down to the family when you retire, you may want to have this on your radar.
Pierre Letourneau is a business succession advisor with TD Wealth. He joins me now to dig into the details. Thank goodness you're here to decipher some of these rules that came out. So, from what I understand, these are amendments to something that came out earlier, and it was a bill-- and you'll correct me here, C208, that was introduced in 2021. So maybe just give us a little background before we jump into actually what happened.
Sure. So Bill C208 was a private member's bill, actually, that was introduced, and it was meant to provide tax relief when a parent was transferring shares of a small business corporation to a child's corporation. So there's a few advantages to purchasing a corporation through a corporation. In the past, the rules were so that that type of transfer was treated as a dividend for the parent, instead of a capital gain. Normally, when you sell shares, you earn a capital gain on that sale.
Right. So it's taxed differently.
It's taxed differently, yeah. So a dividend is taxed at a higher effective tax rate, and, also, because it was a dividend, the lifetime capital gains exemption wasn't available on those types of transfers. So these new rules were introduced to sort of equalize the tax treatment when you sold your business to a corporation owned by your children, equalize that to the treatment that would occur if you sold to a third party.
Now, give us a little more detail on some of these perceived problems. I know there's something called "surplus stripping," which you can explain.
Right. So, with the first set of rules that were introduced and enacted, the government felt that they were a bit too broad, and provided opportunities to take money out of your business, what we call "surplus stripping," take the money out of the business and get capital gains treatment, instead of dividend treatment, when there wasn't a true transfer of the business. So that was the real issue with the initial form of the rules.
So they've made these changes now, and they talk about making sure that it is a genuine transfer. So they want to have that happen. So what are the conditions for this, and then what happens?
Right, so they amended the rules by adding these conditions that need to be met to get the proper treatment, the capital gains treatment. So they're looking for genuine transfers. So the rules state that the control of the business needs to be transferred to the child, any economic interest also needs to be transferred, management of the business needs to be transferred, and then there's some limitation in terms of what the child can do with the business. So the child needs to hold on to the business for a certain period at a time after the transfer. So they can't just flip it, and then, also, they need to remain involved in the business. So are some of the conditions that need to be met.
That's interesting. That's a lot, I mean, when you think about it, and the test for that--
It can be complicated, yeah. So there's a lot of new conditions, but genuine transfers should be able to meet those conditions.
Those conditions, and then, when that happens, then you get that new treatment, as capital gain versus dividend.
Exactly, and all the benefits that come with that.
And explain that a little bit, just so people, just, again, with a capital gain, you get what benefit, versus the dividend?
So you get a better tax treatment, just on the gain, and then, if the corporation qualifies as a small business corporation, you get the lifetime capital gains exemption, which is up to $970,000, roughly, per individual. So that could be a substantial tax savings on the transfer of the business.
Are you seeing a lot of families passing on the business right now? I mean, is this going to help that, I guess, because--
I think it may help that. That's one of the issues, is that I don't think there was as many as you'd think, because there was an incentive to actually sell to a third party. You know, there's other factors involved in that. But, certainly, that was a factor that you'd get a better tax treatment if you had a third party buy your business.
Yeah, you were disincentived to send it down to the family. I know they also came out with an introduction of something, the employee ownership trust, so if you want to actually, say, sell to your employees eventually, what is that?
So that's an arrangement that was promised in last year's budget, but they finally proposed some rules for this arrangement, and it's a trust that holds the shares of the private company for the benefit of the employees. So it's meant to facilitate the transfer to employees. There's a lot of roadblocks that present themselves as you try to transfer your business to the employees, financial roadblocks, also just practical roadblocks. So there are incentives attached with this arrangement that provide some financial relief for the employees to help them purchase the business, and also a bit of tax relief as well, too, for the business owner. So those incentives are meant to facilitate that transfer.
It's interesting, because there's a lot of, I guess, things here, which are very positive for business owners in terms of helping them, you know, either somehow crystallize some of that gain they've made with building their business over the years. With all of those things in mind, what are the things that a business owner needs to start thinking about? You don't sell your business in five minutes. Obviously, it takes time to get it ready and do everything, so how do you start that process?
Well, I think you need to have the right people around you that will provide you with the right advice, and I always say, it's never too early to start planning. Even if you're just starting a business, you know, doing some planning today could provide you flexibility down the road. So it's important to work with a trusted advisor, somebody that has experience with these types of situations and can help guide you through the process.
Give me a little window into that. So if I decide that I have a business, and I want to sell it, let's say, five years from now, when you say, do the planning today, what are the kinds of things that will get highlighted, maybe, in the planning that I may or may not have thought about?
Well, start thinking about who that potential successor may be, right? And once you've identified that, how should you structure your corporation to be able to make that transfer more efficient? If you haven't identified that successor, then maybe there's a specific, sort of, I guess, structure that you want to put in place to help with that process.
That's great, Pierre. Always great to have you on. Thanks so much.
Thanks for having me. [AUDIO LOGO]
[INSTRUMENTAL MUSIC PLAYING]
