Ending unfair taxation on family business transfers

 

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Questions and Answers

Bill C-274: Transfer of small business or family farm or fishing operation.

What is Bill C-274?

 Bill C-274 aims to facilitate the transfer of small businesses or family farms or fishing operations between members of the same family by amending the Income Tax Act. More specifically, it will allow owners and buyers in the same family to enjoy the same rights and privileges as those for a transaction between non-related persons.

What is the current situation?

 The owners of small businesses, family farms or fishing operations who want to retire and sell to their children pay a lot more in taxes than if they were to sell to a stranger. Current tax rules discourage them from passing on their business to their own children and encourage selling to a stranger more advantageous. Bill C-274 will level the playing field by giving the transaction equal treatment.

What is the tax treatment of a small business, family farm of fishing operations sold to a stranger or a family member?

 When parents sell their businesses to their children, the difference between the sale price and the price originally paid is considered a dividend. If they sell their businesses to unrelated individuals, it is considered a capital gain. Unlike a capital gain, a dividend does not include the right to a lifetime exemption and is taxed more heavily.

  • The exemption for a capital gain is $824,176 for small businesses and $1 million for farms and fisheries. After the exemption is applied, 50% of the remaining capital gain is taxed between 47% and 58%, depending on the province. (2016)

  • There is no lifetime exemption on dividends. The total gain of dividend is taxed between 35% and 51%, depending on the province (2016)

Why is it important?

These changes are necessary for the succession of our businesses. Over $50 billion in farm assets are set to change hands over the next 10 year and more than 8,000 family farms have disappeared in the past decade. Only half of small business owners have a succession plan, while 76% of them are planning to retire over the next decade.

Canadian small business, family farm and fishing operations owners report that current tax rules often discourage them from passing on their businesses to their children and encourage selling to a stranger or a larger business. Our bill addresses the problem and helps small business owners ensure that their businesses remain locally owned – protecting and creating local jobs.

Does Bill C-274 apply to all small businesses, family farms and fishing operations?

Yes. All small businesses, farms and fishing operations considered as such under Canadian legislation with a value of less than $15 million are included. 

 How many small businesses, farms or fishing operations will Bill C-274 help?

According to a 2012 CIBC study, close to 30%, or 310,000, of business owners will exit ownership or transfer control of their businesses by 2017. Within the next six years (2022), 550,000 or one-half of owners will exit their business.[1]

Statistics Canada data reveals that 19,080 individuals disposed of eligible small business shares for the 2012 taxation year. Assuming that 32.76% of business owners wish to sell to a family member, according to a study by the Canadian Federation of Independent Business, Bill C-274 would help more than 6,250 small business owners wishing to sell to a family member.[2]

Has any province legislated to address this problem?

Only Quebec. As part of the Quebec budget speech of March 26, 2015, an easing of the tax provisions applicable to the disposition of qualified shares of operations in the primary or manufacturing sectors carried out in conjunction with a transfer of a family business was announced. For the application of the easing, a transfer of a family business will be designated as qualifying, in respect of a taxpayer, where seven qualification criteria are met.[3]

How does Bill C-274 prevent tax avoidance? 

Bill C-274 limits the possibility of a tax avoidance strategy by extending the period during which the family member must hold on to the business to five years after the transfer, rather than two years as is currently the case. If the family business is again sold within five years, dividend stripping is presumed to have taken place and dividend taxes are retroactively charged on the initial transaction. An exception is made in the case of the death of the buyer.

Bill C-274 also calls for the production of an affidavit and an examination of any such family transfer by the Canada Revenue Agency.

 EXAMPLE 1 - Family Farm

Let’s take a farm (FARM INC.) belonging to a couple who want to sell it for $10 million. The buyer creates a new company (BUYERCO INC.) and owns all its shares. BUYERCO INC. borrows $10 million and pays the couple. BUYERCO INC. then merges with FARM INC., and the debt belongs to the merged company and is repaid by the proceeds of the farm sale.

The couple receives $10 million, which they declare as a capital gain (including a lifetime exemption of $1,000,000). But if BUYERCO INC. belongs to a family member, it is deemed not-arm’s length, and the $10 million is considered a dividend (no exemption).

table1

 If they sell their farm to a stranger, the couple makes an after-tax profit of $7,750,000. If they sell to a family member, their profit shrinks to $6,500,000, resulting in the substantial loss of $1,250,000.

EXAMPLE 2 – Small Business

Now let’s take a small mechanics business (SME INC.) belonging to a couple who want to sell it for $1 million. The buyer creates a new company (SMEBUYERCO INC.) and owns all its shares. SMEBUYERCO INC. borrows $1 million and pays the couple. SMEBUYERCO INC. then merges with SME INC., and the debt belongs to the merged company and is repaid by the proceeds of the small business sale.

The couple receives $1 million, which they declare as a capital gain (including a lifetime exemption of $824,174). But if SMEBUYERCO INC. belongs to a family member, it is deemed not-arm’s length, and the $1 million is considered a dividend (no exemption).

table2

If they sell their farm to a stranger, the couple makes an after-tax profit of $956,044. If they sell to a family member, their profit shrinks to $650,000, resulting in the substantial loss of $306,044.



[1] CIBC, Benjamin Tal, “Inadequate Business Succession Planning – A growing Macroeconomic Risk,” November 13, 2012.

[2] CFIB, Doug Bruce and Queenie Wong, “Passing on the Business to the Next Generation, Survey result on small business succession planning,” November 2012.

[3] Revenu Québec, “Conditions for easing of the tax provisions to the transfer of family businesses,” http://www.revenuquebec.ca/en/salle-de-presse/nouvelles-fiscales/2016/2016-06-01.aspx

 

 

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