2023 federal budget: new rules for 2024 impacting business succession planning
By ATB Wealth 6 December 2023 5 min read
The 2023 federal budget was tabled on March 28, 2023. In this article, we discuss two specific tax topics from the budget that may be of interest to business owners considering the sale of their business: intergenerational share transfers and employee ownership trusts.
Intergenerational share transfers
Bill C-208 came into effect on June 29, 2021. The purpose of this legislation was to improve tax treatment when selling a family business to the next generation. The 2023 budget proposes much-anticipated amendments to this legislation, designed to ensure that only “genuine” intergenerational business transfers receive the improved tax treatment. The 2023 budget announces new restrictions on tax benefits when transferring a business from a parent to their child beginning Jan. 1, 2024.
Currently, a business transition from parent to child can only qualify for improved tax treatment if, among other things, the parent sells personally owned shares that qualify for the lifetime capital gains exemption. Additionally, the purchaser must be a corporation controlled by the seller’s child or children. These requirements continue to exist, but the beneficial tax treatment would now also be available for sales to a corporation controlled by the seller’s nieces and nephews.
Under the new rules proposed in the 2023 budget, there are two methods for avoiding negative tax consequences in an intergenerational business sale: an “immediate” transfer within three years and a “gradual” transfer over five to 10 years. The transferor (parent, aunt, or uncle) and the children, nieces, or nephews who control the purchaser must file a joint election, notifying the Canada Revenue Agency of which transfer method was chosen. Each method includes several requirements that must be met over the transfer period for the sale to be eligible for beneficial tax treatment.
These requirements are complicated and depend on whether the family elects for an “immediate” or “gradual” transfer. They focus on five objectives designed to indicate whether a transfer is genuine enough. Simplified, these requirements include, among other things:
- The transferor must relinquish control over the sold company immediately, with all voting shares transferred to the purchaser within 36 months of sale;
- The transferor and their spouse or common-law partner must relinquish most of their interest in the future growth of the company, with that full interest transferred to the purchaser within 36 months of sale. For a gradual transfer, there are additional requirements for the transferor and their spouse or common-law partner to divest of a significant portion of their residual interest within 10 years.
- The transferor must transfer management over the business to the relative(s) who acquired it, within a “reasonable” time.
- The relative(s) who acquired the business must retain control for a minimum period of time, depending on the selected transfer method.
- At least one qualifying relative must remain actively involved in the business for a minimum period of time, depending on the selected transfer method.
Budget 2023 contains additional changes to the rules for intergenerational business transfers. You should consult with your tax advisor to interpret these rules if you intend to transfer your business to your children or to a niece or nephew.
New tax rules for Employee Ownership Trusts (EOTs)
An Employee Ownership Trust (EOT) describes a business ownership structure where a trust holds shares of a corporation for the benefit of the corporation’s employees. An EOT may be used to allow the employees of a business to acquire shares from the current business owner. Budget 2023 proposes new tax rules to facilitate the use of EOTs in business succession planning effective Jan. 1, 2024.
Extend the capital gains reserve
The sale of shares by the current business owner will generally result in a capital gain where the fair market value of the shares sold is greater than the cost of the shares. An option exists to defer a portion of the capital gain realized by claiming the capital gains reserve. Generally, at least 20 per cent of the capital gain must be reported in the year of sale and each of the four following years.
Budget 2023 proposes to allow the capital gains reserve to be utilized over a maximum 10-year period, as opposed to the regular five years, for qualifying business transfers to an EOT.
Exception to the shareholder loan rules
Where a shareholder borrows funds from their corporation, the loan amount will generally be included in the shareholder's income in the year the loan arose. An exception exists where the loan is repaid by the end of the taxation year following the year in which the loan was made.
Budget 2023 proposes to introduce a new exception to extend the shareholder loan repayment period from one to 15 years, in the case of funds borrowed by an EOT to purchase shares in a qualifying business transfer.
Exempt EOTs from the 21-year deemed disposition rule
In many cases, trusts are designed to be a time-limited structure. This is, in part, due to the 21-year deemed disposition rule, whereby certain trusts are treated as if all of the trust property is sold on the 21st anniversary of the trust’s existence. The result of this deemed disposition is that the trust will trigger any accrued capital gains every 21 years, at a minimum.
Budget 2023 proposes to exempt EOTs from the 21-year deemed disposition rule, as an EOT is designed to be a long-term structure for employee share ownership.
New rules will be introduced to define qualifying conditions to be considered an EOT. Notably, an EOT would be required to hold a controlling interest in the shares of one or more qualifying businesses and must have only two purposes: 1) Holding shares of qualifying businesses for the benefit of its employee beneficiaries; and 2) Making distributions to employee beneficiaries that are determined solely on the reasonable application of the following factors: an employee’s length of service, remuneration, and hours worked. Various other rules will apply that are beyond the scope of this article.
Additional tax incentive proposed for vendors in 2024-2026
Since the date this article was originally posted, one additional change has been proposed. To encourage more business owners to consider a sale to an EOT, the Fall Economic Statement proposes to exempt the first 10 million dollars of capital gains realized on the sale of a business to an EOT, subject to certain conditions.
The sale of a business requires significant planning and can be one of the most significant tax events for a business owner. We encourage you to speak with your tax advisor well in advance of a business sale, including a discussion of these budget announcements.
For information on other business income tax measures, including various tax credits designed to incentivize investment in clean energy and proposed changes to the General Anti-Avoidance Rule (GAAR), please refer to the Government of Canada’s budget web page.
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