You’ve surely heard a business owner tell you that it is more advantageous to sell a business to a third party than to their own children. Finally, since January 1, 2024, this statement is no longer true, and Quebec business owners can benefit from relief from certain tax provisions, which now allow the sale of their business to the next generation, in a tax-advantaged manner.
To understand the scope and conditions of application of these new provisions, it is useful to review the prohibitive rules that previously applied, more specifically the former application of Section 84.1 of the Income Tax Act (ITA) and its equivalent in the Quebec Taxation Act.
Section 84.1 ITA has the effect of converting a taxpayer’s capital gain into a taxable dividend when the shares of a corporation are sold to another corporation with which the taxpayer does not deal at arm’s length (such as a corporation owned by the taxpayer’s child). The marginal tax rate for a capital gain is 26.65% in 2024, while that of a dividend is 48.7%, a difference of 22%!
The former application of Section 84.1 ITA was punitive in the context of inter-generational sales because the family could not take advantage of the typical tax-advantaged way to structure a transaction, which is to have the purchaser incorporate a new corporation to make the purchase. This typical structure permits future profits of the subject corporation to be used to pay the purchase price (and a third-party loan is often taken out by the new purchaser corporation to at least pay a portion of the purchase price up front).
In addition, since Section 84.1 ITA reclassifies the capital gain as a dividend, the business owner loses his ability to take advantage of a valuable capital gains deduction if the shares being sold are shares of a “qualified small business corporation”. This deduction is expected to reach $1,016,836 in 2024 (indexed each year), which represents an additional lost tax savings to the business owner of up to $271,000!
In 2016-2017, Quebec adopted a relief regime to exempt certain business transfers from the application of these rules. However, the federal legislator did not adopt similar rules, which made the Quebec relief system useless. In 2021, by a private bill from a Manitoba MP, Section 84.1 ITA was substantially amended with the aim of promoting the transfer of family businesses. The two exceptional regimes, that of the federal government and that of Quebec, have coexisted until the adoption of certain modifications by the federal government in 2023, which, as mentioned above, came into force on January 1, 2024. Quebec has confirmed its intention to harmonize its rules with those adopted by the federal government, which now gives the degree of comfort and certainty required by business owners to implement the business transfer process to the next generation.
A vendor who is an individual residing in Canada (and Quebec, as the case may be). If the subject corporation is owned by a family trust, the vendor must undertake certain prior transactions to benefit from the relief.
Shares of a corporation that the vendor holds as capital assets and which qualify as “qualified small business corporation shares” or “shares of a family farm or fishing corporation”. Essentially, the corporations covered are operating companies, as opposed to investment companies which typically hold assets that generate passive income (for example, rental properties). It is necessary to perform a tax analysis to determine whether the shares qualify for transfer purposes, particularly with regard to the length of time the vendor has held the shares and the percentage of the corporation’s assets that are used in its business.
To a corporation controlled by a child of the vendor or his or her spouse. The term “child” has a broad meaning, which includes a grandchild, a nephew or niece and the spouse of these persons. The term “spouse” includes a common-law partner.
Section 84.1 ITA allows the vendor to choose between two avenues: immediate business transfer and progressive business transfer. These two avenues have different conditions of application, but will ultimately result in a transfer of control and equity of the subject corporation to the child. The time period granted to the parent to transfer control (legal and factual) to the child, as well as the conditions relating to the retention of economic interests in the corporation, vary between the two avenues, as does the time limit for the applicable requirement to enable the tax authorities to verify compliance of the business transfer with the applicable legislative provisions.
These new measures are more than welcome. They will allow the transfer of businesses to the next generation, while ensuring that the founders can reap the fruit of their efforts by benefiting from significant tax savings, which they could only otherwise have benefited from by selling to a third-party.
For business owners who were simply waiting to leave their shares to their child in their will, they can now act during their lifetime and begin the transition process immediately, with added tax benefits. Furthermore, these added tax benefits may also apply to the business owner who intended to pass the business on to his child during his lifetime without payment, since strategies are available to still do so while withdrawing significant sums from the company tax-free.
De Grandpré Chait is proud to have the expertise required in taxation and business law to support Quebec business owners in their business succession plans. We can carry out the tax analysis, draft the agreements necessary to complete the transaction and support the next generation in finding and setting up financing.
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