In our previous article on this topic, we discussed Bill C-208 (the “Legislation”), a Private Member’s bill that amends the Income Tax Act (the “Act”) to change certain rules in sections 55 and 84.1 of the Act to facilitate intergenerational transfers of shares of family business corporations.
The Legislation received Royal Assent on June 29, 2021. On June 30, 2021, the Department of Finance Canada (“Finance“) issued a news release (the “News Release“) with comments on the Legislation. Additionally, as members of the tax community examine the Legislation in closer detail many commentators are uncovering and publishing information about critical flaws that suggest that the Legislation will require further amendments. Our previous article discussed a number of shortcomings and interpretive difficulties with the Legislation, but a further update is needed.
Amending the Legislation
Our previous article noted that Finance had raised a number of objections to the Legislation and did not support it. Nonetheless, the Legislation was passed by both Houses of Parliament with support from all major political parties. The News Release has been heavily criticised in the media and from organizations including the Canadian Chamber of Commerce, the Canadian Federation of Agriculture and the Canadian Federation of Independent Business. The News Release suggested that, because the Legislation did not include an “application date”, Finance would be proposing amending legislation to “clarify” that the amendments contained in the Legislation would apply starting January 1, 2022. Some commentators have concluded that the News Release amounts to Finance overriding both parliamentary rules and federal law by delaying implementation of the Legislation. However, this is clearly not true. The Legislation became law and came into force upon receiving Royal Assent. The federal Interpretation Act confirms that “if no date of commencement is provided for in an Act, the date of commencement of that Act is the date of assent to the Act.” Readers should be assured that the Legislation is now law.
There will also be practical hurdles to overcome for amending legislation to be proposed, passed and enacted. As of the time of writing, both Houses of Parliament are on summer recess. There is a high level of speculation that the current government will call an election for the Fall of 2021, which would mean that there may be no further sittings of the current Parliament. And even if Parliament does sit and the government introduces amending legislation, Canada currently has a minority government that requires support from other major parties to pass any legislation. Given that the Legislation itself was supported by members of the major opposition parties (and by some members of the governing party), the government may well not find the support that would be required to amend the Legislation. It may be that amending legislation can only be passed by a future majority government.
Notwithstanding these procedural hurdles, it is becoming increasingly apparent that the Legislation itself contains significant drafting deficiencies such that future amendments should not only be expected but will be required to maintain the integrity of the Act.
The Legislation originated as a Private Member’s bill (some might say to fill the legislative vacuum resulting from Finance’s failure to act). That meant that it was not drafted by Finance nor was it thoroughly vetted by policy and legislation experts within the department. Taxing legislation is typically drafted with utmost care and precision; this Legislation was not subjected to those same rigours thus leading to inevitable technical deficiencies.
In addition to those previously discussed, the technical deficiencies in the Legislation include the following:
- The new rules may enable surplus-stripping transactions that are not legitimate intergenerational transfers. An individual may be able to structure a sale of shares which utilizes his or her lifetime capital gains deduction (“LCGD“) which results in the individual being able to extract cash from a corporation with little or no tax being paid. And this can now be done in a non-arm’s length scenario which previously would have resulted in tax-free (or tax-reduced) capital gains being converted to taxable dividends.
- The rules in new paragraph 84.1(2.3)(a) appear to refer to the death of a corporation, which is a legal impossibility.
- The LCGD “grind” in new subsection 84.1(2.3) appears not to be effective because it only applies for the purposes of paragraph 84.1(2)(e) – which is not the relevant provision for computing the deduction amount.
- The formula set out in paragraph 84.1(2.3)(b) does not operate to achieve the intended result; in fact, a mathematical application of the formula would result in its application when the subject corporation’s taxable capital exceeds $15 Million by many orders of magnitude.
- The new rules only require that a child or grandchild “control” the purchasing corporation. That can be accomplished by arranging for the child or grandchild to hold only nominal-value voting shares with no true equity participation in the purchasing corporation. There is no requirement that the child or grandchild be engaged in the business, let alone hold true operational control of the purchasing corporation.
- Although the purchasing corporation is prohibited from selling the purchased shares for 60 months following the purchase, this does not prevent the child or grandchild controlling the purchasing corporation from selling his or her shares in the purchasing corporation. Nor does it prevent the purchasing corporation from selling its underlying business.
Note that almost all of the technical deficiencies relate to the changes to section 84.1 of the Act. The changes to section 55 of the Act really only amount to a change of policy from how those provisions formerly operated.
Some taxpayers may view the new Legislation as an opportunity to engage in transactions that are not legitimate intergenerational transfers to achieve tax-savings outcomes that were not previously possible.
However, such taxpayers could be proceeding with a significant degree of peril. What will be the consequences if the inevitable amending legislation applies retroactively to those transactions. Retroactive legislation is not impermissible, nor is it uncommon. In fact, one may read the June 30 News Release as an explicit statement (or threat?) by the government that future amending legislation will be made retroactive.
At the same time, taxpayers who are, as a matter of timing, legitimately engaging in intergenerational transfers of family businesses should not be penalized for proceeding by way of fully-enacted and in-force legislation. One would caution, however, of structuring such transactions in a manner that does not provide a relief-valve should retroactive legislation in fact apply even to those legitimate and non-tax driven transactions. For example, it might be advisable for the transferring parent to take back consideration for the sale in the form of high-paid-up capital (“PUC“) preferred shares rather than in the form of a promissory note. The PUC of preferred shares could later be ground-down thus ameliorating negative tax consequences that could result from retroactive legislation.