Converting a private corporationâ€™s income into capital gains
Anti-surplus stripping rules
Changes are proposed to prevent individual taxpayers from using non-armâ€™s-length transactions that increase the cost base of shares of a corporation and avoid the application of Section 84.1. Section 84.1 is intended to prevent corporate surplus from being removed at the lower capital gains tax rates instead of the higher dividend tax rates where an individual sells shares of the corporation to a non-armâ€™s- length corporation.
Two measures are proposed:
- Anti-avoidance rule to be expanded â€“ will expand to apply to situations where the cost base of shares is increased in taxable non-armâ€™s length transactions. The purpose is to prevent a taxpayer from extracting corporate surplus on a subsequent sale to a non-armâ€™s length company to the extent that the cost base of the shares is a result of previously realized non-armâ€™s length capital gains. In some cases a capital gain will be realized on the initial sale of shares as well as a deemed dividend on the subsequent non-armâ€™s length sale of those shares. This would result in punitive double taxation.
New anti-stripping rule â€“ the proposed rule will apply to prevent the distribution of corporate surplus to an individual shareholder resident in Canada on a tax â€“reduced or tax-free basis in a non-armâ€™s length transaction, where that surplus would otherwise be distributed as a taxable dividend. It will apply where it can reasonably be concluded that one of the purposes of the transaction (or series of transactions) is to cause a significant reduction or distribution of the assets of the private corporation in such a manner that the tax on the amounts received is less than what the individual would have paid if the corporation had paid them a taxable dividend immediately before the transaction.
Lifetime capital gains exemption
The concern here is that common ownership structures can allow multiple family members to make use of their capital gains exemption (CGE) from the sale of a family-owned business.
Under the proposals, the capital gains exemption will be denied in the following circumstances:
- Individuals under the age of 18 will not be allowed to use the CGE;
- Beneficiaries of trusts will no longer be permitted to access the CGE with respect to gains on the value of shares that accrue during the period in which the trust holds the shares: and
- Individuals who are subject to TOSI with respect to a share will not be able to use the CGE on the sale of such shares.
A transitional rule would allow an election to be made by the end of 2018 to crystallize a capital gain and claim the CGE so as to increase the adjusted cost base of the â€œqualified small business corporationâ€ shares.
The above is included in draft legislation, and, if enacted, both are effective July 18, 2017 which hits targeted planning immediately.
Additional consideration is to be given as whether there is an adverse impact on genuine business transactions involving family members. There could be an issue in certain cases on the transfer of a business from one generation to another within a family because the lifetime capital gains exemption would not be available.