Transferring the Farm to the Kids – New Tax Rules

Posted on November 14, 2022 in Agricultural Business Law | Corporate, Commercial & Contract Law | Tax Planning | Wills & Estate Planning by Michael J. Deobald, TEP

When business owners retire, they often look to sell their business.  With farming, the new business owners are often one or more children.  This has historically been a problem from a tax perspective.

If the parents operate their business through a corporation, the sale of the business will usually proceed by selling the assets of the business or by selling the shares of the corporation that operates the business.  A sale of shares can have many advantages, including the possibility of claiming the capital gains exemption to significantly reduce the tax due by the sellers.

If the parents sold the shares of their corporation to an unrelated buyer, the parents could typically claim their capital gains exemption and would receive capital gains treatment on the amount of any sale proceeds that exceed their available capital gains exemption.  The buyer will usually purchase these shares with a corporation.  This allows the buyer to use corporate money (either existing or borrowed) to pay for the shares rather than personal money.  Because corporations pay a lower tax rate on business income than individuals, this allows the buyer to pay for the new business much faster.

However, this is where the problem comes in.  If the corporation that buys the shares from the parents is controlled by a related person (such as one or more of their children), then the parents are deemed to receive dividends.  This means the parents lose both the ability to claim their capital gains exemptions and the capital gains treatment entirely.  Because dividends are taxed at a higher tax rate than capital gains, the result is very bad for the parents.

Until recently, the only way to avoid this result was for the child(ren) to personally (rather than through a corporation) purchase the shares of the parents’ corporation.  However, this scenario punished the children because they had to use personal, after-tax, dollars to pay their parents for the shares rather than corporate, after-tax, dollars.

The result – the parents would be better off financially to sell their business to a stranger than to their own children!  Very unfair, especially in the farming context where the business is often transferred to the next generation.

On June 29, 2021, new tax rules (called Bill C-208) were enacted to change this result. While the Department of Finance has stated it intends to amend the new rules further, it has acknowledged that the legislation is currently law and any amendments will not be effective until November 1, 2021 or later. The goal of the new rules is to allow parents to sell the shares of their corporations to a corporation controlled by their children and avoid the punishing result of deemed dividend treatment.

Until November 1, 2021 (or perhaps longer), the following requirements must be met: (1) the shares being sold must be Qualified Small Business Corporation Shares or shares of a Family Farm Corporation, (2) the purchaser corporation must be controlled by one or more children or grandchildren of the seller of the shares, (3) the children/grandchildren must be 18 years old or more, (4) the purchaser corporation must not dispose of the shares within 60 months of the purchase, (5) the seller must provide the Federal Government with an independent assessment of the fair market value of the shares purchased and (6) the seller must provide the Federal Government with an affidavit signed by the seller and a third party attesting to the disposal of the shares.

If these conditions are all met, the parents can sell their shares and utilize the new beneficial rules under Bill C-208.  However, some of these conditions take some work to satisfy.

Not all corporations that carry on farming are Family Farm Corporations.  For example, if any of the assets of the corporation are not actively used in farming (e.g. rental property, investments, GICs or even too much cash), the corporation may not qualify.  This is a condition that must be thoroughly reviewed by the family’s tax advisors to make sure it is satisfied.

If the shares are disposed of by the purchaser corporation within 60 months, the favourable tax rules will not apply and the parents could be exposed to deemed dividend treatment.  The parents will want to make sure that this restriction is known and accepted by the children.

The concept of an “independent assessment of the fair market value” of the shares is new.  It is not used anywhere else in the tax legislation.  This wording likely means that the parents are going to need to engage their accountant or another third party to prepare this assessment.  This will take time and will result in additional costs.  The parties should discuss this with their advisors early in the process to confirm what will be necessary. While not perfect, Bill C-208 is a welcomed step in improving fairness for family businesses. Families looking to transfer their business to the next generation should contact their tax advisors to get more information on how these new rules might work in their situation.

Michael J. Deobald
500 – 123 2nd Avenue South, Saskatoon, SK S7K 7E6
Telephone: 306-244-0132

This article is provided for general informational purposes only and does not constitute legal or other professional advice and does not replace independent legal or tax advice.

This article was originally published in The Western Producer on October 7, 2021.