If you plan to transition your business to your children or grandchildren soon, new rules may help. These rules fall under Section 84.1 of the Income Tax Act (Canada) (the “ITA”). They create planning opportunities for family business transfers.

If you qualify, you may transfer your business using your Lifetime Capital Gains Exemption (LCGE). This exemption can reduce or eliminate tax. The tax savings depend on your remaining LCGE and the business value.

Tax-Efficient Strategies for Business Succession

You may also use retained earnings inside the company to fund the purchase price. Retained earnings represent after corporate tax funds. This strategy may allow you to extract funds from your corporation tax-efficiently. In simple terms, you can “strip” money out of your corporation tax-free.

Let me tie this into a couple of related questions that I am frequently asked. Business owners often ask whether they can simply gift shares to their children. The short answer is yes. You can legally gift shares to your children. However, gifting shares to a non-arm’s-length party triggers special tax rules. Children qualify as non-arm’s-length parties. Section 69 of the ITA applies to these transfers.

Section 69 and Fair Market Value

The law treats the transfer as if it occurred at fair market value. This rule applies even if you receive no payment. The tax system assumes you received proceeds equal to the shares’ fair market value.

If the shares qualify as Qualified Small Business Corporation (QSBC) shares, you may claim your LCGE. This exemption can offset part or all of the capital gain. Several factors affect eligibility. Alternative Minimum Tax may also apply.

If the shares do not qualify as QSBC shares, you may still gift them. However, the transfer will create a taxable capital gain. The gain equals the difference between the fair market value and your adjusted cost base.

Maximizing Wealth with Intergenerational Transfer Rules

The intergenerational transfer rules are very advantageous if you qualify and if the circumstances are right. You can still use your capital gains exemption but take it one step further and actually remove excess retained earnings from your company tax free. If you simply pay a dividend out of your company to yourself you will likely pay at least 40% (and possibly as much as over 50%) tax. Using the intergenerational transfer rules you may be able to pull out, completely tax-free, an amount equal to the purchase price of the business. Of course, the rules have to be properly analyzed to ensure that you qualify for these rules. As of January 1st, 2024, the rules were amended to ensure that these transactions are limited to genuine intergenerational transfers. Please inform yourself as to what your most tax-efficient method is to transfer your business to your children, and preserve that wealth for your family.