Five tax changes that affect business succession planning

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(From the July 2024 Edition of eFORUM)

By Kevin Wark


Recent tax changes have increased both planning opportunities and complexity for shareholders contemplating the sale of their business while alive or on death. Here’s a summary of the main changes and implications for shareholders of private corporations as they apply to different sale situations.


  1. Sale to family members — The tax rules in section 84.1 of the Income Tax Act, which may apply on the sale of a business to the business owner’s children, have undergone two significant revisions in the past three years. In 2021, a private members’ bill was enacted that provided a broad exemption to section 84.1. This permitted the sale of a business to a corporation controlled by children, without the gain arising from the sale being converted to a deemed dividend (denying access to the lifetime capital gains exemption (LCGE)). However, Finance Canada was concerned about certain “tax loopholes” created by this new exemption and has now modified the rules, putting additional restrictions in place. The new rules are effective for dispositions taking place after 2023.

  2. Sale to employees — To support the sale of a private corporation to the employees of the business, a new Employee Ownership Trust (EOT) vehicle is available. An EOT is a special purpose trust that permits employees to purchase a business, with the purchase price paid over an extended period using business profits (and without application of the shareholder loan rules for 15 years). Certain tax advantages are available to the selling business owner, including an extension of the capital gains reserve period from five to 10 years and access to a $10 million “super capital gains exemption” from 2024 to 2026. While the EOT legislation is effective for dispositions after 2023, details of the super capital gains exemption still need to be finalized.

  3. Increase in capital gains inclusion rate — Draft legislation was recently released that will increase the capital gains inclusion rate from one-half to two-thirds for capital gains realized on or after June 25, 2024. However, individuals and certain trusts continue to qualify for the one-half inclusion rate on up to $250,000 of capital gains realized in a calendar year. In addition, the LCGE will increase to $1.25 million for share dispositions on or after June 25, 2024. Business owners who realize capital gains in excess of this limit will experience an increase in their capital gains tax. Also, the stop-loss rules, which can apply when corporate-owned insurance is used to fund the redemption of shares on death, are being modified to potentially increase taxes payable by the estate of the deceased.

  4. Canadian Entrepreneurs’ Incentive (CEI) — A new tax initiative announced in Budget 2024, effective for 2025, is designed to encourage investment in new businesses in certain sectors. Eligible business owners will be entitled to a reduction in the capital gains inclusion rate to one-third (up to a lifetime limit of $2 million) on capital gains arising from the sale of shares in certain qualifying businesses. This inclusion rate reduction will initially apply to $200,000 in capital gains realized in 2024 and increases in $200,000 increments to 2034. The CEI can apply in addition to the LCGE. More detailed legislation is expected to be released in the fall of 2024.

  5. Alternative minimum tax (AMT) — The rules governing the calculation of AMT have been modified, effective for 2024. These changes can result in shareholders who realize capital gains that are eligible for the LCGE paying significantly more AMT than under the former rules. This AMT can be refundable in future years if the taxpayer’s regular Part I income exceeds AMT payable in that year.

Clearly, the tax rules governing business succession are becoming increasingly complex. Advisors can support business owner clients by alerting them to these developments, encouraging them to speak with tax experts, and reviewing their business-related insurance needs in light of these changes.

 

KEVIN WARK, LLB, CLU, TEP, is managing partner of Integrated Estate Solutions and a tax advisor to CALU. He is the author of the popular consumer book The Essential Canadian Guide to Estate Planning (3rd Ed.), as well as tax guides on life insurance transfers, insured buy-sell agreements, and income-splitting strategies, available through Amazon.ca.