WESTERN PRODUCER — Farmers are advised to take advantage of the revamped Bill C-208 because it offers them significant tax savings when it comes to succession.
Brandon-Souris MP Larry McGuire initially introduced it as a private member’s bill in 2021. It sought to amend the federal Income Tax Act to exclude the intergenerational transfer of farms and other small businesses from current anti-avoidance rules. Under the changes, those transfers receive equal capital gains treatment as do businesses selling to unrelated parties.
Capital gains are the profits from the sale of property or an investment. Every Canadian has a $1 million lifetime capital gains exemption, meaning the first $1 million is not taxed and anything over $1 million is taxed at 25 percent.
But until Bill C-208, anti-avoidance rules in Canada’s Income Tax Act characterized capital gains earned for shares sold to a family member’s corporation as a taxable dividend, which came with a tax rate of 46 percent. They were ineligible for the capital gains exemption.
Shares sold to a third party, however, would not be viewed as a taxable dividend and would be eligible for the exemption.
The bill passed in 2021, but in a release issued in July of that year, federal finance minister Chrystia Freeland said amendments to the legislation were needed to close tax avoidance loopholes that may have resulted from the bill. Those amendments came into effect on Jan. 1 of this year.
Among those changes were the removal of a requirement that purchasers have to hold shares for at least 60 months after purchase. Changes also introduced two different transition plan term options: an immediate (three-year) or a gradual (10-year) approach.
Gaining capital gains treatment eligibility is “very important because it gives us the lowest tax rate,” said Edith Frison, a tax specialist with MNP in Brandon.
“It was pretty unfair that if we were selling our business to our own child, we weren’t allowed to get capital gains treatment or use capital gains exemption, but if we were selling to a third party, we would,” she said.
“Why would you ever want to pass on equity from something you built your whole life to some stranger instead of your own child?”
During a recent presentation at Manitoba Ag Days, Frison focused on how farmers could best take advantage of the legislative change.
Producers can now sell farm shares to their children, creating a shareholder loan. In basic terms, she said, “we take the asset, we sell it to our kids, we record the million-dollar gain on our personal tax return. It’s sheltered by capital gains exemption, and Mom and Dad can pull that money out over time. So, they don’t have to take wages, they don’t have to take dividends and they have very little income to report in the future.”
Frison outlined one simplified scenario for how a transaction might unfold. In her example, Mom and Dad have a farm worth $2 million (a number she admits is probably too low, but it makes the math easier) and are ready to retire and transfer the farm to their offspring. The son or daughter would need to go to a lawyer to set up a new company that they will control.
That new company, owned by the children, would either get a loan to buy the shares of their parent’s company, or they would arrange to finance the deal by paying Mom and Dad over time through farm operations.
If the farm was bought out immediately, each parent would have a $1 million capital gain on their personal tax return. That would then be sheltered by their lifetime capital gains exemption. It would be the same if, instead, the deal were drawn over time.
“So, essentially, we’ve created a new company that owns the family farm, and that new company owes Mom and Dad, or the bank, $2 million,” Frison said.
When it comes to opting for the immediate or gradual plan, Frison said it depends on how ready everybody is to transition.
“Are Mom and Dad ready to give up everything right away? Are the children ready to take on that management role? Sometimes we see that children need a bit of training to get the skills and knowledge to the point where they are able to continue,” she said.
In addition to the transfer of all assets and equity, both plans require the transfer of legal and factual control of the company. Legal control refers to the voting of common shares. Factual control means controlling the day-to-day operations.
“There has to be a transfer of management,” said Frison. “Management would include who’s making decisions daily about the operation. That has to transition to the next generation; it can’t stay with Mom and Dad.”
For the immediate transition plan, all parties have to be ready to transfer the majority of legal and factual control to the children immediately, with the rest of the control, along with management of the business, going to the children over the next three years. After all control is transferred, the children will have to maintain ownership and control of the farm for three years before they are allowed to sell.
“We can’t do this if Mom and Dad continue operating the farm and the child lives in Bermuda or somewhere,” said Frison.
If the child isn’t quite ready for that immediate switch, she suggested the family might be better to look at the longer-term option.
With the gradual transition plan, legal control (voting shares) must be transferred immediately, but the parents can still participate in the factual control of the company. Then, over the next 36 months, most of that factual control must be transferred to the children. By the end of 10 years, the parents will have no more control or equity in the company.
“They would have to transfer management decisions to the children within a reasonable amount of time, which is always up for debate, but probably within five years,” said Frison.
“I think we’d be pushing it to 10 years.”
With the gradual transition plan, after all control is transferred, the children will have to maintain ownership and control of the farm for five years before they are allowed to sell.
Also, with the gradual plan, everything remains open for reassessment for 10 years after the transaction is complete, whereas normally, everything becomes statute-barred three years after filing a tax return, Frison noted.
In both scenarios, while the parents must give up control of the company, they can remain employees.
“Sometimes folks want to continue to drive the combine or the tractor,” said Frison.
“We can continue to pay them as employees. It’s just that we have to pay them a reasonable wage. So, whatever we’re paying our hired hand, that’s what we also have to pay Mom and Dad.”
Frison said there are a number of ways to approach a farm transition, and the options opened up by Bill C-208 aren’t always going to be the best approach.
“This is really just another tool in our toolbox that could help your family pay very little tax overall,” she said.
“It’s a complex transaction and needs to be well documented. So please be sure to include an accountant or a lawyer if you’re planning to do this.”
