By: Florence Marino B.A., LL.B., TEP | Vice President, Tax & Estate Planning
The manner in which tax proposals have been introduced in recent years has seemed somewhat chaotic to those of us with an ordered mind. It feels like we are in an endless cycle of announcements, draft legislation, submissions, more draft legislation, more submissions, sometimes postponement of implementation, final legislation, but with further details and technical amendments to follow along with openness to receiving more submissions. It’s no wonder that there are some loose ends to follow up on.
Bill C-59 which included the new GAAR, the modified intergenerational business transfer rules (see: What does life insurance have to do with proposed intergenerational business transfers? – Lots – Tompkins Insurance), most of the employee ownership trust framework, substantive-CCPC anti-avoidance rules and “EIFEL” rules limiting interest and financing expenses, received Royal Assent on June 20, 2024.
Bill C-69 which included 2024 Federal budget measures (other than the capital gains inclusion rate change), significant amendments to the alternative minimum tax (AMT) and the introduction of the time-limited $10-million super-exemption for sale of business to an employee ownership trust (EOT), also received Royal Assent on June 20, 2024. We have been following this tax legislation and provide this brief update on items of interest.
Dividend received deduction denial for life insurers – Problem fixed
An amendment was introduced to Bill C-59 in committee that was ultimately enacted. This is good news. It provides an exemption for insurance corporations receiving dividends on shares from Canadian corporations being taxed as business income. This exemption applies where dividends are received on shares held “in connection with an insurance contract entered into, issued or acquired in the ordinary course of an insurance business…” If this amendment were not enacted, this would have materially impacted the returns, benefits and costs to new and existing policyholders. See: Tax Legislation tabled – Some highlights – Tompkins Insurance
EOTs get further incentives but with long-tail strings attached
Originally proposed in the 2023 Federal Budget, with draft legislation in August of 2023, the incentives for sale of businesses to EOTs were not seen as sufficiently motivating to vendors. The Fall Economic Statement in November of 2023 announced the intention to add a $10 million capital gains super-exemption to encourage vendors to sell to EOTs.
The main framework for sale of a business to an EOT was contained in Bill C-59 that received first reading on November 30, 2023, but it did not contain details of the super-exemption. (See: Employee Ownership Trusts – An unchartered option for sale of business in Canada – Tompkins Insurance) Bill C-69 received first reading on May 2 and contained the details of the super-exemption and an exemption from AMT for the vendor for capital gains eligible for the super-exemption. (For our prior discussion of AMT see: Alternative minimum tax – Where are we now? – Tompkins Insurance)
The $10-million super-exemption is available to an individual (other than a trust) who is at least 18 years of age on the sale of shares to an EOT or a corporation wholly owned by an EOT. The target corporation cannot be a professional corporation. The requirements are more stringent for the super-exemption than the requirements under the EOT rules for a “qualifying business transfer” (QBT) itself.
The trust that acquires the shares on the QBT can not be an existing EOT. The transfer has to occur between January 1, 2024 and December 31, 2026. Throughout the 24 months immediately prior to the QBT, the shares had to be owned by the vendor, a related person or a partnership in which the vendor is a member and more than 50% of the fair market value of the target corporation’s assets had to be used principally in an active business. At any time prior to the QBT the vendor or their spouse/common-law partner had to have been actively engaged in the business on a regular and continuous basis for a minimum of 24 months. Immediately after the transfer, at least 75% of the beneficiaries of the EOT must be resident in Canada.
All shareholders who wish to sell their shares to an EOT and qualify for the super-exemption appear to have to dispose of their shares in the same transaction based on the legislation. A joint election must be filed with the CRA and indicate the total amount of the exemption and the allocation amongst the vendors of that amount.
And what about the long-tail strings attached? If certain “disqualifying events” occur within 24 months of the QBT (i.e., if the trust ceases to be an EOT or if the 50% active business asset test is not met), the super-exemption will be retroactively denied to the vendor and the EOT will have joint and several liability with the vendor. If these events occur after 24 months (based on the current legislation, with no sunset, end date or extenuating circumstances such as financial difficulties), the EOT will be assessed and be solely liable for a capital gain equal to the amount of the super-exemption claimed by the vendor. It has been observed that this contingent liability could result in difficulty obtaining external financing for these types of business sales.
It is unclear if these added incentives will tip the balance in favour of greater use of this succession planning option. Life insurance can be a useful tool covering debts incurred by the EOT to buy the shares of the target in the event of death of a key employee and in funding buy-sell obligations on death in respect of capital interests or shares distributed by EOT trusts. At the 2024 CALU CRA and Finance Roundtable, the Department of Finance confirmed that the EOT legislation specifically contemplates capital distributions from an EOT to beneficiaries of the EOT which could include the distribution of shares of a corporation owned by an EOT.
Complex patchwork of incentives for private company share sales
The super-exemption for a sale of shares to an EOT is added to already existing incentives provided under the Act for the sale of private company shares, including: the lifetime capital gains exemption; the small business share rollover deferral; and the intergenerational business transfer framework. Draft legislation is not yet released for another new incentive, the Canadian entrepreneurs’ incentive proposed in the 2024 Federal budget. Each of these regimes have different thresholds, definitions, tests and parameters. While tax incentives are great, it can be complex and challenging to determine if any given situation qualifies and if the incentive is available.
FOOTNOTE:
This publication is protected by copyright. Tompkins Insurance is not engaged in rendering tax or legal advice. TOMPKINSights contains a general discussion of certain tax and legal developments and should not be construed as tax or legal advice.
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florence@tompkinsinsurance.com
