The anti-avoidance rule, in its most recent form, created a problem with succession planning. Parents who wanted to transition
their business to their child by selling shares to their child’s corporation would have any gain on the sale of the business taxed at
the higher dividend rate. If the parents utilized their respective LCGEs on a sale directly to their child and the child later sold the
shares to a related corporation, that child could face the same dividend tax treatment. The anti-avoidance rule prevents the child
from using a corporation to effectively finance the purchase, even where the child is paying the full fair market value for the
business as a third party would. In contrast, had the parents chosen to sell the shares to an unrelated corporation, any gain
realized would be sheltered by any available portion of their LCGEs and/or taxed at the lower capital gains rate.
Under the proposed legislation, the existing anti-avoidance rule is expanded to include the sale of shares by an individual to a
related corporation where the individual’s tax cost includes sales or gains realized by a unrelated person. The anti-avoidance rule
would apply even if the unrelated person paid capital gains tax.
For example, consider a situation where parents sell shares of a corporation to their child, do not claim their LCGEs and pay tax
on the capital gain realized on the sale. By paying the necessary taxes, the child could then sell the shares to his or her
corporation and receive funds on a tax-paid basis to repay the parents. Under the proposed rules, this type of sucession planning
may result in the same gain being subject to both capital gains and dividend tax. This will have a significant impact on transitioning
a business within a family.
The proposed legislation could also be troublesome for many estates. Upon death, individuals are deemed to dispose of all assets
at fair market value and their estate to acquire the assets at the same value. In the case of shares held by the deceased individual,
this will often result in a capital gain. Double taxation can result where the estate has to pay tax on such capital gains, as well as
on dividend income incurred to liquidate the estate assets from within the corporation. Tax structuring commonly referred to as the
“pipeline” is used in estate planning to deal with the above situation, but at an effective tax rate equal to an individual’s capital
gains rate, will no longer be a tax-effective alternative under the proposed legislation. Other structuring alternatives are available,
however they would need to be acted upon in a timely manner.
If enacted, the rule applies to shares disposed of on or after July 18, 2017.
Many in the tax community had been hopeful the federal government would ease some of the restrictions on intergenerational
business transfers; however, it appears the proposed legislation has created further challenges.
Recharacterization of Corporate Distributions
Generally, capital gains realized by a corporation are included in income at 50 percent, similar to capital gains realized by an
individual. The untaxed portion can be paid out as a tax-free dividend to the shareholder.
The federal government proposes to add a new rule to prevent tax planning that circumvents specific tax rules meant to prevent
the conversion of a private corporation’s surplus into tax-exempt, or lower-taxed capital gains. Generally, the rule applies where
there is a sale of property to a related party (and could be interpreted to apply more broadly to unrelated parties), there is a
significant reduction or disappearance of assets from a corporation and it can reasonably be considered that a related individual
has avoided tax as part of the transaction(s) carried out. The new rule prevents the untaxed portion of any capital gain realized by
the corporation from being included in its capital dividend account. Furthermore, amounts received or receivable by the individual
would be recharacterized as dividends and therefore subject to dividend tax rates, regardless of what form the amounts would
As a result, the effective tax rate on a sale of assets by a corporation to a related person can be significantly higher than if the
assets were sold to a third party. The new rule may also apply in a situation that shares the above characteristics, but does not
involve a disposition of property.
If enacted, this new rule applies to amounts that are received or become receivable on or after July 18, 2017.
The wording of the proposed rule is vague and may be applied broadly. As the intention of the involved parties is considered when
determining whether this rule applies, any significant dispositions of assets may need to be supported by an established intention,
particularly where the corporation makes use of its capital dividend account shortly after the disposition.
2. Impact to You and Your Business
These proposed changes create complexities in the disposition of assets, shares, transition or succession of a business and
estate planning. It is recommended the direct consequences to you, your family, and your business be discussed with a MNP Tax