Proposed Changes to Address the Conversion of Income into Capital Gains, Part 2

by in Canadian Government News and Updates
Proposed Changes to Address the Conversion of Income into Capital Gains, Part 2
The problem with Section 84.1, according to the Department of Finance is the wording as it describes a specific type of avoidance transaction.  Therefore, the section does not apply to transactions that avoid its specific terms.  In particular, the section can be avoided to enable an individual shareholder to obtain capital gains treatment rather than taxable dividend treatment with respect to taxable capital gains that are ineligible for the Lifetime Capital Gains Exemption. 

With the case of intergenerational business transfers, the government did mention that they are reviewing the current income tax system that may have had adverse effects on genuine business transactions involving family members. 

Section 84.1 does not apply to the sale of shares from one individual to another.  Therefore, it has no impact on the sale of shares within the family as long as the transaction occurs at the individual level.

The Government proposes to amend section 84.1 to prevent individual taxpayers from using non-arm’s length transactions that “step-up” the cost base of shares of a corporation in order to avoid the application of section 84.1 on a subsequent transaction.

Specifically, the Government proposes to extend the current rules in subsection 84.1(2) that result in a so-called “soft” cost base if the LCGE is claimed to cases where cost base is increased in a taxable non-arm’s length transaction. 

The Government also proposes to add a separate anti-stripping rule to address tax planning strategies that circumvent specific provisions of the tax law meant to prevent the conversion of a private corporation’s surplus into tax-exempt or lower-taxed capital gains.  This would apply to a non-arm’s length transaction where it is reasonable to consider that “one of the purposes” of a transaction is to pay an individual shareholder/vendor non-share consideration (such as cash) that is otherwise treated as a capital gain out of a private corporation’s surplus in a manner that involves a significant disappearance of the corporation’s assets. 

Are you in favor of these proposals? Tell us your thought! Better yet, let the Government know what you think of the proposals.  There is an ongoing public consultation through the Department of Finance. We highly recommend that you participate in this or write to your MP!

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