Selling business shares to a child, spouse, family-controlled corporation or another related person is not treated like an ordinary arm’s-length sale. The non-arm’s-length rules, fair market value and section 84.1 can change the nature of the proceeds received.
The transaction should therefore be planned as both a commercial transfer and a tax transaction. A family relationship does not eliminate the need for valuation, real financing and documentation comparable to an external sale.
Why section 84.1 is central
When an individual sells shares of a Canadian corporation to another corporation with which the individual does not deal at arm’s length, part of the proceeds that might otherwise produce a capital gain can be deemed to be a dividend. The rule is intended in part to prevent corporate surplus from being extracted as a gain.
The calculation depends on adjusted cost base, paid-up capital, consideration received and the history of the shares. Reorganizations, freezes and earlier transfers should therefore be traced before the price or payment method is set.
Intergenerational transfers: confirm the current conditions
Special rules may allow a genuine intergenerational transfer to be treated as a gain rather than a dividend. The framework includes conditions involving control, children’s participation, management, time periods and the retention of interests in the business.
A paper sale under which the parent continues to control and operate the business with no meaningful transition may not satisfy the conditions. The plan should describe the operational succession as clearly as the financing.
Establish fair market value and financing
The price must be supportable even when the parties are family members. A low value may confer a benefit; an excessive value can leave the buyer with debt that the business cannot service. The valuation should consider earnings, assets, risk and payment terms.
Vendor financing, promissory notes, future dividends and guarantees should be modelled. The parties need to know where repayment funds will come from and how much commercial risk remains with the seller.
- Independent valuation or value memorandum appropriate to the business size.
- Sale agreement and notes reflecting the actual terms.
- Transition plan for control, management and responsibilities.
- Repayment capacity based on reasonable cash flow.
Coordinate the capital gains deduction and succession
Even when capital-gain treatment is available, the shares must meet the relevant conditions before the capital gains deduction can be considered. Passive assets, associated corporations and pre-sale transactions can affect eligibility.
The transaction should also be integrated with the will, shareholder agreement and the seller’s retirement plan. Our corporate reorganization and tax planning services can coordinate these steps.
Treat a family sale as a real transaction
A successful succession is not a simple transfer of a share certificate or reliance on one tax rule. It requires a price, financing, transfer of control and documentation that reflect what the family will actually do.
Impôts Ici can compare scenarios, analyze section 84.1 and prepare the financial information with legal advisers. To begin before signing, contact our team.
