‘Clock is ticking’ for Jan. 1 tax changes for private companies
Owners of family businesses and private companies in Canada have only a few days to make some key decisions
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Owners of family businesses and private companies in Canada have only a few days to make some key decisions before new tax changes come in that will affect and possibly penalize them.
“Most of the legislation that affects companies is coming into place on January 1, and one part of it is already in effect (the Mandatory Disclosure Rules),” says Richmond Hill, Ont.-based lawyer Adam Friedlan, who specializes in tax and estate planning.”
“The rules [the Mandatory Disclosure Rules] are new, they’re broad and it’s hard to know when you have to report, and yet there are significant penalties if you don’t report,” he says.
“The uncertainty about reporting requirements and timing is making transactions involving the sale or transfer of family and private businesses more complex,” Friedlan adds.
GAAR – General Anti-Avoidance Rule
The Jan. 1 changes include amendments to a Canadian income tax provision called the General Anti-Avoidance Rule (GAAR). The GAAR applies to transactions that comply with the letter of the law but not necessarily the spirit of the law — which is being revised to implicate transactions that lack economic substance.
An example of a transaction lacking economic substance would be a “capital gains strip,” Friedlan says.
Up to now, taxpayers had no obligation to disclose the transaction to the Canada Revenue Agency other than as part of their regular tax filings, and the CRA could apply or not apply GAAR based on existing law. If GAAR applied the taxpayer would pay the tax that would occur if the spirit of the laws had not been violated but there would be no penalty.
In terms of penalties, after Royal Assent of the legislation , if transactions are subject to GAAR, and the taxpayer does not voluntarily disclose the transaction the taxpayer will have to pay an additional 25 per cent of the tax savings they attempted to derive from the transaction,.
“There is no certainty as to when the GAAR applies, and it is not always clear when there is ‘abuse’ of the rules,” Friedlan says. The result is that taxpayers, are facing new possible penalties under the new regime, and taxpayers will not be sure when to disclose or not to disclose their deals.
“There will be considerably more uncertainty after January,” Friedlan says.
Bill C-208 revised rules
Changes affecting the intergenerational transfer of business come from a revision to a law introduced as Bill C-208 in 2021.
As Friedlan explains it, before this law, family members who bought and sold shares in a private corporation they held could not take advantage of the capital gains exemption of up to $1 million and use internal corporate funds to finance the transaction – an exemption that could free up funds to finance the change of ownership transaction.
The original private member’s bill changed this to make it easier to use the exemption. “However, the Department of Finance had concerns,” Friedlan says.
“So revised rules will come in, effective January 1, 2024, replacing the rules introduced by Bill C-208. These new rules are technically more complex and have additional requirements relating to who is involved in the business and to what extent the parents can hold shares (and of what type) in the business after the transfer,” Friedlan says.
“This makes the rules both harder to work with and narrows the circumstances in which they can be used. In other words, the rules are more complex and less generous to taxpayers.
“The effect of these new rules is a rush of transactions relying on the Bill C-208 rules in advance of January 1, 2024,” Friedlan says.
Indeed, a recent KPMG in Canada study found that nearly eight in 10 (79 per cent) Canadian family business leaders are speeding up their transition and leadership succession plans due to growing pressures both outside and inside the family.
“Notably, 70 per cent say they are accelerating their succession plans or putting them into effect before January 1, 2024, to avoid the incoming tax changes,” the KPMG survey said.
Alternative Minimum Tax
Rules relating to the Alternative Minimum Tax are also being tightened on Jan. 1, which requires taxpayers to pay a minimum amount of tax based on a parallel computation of income.
Until now, the federal AMT has been set at 15 per cent rate, with a basic exemption of the first $40,000 of income. Taxpayers whose AMT turned out to be higher than their taxes under the regular rules were liable for the higher AMT, but they could recover some of this back over seven years if their regular tax turned out to be higher.
The federal AMT is being changed in the new year to a minimum of 20.5 per cent rate. At the same time, the basic exemption to AMT is going up to $173,000, and the income base used to calculate the AMT is being broadened. There are implications to the Provincial AMT as well.
The revised AMT will affect wealthier people because of, among other things, the higher exemption amount Friedlan says.
For the wealthy, “the new AMT could raise the effective tax cost on capital gains, charitable donations, certain loss carryforward use and certain expenses, among other things. In particular, in future years if taxpayers realize large capital gains, they could be hit by a much larger AMT bill,” Friedlan says.
Mandatory disclosure rules
The mandatory disclosure rules are already in place, “but the tax profession is still digesting them,” Friedlan says. These rules could require people selling a business to report a sale if it has certain “hallmarks.” The rules could apply to transactions that the government designates as “notifiable.”
“The hallmarks can apply in a broad variety of circumstances, so private company owners can be faced with reporting obligations on relatively routine scenarios, and there are steep penalties for non-compliance,” Friedlan says.
“The government has issued guidance on this regime, but it is often hard to figure out when it applies. This is making transactions a bit harder to get through,” he adds.
Meanwhile, as the New Year approaches, “the clock is ticking,” Friedlan says.
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