From farming to fishing and countless other industries, the family-run business is an integral part of the Canadian economy. Passing along those businesses to the next generation is one reliable way for families to create a legacy for themselves and generate employment for their children, grandchildren and communities.
In recent years, the federal government has introduced measures designed to help these small businesses that have had unintended consequences for the intergenerational transfer of businesses. Fortunately, Ottawa, in its recent budget, announced its intention to bring clarity to this issue. Whether these measures succeed will depend on how well the government can engage with various stakeholder groups to deliver on the budget’s promises.
The value of the small-business sector to the Canadian economy is well documented. According to federal data from December 2019, small businesses make up 98 per cent of all businesses in Canada and provide jobs to more than two-thirds of the private labour force.
The pandemic hit them hard. Statistics Canada found that small-business owners are nearly twice as likely to express uncertainty over their outlook as their medium-sized or large-business counterparts.
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So it is encouraging to see the federal government recommit itself to the growth of small businesses in its latest budget, placing them “at the heart of our economy and our communities.”
To that end, the budget includes measures designed to stimulate growth, and specifically to keep small family-owned businesses in the family.
The most significant measure is a followup to what was formerly Bill C-208, which received royal assent in June 2021. With roots dating back to an economic statement issued by the Liberal government in 2017 signaling its intention to enact private tax reform, Bill C-208 set out to facilitate and even encourage intergenerational business transfers. It did so by excluding certain transfers from a section of the Income Tax Act that prohibits “surplus stripping”— that is, returning the after-tax profits of a business to an individual as a low-tax capital gain rather than as a high-tax dividend. Without this change, these roadblocks have historically made it more attractive for owners to sell their business outside the family, from a tax perspective.
But the new rule wasn’t watertight. Shortly after the enactment of the bill, the government stated its intention to introduce amendments to Bill C-208 to ensure the new regulations were used only for implementing genuine intergenerational business transfers rather than opening the door to tax avoidance.
Canadians considering the transfer of their small businesses using these soon-to-be-changed rules were left with the same questions they had before C-208: Would they be subject to audits in the future? Would their tax treatment be revoked? Would it be better to wait, but risk a change in circumstances?
Now the federal government is hoping to clear up some of that uncertainty by implementing new legislation in the fall. Before releasing it, the government is embarking on a comprehensive consultation process.
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Certainly, the transfer of businesses from parent to children can occur in a tax-efficient way when said parent retires or dies — but that’s little comfort to small-business owners who would prefer to see their children carry on their legacy or guide them as they do so. These rules should correct that, providing greater peace of mind to the nearly 60 per cent of small-business owners aged 50 and over who may be contemplating retirement in the next several years.
The government cannot succeed in helping small businesses innovate and grow if it does not get Bill C-208’s successor right.
As part of the consultative process, the government should consider some key factors.
First, make sure the rules apply only when there is a bona fide intergenerational transfer of the business, not when the main objective is surplus stripping. Then, decide which businesses qualify under the new rule.
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The government should also determine if there is a policy desire to ensure the business stays in the family for a defined period post-transfer and what measures are needed to ensure compliance. Finally, identify if there is a policy desire to put guardrails on the payment terms when businesses are transferred to the next generation. Must the children reimburse the value of the business? If so, what are the repayment terms, and what sources of funds — business or third party — can they use?
If done right, this initiative will finally remove the tax incentive for existing small-business owners to sell to non-family members. It gives the next generation of entrepreneurs a fighting chance when their parents consider selling. It also gives those who are most likely to drive economic growth — the children or grandchildren of entrepreneurs — the ability to start with their parents’ business as a platform rather than from scratch.
These measures alone won’t be enough to keep Canada’s family-owned small businesses afloat. The support that burst forth during the pandemic — one survey found that 75 per cent of Canadians said the pandemic has made shopping and supporting businesses in their community more important — must continue. Small businesses still need the loyalty of everyday Canadians.
But such measures will help build continuity within small-business ownership, legitimizing the hard work and financial commitment of founders who want to build something they can pass on to their children or grandchildren.