In today's episode Jason and Kim are going to talk on a topic that has been in the news recently the Bill C-208. It is a private member's bill that amends the Income Tax Act (Canada) (ITA) in an attempt to alleviate the financial disadvantage that typically arises for taxpayers who sell their business, family farm or fishing corporation to their children or grandchildren, as compared to selling to an arm's length third party. This disadvantage is caused by certain tax rules, specifically an anti-avoidance rule in section 84.1 of the ITA. Despite Bill C-208's best efforts to "fix" this problem, the language used in the legislation does not appear to work as intended. It raises many concerns that will likely need to be addressed by the government through further amendments to the legislation. Kim is here to talk about what the heck this thing is and how it affects business owners in general.
Episode Highlights:
- 01.14 Kim talks about Bill C-208 that has been in the news recently. He explains what it is, what it is trying to fix, and how this has gotten so twisted?
- 01.40 Kim: In 1985, the Government of Canada introduced the capital gains deduction, and most business owners know the capital gains deduction. It started off with $500,000 if you own shares of a qualified small business corporation, which generally means active business, not a lot of passive assets, or qualified farm property, and you disposed of that, then you would be able to claim the 1st $500,000 of gains tax-free so, that first came in 1985. Back then government was smart enough and introduced some anti surplus tripping rules around capital gain deductions.
- 02.25 Kim says that to understand surplus tripping, you first need to understand the only way you can remove after-tax corporate retained earnings or what we call surplus? So, it's after-tax surplus in a corporation and remove it to its shareholders. What is the only way by definition?
- 03.31 Jason says he is a big believer in Charlie Munger's saying – "Show me the incentive, and I'll show you the outcome." He says, "If I could find a way to be creative and find a way to have money recharacterized as a capital gain instead of a dividend, and then by nature, I am going to find a way to do it."
- 05.50 Kim affirms the government who has been concerned about surplus stripping they have always been concerned about that because capital gains were not taxable in Canada until 1972. So, prior to that, capital gains were without tax.
- 06.30: Kim asks in 1985 when they introduced the capital gains deduction. They introduced the anti-surplus stripping rule to prevent the withdrawal of surplus in conjunction with the capital gains deduction, and how did they do that?
- 09.00 Kim says in 2017, during the private corporation tax battle, the government introduced these anti surplus stripping rules. Do they finally had enough? The courts have been sympathetic to surplus tripping over the year because there's no provision that outright prohibited. There are anti-avoidance abuse rules like 84 sub two and the journal entry orders rule that the government can invoke, but they've never been really that successful in recharacterizing a capital gain as surplus as a dividend.
- 09.52 Jason reiterates it wasn't such a scattered piece of legislation across the city in this country's history, at least when it comes to tax that's refer.
- 10.38 Kim says fast forward to August, September and there the government was just getting beaten up hard and finally the press somewhat understood the issues and so they're becoming a little more sympathetic rather than just saying, "Hey, this is great and buying into the government line, and so they abandoned in October of 2017 these crazy circle stripping proposals."
- 12.30 Kim recalls somewhere around 2013 a private member's bill was introduced to try and solve the above-mentioned issue, but it was quickly shut down and killed like most private members' bill.
- 14.40 Kim explains the governing for 18 or 19 liberals that studied this issue and voted against party lines finally have enough because this issue has been around for a long time and so knowing full well that it got passed or that it's imperfectly. They thought we are going to squeeze the department of finance into a corner here and force them to deal with this issue. So, today we have the legislation in place.
- 16.10: Jason agrees that they have now set a new precedent that a bill can reach low assent. If it does not specifically state the date at which it starts, the President can kick it down the road as smart as far as they want.
- 16.30: Kim clarifies that the interpretation Act specifically deals with this, and it's quite clear that if there's no effective date or coming into force provision, it is effective law on the date that it receives oral assent.
- 17.52: Kim says in an unprecedented news release that came out on 19th July from the Department of Finance, they clarified that it is actually Krista Freeland, so the Minister of Finance, who confirmed that Bill C208 is effective law.
- 19.40: Kim points out that if it is any government that comes out and recognizes that this piece of legislation that has passed is imperfect and allows for abuse; because let's be serious, should surplus that is removed from a corporation be taxed as a capital gain? In my opinion, generally, No.
- 20.03: Should surplus remove from a corporation be taxed as a capital gain? Kim generally thinks the answers should be consistent with accounting 101, which is No. It should be taxed as a dividend. There are exceptions to that general rule, and so he blames the government for being concerned about abuse and surplus surfing.
- 22.40: Kim is not sympathetic to the government. He says that the Department of Finance has other priorities, and COVID certainly shifted a lot of those priorities. They have had 36 years to deal with this issue. Instead, they decided to play politics with it and go on a listening tour instead of actually having the bureaucrats, you know, roll their sleeves up and come up with some solutions.
- 24.00: Kim inquires How many clients do you deal with on a year-to-year basis that are transferring their business to the next generation? He further says, "Certainly some, but as a great is it one month, two months, three months, 10 months? I would say it's probably on average for me, and I have been doing this a long time, maybe once a year."
3 Key Points:
- Bill C-208 was granted Royal Assent on Tuesday, 29th June. It amended the Income Tax Act (ITA) to provide tax relief to families who wish to transfer shares of small businesses or family farms and fishing corporations to their children.
- Kim explains how the private member's bill, which is now passed into law as Bill C208, is imperfect and is very poorly drafted. There is no legitimate or illegitimate test for intergenerational transfer.
- Jason says Canadians like to believe and assume that their government does not purposely pass crappy legislation. This is something he has encountered multiple times.
Tweetable Quotes:
- "If a non-arms link corporation decides to buy your shares using money that is within their holding companies, the same kind of surplus, same kind of tax rate and then buys your shares it does qualify for the capital gains exemption." - Jason
- In the abandonment, they promised to fix the intergenerational transfer issue, and that was good. – Kim
- "You are indifferent to how you take money." – Jason
- "We have a flat piece of legislation, there are opportunists, who will try to take advantage of it. We know that this is going to get corrected because they've been eyeing this thing for a while and now, they have created a created a demon they got to slay." - Jason
Resources Mentioned
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