Family Business Succession
Section 84.1 creates deemed dividends when children use corporate funds to buy parents' shares. Custom-written for CPAs.
Hugh Woolley
Learn how new intergenerational transfer rules allow parents to claim capital gains exemption while children pay with corporate funds. You will understand immediate transfer conditions completed in 36 months versus gradual transfer over 60 months, butterfly reorganizations separating real estate from operations, and redemption programs for investment companies under RDTOH.
Parent sells operating company worth $2 million to child's holding company. Child takes back promissory note. Operating company pays dividends to child's holding company repaying note over time. Section 84.1 applies creating deemed dividend. Parent owes $940,000 tax immediately instead of expected $70,000 over 10 years. The structure fails.
Section 84.1 historically prevented parents from claiming capital gains exemption when children used corporate funds to pay purchase price. This forced either children to fund purchase with after-tax personal dollars or parents to forgo the exemption. New 2024 intergenerational transfer rules replaced Bill C-208 allowing genuine business transfers where parents claim exemption and children use corporate funds. Two methods exist: immediate transfer completed in 36 months and gradual transfer over 60 months. Both require strict conditions. Failure creates retroactive deemed dividend with joint and several liability.
This session covers complete family business succession strategies from fundamental considerations through technical transfer rules:
- Relationship dynamics: parent/adult/child transitions, owner versus employee versus family member roles
- Business benchmarks: F1 Co providing job only, F2 Co generating profits, F3 Co including real estate
- Butterfly reorganization separating real estate from operations tax-free
- Freeze approaches using fixed-value preferred shares with trusts holding common growth
- New intergenerational transfer conditions: control tests, ownership limits, active engagement requirements
- Immediate (36 months) versus gradual (60 months) transfer timing and control standards
- RDTOH system redemption programs when real estate rented to arm's length tenants
The new rules require parent cannot control purchaser corporation or subject corporation at disposition time and all times after. Immediate transfer tests both de jure and de facto control. Gradual transfer tests only de jure control. Parent cannot own over 50% of shares except non-voting preferred freeze shares. At least one child age 18 actively engaged in business throughout 36-month or 60-month period. Child takes over management within timeframe with parent permanently ceasing management. Businesses remain active throughout. Parent and children file joint election. If any condition fails the entire plan collapses retroactively creating immediate deemed dividend taxed at ineligible rates.
Family business succession requires balancing tax efficiency with family dynamics, management capability, and financial reality. This program gives you comprehensive framework from initial considerations through technical execution. You will understand when immediate transfer works for straightforward situations versus gradual transfer for complex management transitions. Learn to structure butterfly reorganizations, implement effective freezes, calculate redemption programs, and most importantly recognize when traditional approaches serve clients better than risking retroactive deemed dividends with joint liability exposure.
Seminar Snapshot
This program walks through family business succession from fundamental considerations through complex new intergenerational transfer rules. Learn at your own pace with instant access.
Family Business Succession
Course Syllabus
Family Business Succession Fundamentals
Understanding why, when, and how to transition businesses to the next generation
Reasons for Family Succession
- Logical and natural successors if children actively engaged in business
- Provide job, career, and financial opportunity to children
- Assist children financially and reward their efforts
- Lasting legacy keeping business in family
- Children bring new talents, skills, and energy (tech-savvy generation)
- Easy way to get paid over time versus arm's length sale
Critical Questions and Challenges
- Are children capable of running business
- Are children interested or do they prefer a different career
- What if one child interested, others not
- How to treat all children fairly (not necessarily equally)
- Will children get along with each other
- Level of politics and drama in family
- Level of commitment by children
- Do parents want full payment or give business away
- Can business support multiple families
Relationship Complexity
- Parent/adult/child relationship dynamics
- Owner versus employee versus family member roles
- Shareholder accrues value from business ownership
- Employee paid salary for work performed
- Family member has emotional interest, legacy, family dynamics
- Conflict arises when roles overlap creating different motivations
Three Business Benchmarks
- F1 Co: $2M revenue, $200K profit, provides owners with job, minimal value beyond working capital, struggles to support multiple families
- F2 Co: $8M revenue, $1.6M profit, valued at 5x pre-tax earnings = $8M, produces significant after-tax income, accumulates surplus cash
- F3 Co: F2 Co plus $10M real estate purchased years ago, total value $18M, more complex with operations and real estate aspects
Butterfly Reorganizations and Estate Freezes
Separating real estate from operations and implementing freeze structures
Operating Business Versus Real Estate
- Operating business requires ongoing management effort, value depends on future success
- Real estate has intrinsic fundamental value, can be rented, sold, or financed if business fails
- Common to treat differently in succession planning
Butterfly Reorganization
- Type A butterfly splits real estate into separate corporation (PPM Realtyco) from operating company (PPM Opco)
- Tax-free reorganization, no new entity for business so easy to carry out
- Land transfer tax exemption in Ontario for type B butterfly or affiliate exemption
- Fair market value rent now charged reducing operating company value
- $400K annual rent reduces pre-tax income from $1.6M to $1.2M, value drops from $8M to $6M
Freeze and Earnout Approach
- Parent reorganizes shares into fixed-value preferred shares
- Trust established for children obtains common shares
- Operating company frozen for active child and family
- Real estate company frozen for all children recognizing family ownership
- Parent paid over time through redemptions
Pros and Cons of Using a Trust
- Pros: control (parent as trustee), financial flexibility (parent as beneficiary), multiply capital gains exemption, pass on in 21 years to grandchildren, include minors with section 74.4 caution, family law protection
- Cons: more complex, income splitting at age 24 with excluded shares TOSI exception fails if trust-owned
Active Income and Tax Implications
- Rental income from operating company to real estate company deemed active (associated corporations)
- No tax to establish structure
- Parent has capital gain on hand ($16M example), tax approximately $5.3M after $1.25M capital gains exemption
Section 84.1 and Historical Problems
Understanding surplus stripping rules preventing extraction of ACB created by the capital gains exemption
Section 84.1 Purpose and History
- 1972 capital gains introduced, estate and gift tax repealed
- Section 84.1 cannot strip V-day value (December 31, 1971 ACB) using corporate funds
- 1985 capital gains exemption introduced, section 84.1 extended
- Main rule: if ACB arises from capital gains exemption claimed by you or non-arm's length person and you use that ACB to strip funds from corporation, deemed dividend results
The Family Business Dilemma
- Parents sell $2.5M business to child's holding company, claim capital gains exemption
- Child takes back note, uses corporate dividends to repay note
- Section 84.1 applies: note creates deemed ineligible dividend to child
- Tax to child immediately: $2.5M note requires $4.7M gross dividend, $2.2M personal tax
- Alternative: parents don't claim exemption, cost $900K tax (still expensive)
- Unfair: rule does not apply to arm's length sale, discriminates against families wanting genuine intergenerational transfers
Failed Planning Attempts
- Many attempts to convert soft ACB to hard ACB applying GAAR
- Pomerleau, Descarries, Wild cases all found subject to GAAR
- Quebec developed provincial rule solving issue provincially, ignited political debate
- Result in many cases: family business sold to unrelated party instead
New Intergenerational Transfer Rules
2024 rules replacing Bill C-208 allowing capital gains treatment with corporate funding
Overview of New Rules
- Deems sale to occur at arm's length when conditions met
- Parent owns subject corporation personally (not through trust)
- Shares must be QSBC or FFFC (family farm fishing corporation)
- Transfers to purchaser corporation controlled by children at least age 18
- Child includes: child, niece, nephew, grandchild, and same for spouse/common-law partner
- Joint election required, can only be used once
- Parent and children jointly and severally liable for additional tax if conditions not met
Two Transfer Methods
- Immediate Transfer (Subsection 84.1(2.31)): completed in 36 months
- Gradual Transfer (Subsection 84.1(2.32)): completed over 60 months to 10 years
- Substantive conditions largely same, differences in timing and control standard
Control and Ownership Conditions
- At disposition time and all times after: parent cannot control purchaser corporation, subject corporation, or relevant group entity
- Immediate transfer: parent cannot have de jure or de facto control
- Gradual transfer: parent cannot have de jure control only (de facto not tested)
- Parent cannot own directly or indirectly over 50% of shares except non-voting preferred shares (freeze shares carved out)
- Non-voting preferred shares defined as specified class (non-voting, fixed value, dividend not exceeding prescribed rate)
After Disposition Conditions
- Throughout 36 months (immediate) or 60 months/final sale time (gradual): children must have de jure control of purchaser corporation
- At least one child age 18 engaged on regular, continuous, substantial basis in business
- Within 36 months (immediate) or 60 months (gradual) one child begins managing business, parent permanently ceases management (parent can have advisory role)
- All businesses relevant to QSBC/FFFC status must remain active throughout period
Exceptions Allowing Early Sale
- Child sells to arm's length party (must sell 100%)
- Child sells shares to another child (conditions continue to apply to new child)
- Manager child suffers mental or physical impairment or death
- Business liquidates with all assets to creditors
Immediate Versus Gradual Transfer Comparison
- Immediate: shorter time (36 months), more flexible with freeze share retention, more stringent with de facto control test
- Gradual: longer time for things to go wrong, but also more time to meet management condition in complex transitions, uses only de jure control test
- Gradual has additional ownership conditions at "final sale time"
Risks and Pitfalls of New Rules
Understanding what can go wrong and joint liability implications
What Happens If the Plan Fails
- Retroactive impact: arrangement reverts to default rules, note deemed dividend immediately
- Parent has immediate ineligible dividend (example: $2M dividend taxed at 47% = $940,000 versus expected $70,000 over 10 years)
- Additional tax of $870,000 if plan does not work
- Parent and children jointly and severally liable
Common Pitfalls
- Child group ceases to have active person throughout required period
- Management control not passed from parent to child group
- Sale of operating company within 36 months without meeting exception conditions
- Operating company ceases active business or changes business
- Child group ceases to control purchaser corporation (except on complete sale)
- Another person controls operating company legally or de facto
- Gradual transfer: taxpayer goes from onside to offside on ownership condition (depends on interpretation of "final sale time")
Trust and Structure Limitations
- Cannot use trust for parent to hold shares (must remove first)
- Cannot use trust for children to control purchaser corporation (must be direct control)
- Only one purchaser corporation allowed (possibly separate holding companies above)
- If reversionary trust rules subsection 75(2) applied, trust cannot rollout tax-deferred to beneficiary other than transferor or spouse
Relevant Group Entity Issues
- Transfer of ownership and control conditions also apply to relevant group entity
- Relevant group entity: any entity carrying on active business relevant to determining QSBC or FFFC status
- Example: real estate company rental income deemed active because associated with operating company, therefore transferring real estate company requires also transferring operating company
- Operating company can transfer standalone without real estate company
Practical Application and Case Studies
Working through complete examples with calculations
Simple Immediate Transfer Example
- David owns operating company $2M value (ACB nil), $1M capital gains exemption available
- Evan (child) sets up holding company, buys operating company for $2M note
- Conditions met: Evan actively engaged, controls holding company, active business throughout 36 months, joint election filed
- Operating company pays dividends to Evan's holding company, repays David $200K per year (10-year reserve allowed)
- Result: capital gain to David (not deemed dividend), may claim exemption, minimum $200K gain reported per year cumulatively before exemption claim
- Gain below $250K per year subject to 1/2 inclusion rate
- David claims exemption gradually keeping marginal tax rate low
Large Value Transfer Considerations
- Frank and Francine own real estate company $40M value, well above capital gains exemption limit
- Advantages: use corporate funds, claim 10-year reserve, claim capital gains exemption (minor as percentage of total)
- Question: is it worth the risk for large values where exemption percentage is small
PPM Operating Company Sale to Mary
- Value $6M, Peter has $1.25M capital gains exemption available
- Mary sets up holding company, buys PPM Opco for note
- Dividends from PPM Opco to Mary's holding company pay note to Mary who pays Peter
- Peter does not claim capital gains exemption (costs $450K in this approach)
- Alternative to new intergenerational transfer rules with less risk
Section 74.4 Freeze Issue
- If minor children can benefit under trust, imputed income to parent at prescribed rate times value of preferred shares
- At 5%, deemed interest income on $16M freeze = $800K per year
- Prescribed rate floats quarterly
- Exception if small business corporation
- Solutions: parent receives dividends on preferred shares equal to imputation (grossed-up), exclude persons under 18 and spouse from trust benefits, ensure corporation remains small business corporation
RDTOH System and Redemption Programs
Managing investment real estate under the refundable dividend tax system
RDTOH System When Real Estate Not Used in Active Business
- Real estate rented to arm's length tenants (not used by operating company)
- Butterfly proceeds, real estate company now under RDTOH system
- Capital gains exemption not available for operating company for 24 months (had over 50% assets not in active business)
- Must use redemption approach for real estate company (not capital gain approach)
RDTOH Calculations
- $400K rental income, 50.2% tax = $200,800
- RDTOH refund on ineligible dividend = $122,667
- Net corporate tax = $78,132 (approximately 20%)
- Dividend to obtain full refund = $320K
- Personal tax on dividend at 47.74% = $152,768
- Parent after-tax income = $167,232
Redemption Program Timeline
- Initial preferred share value $10M
- Annual redemption $320K producing dividend obtaining refund
- Preferred shares reduced to $9,680,000 after year 1
- Continues for 33 years to complete redemption (parent age 100)
- In practice rent increases over time shortening period
Redemption Formula
- v = value of preferred shares
- r = return on rent as percentage of value
- t = tax rate net of dividend refund
- Annual redemption = v x r (1-t)
- Percentage of value per year = r (1-t)
- Number of years = 1 / [r(1-t)]
- Example: 4% return, 19.5% tax rate = 31 years
Redemption Period Sensitivity
- 3% return = 41 years
- 4% return = 31 years
- 5% return = 25 years
- 6% return = 21 years
- 7% return = 18 years
- Very dependent on rate of return on share value
Refinements Shortening the Period
- Valuation discount for latent tax (20% discount changes 4% return to 5%, shortens to 25 years, parent age 92)
- Continue in estate 4 more taxation years with straddle year-end (shortens by 4 years)
- Rent increases 3% annually (year 20 rent $722K, average $561K, effective 7% return on $8M, shortens to 18 years)
- Combined refinements: 14 years during lifetime plus 4 years in estate, parent age 81 at completion (very realistic)
Additional Planning Considerations
Trust structures, control, family law, and timing
Reversible Freeze with Parent as Beneficiary
- Parent becomes beneficiary of freeze trust
- Eliminates issue of freezing too early
- Time horizon 21 years before decision required
- If comfortable after 21 years, trust distributes tax-free to children
- If not comfortable, trust distributes portion to parent
- Important to begin redemption program early (age 65) for real estate investment companies
Other Important Aspects
- Limits to discretion of discretionary trust (trustees cannot exercise arbitrarily, must consider best interests)
- Family law considerations (gift after marriage with suitable trust provisions provides protection)
- Maintaining control options: special voting shares, non-voting common shares, trustee role, trustee replacement power (but not for intergenerational transfer rules)
- Shareholders agreement especially useful if trust not used
- If parent is beneficiary: cannot be settlor, cannot be sole trustee (subsection 75(2) applies otherwise)
Observations and Recommendations
- New rules prone to going wrong, some factors beyond control
- Good for smaller situations where exemption meaningful percentage, not as good for large values with better alternatives
- Very specific transaction setup required, cannot vary much
- Rules very rigid and complex, need professional advice checking every aspect
- Consider having child group indemnify parents for additional tax (but reportable transaction)
- Checklist provided as guide (not foolproof)
- Big question: do you want to do this at all, or prefer traditional approach like estate freeze with redemption program
- Key point: retroactive adverse tax impact if goes wrong later
Meet Your Presenters
Michael Cadesky
Michael Cadesky is the managing partner at Cadesky Tax and a committed contributor to the tax and accounting professions since 1980, earning the title of Fellow from CPA Ontario. He is a past governor of the Canadian Tax Foundation, past chair of STEP Canada and STEP Worldwide, and past chair of the CPA Canada Tax Committee for Small and Medium-Sized Enterprises. Michael is also the co-author of 11 books on tax subjects and the author or co-author of numerous papers and articles on Canadian and international taxation.
Hugh Woolley
Hugh Woolley is an independent tax consultant who has taught income tax for over 30 years for a number of different professional organizations. Hugh has written courses for CPA Canada and over 10 papers for the B.C. Tax Conference as well as papers for the CTF's National Tax Conference and STEP Canada's National Conference. From 1990–1992 he worked at the CRA's Rulings Directorate in Ottawa writing "butterfly" tax rulings. Hugh is a past Governor of the Canadian Tax Foundation.
FAQ
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Immediately upon purchase. All course materials are available on-demand, allowing you to start learning right away.
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You have 1-year all-access to the course materials. Watch and review the content as many times as you need, at your own pace.
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Yes. Upon completion, you will receive a verifiable CPD certificate indicating all instructional learning hours and required details.
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Full video recording of the seminar, plus slides with detailed notes for your reference. Additional resources may be included.
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