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Bill C-208 – Surplus Stripping is Now Law, However Proceed with Caution

Prior to June 29, 2021, when a small business owner sells the shares of their company to a corporation owned by their children or grandchildren, the small business owner would be taxed at the higher dividend rate.  However, if that same transaction occurred with a corporation to which the small business owner was not related, the transaction would be taxed at the lower capital gains rates and may also allow the seller to access their lifetime capital gains exemption, resulting in no tax on the transaction.  Bill C-208 will even the playing field by providing the same tax treatment for intergenerational transfers as is available when shares are sold to unrelated third parties.

Bill C-208 is a private member sponsored bill that allows small business owners to claim capital gains treatment on the sale of the shares of their small business to family members and receive the same preferential tax treatment as selling to a third party.  Prior to this bill, a business owner who sold the shares of their corporation to a related person would be penalized with proceeds being taxed as dividends rather than capital gains.  The legislation is intended to facilitate intergenerational transfers.

Risk of Retroactive Changes

On June 29th, 2021, Bill C-208 received royal assent and became law, however the Department of Finance Canada will push parliament to retroactively amend this new legislation.  As it stands, the bill amends sections 55 and 84.1 of the Income Tax Act (the Act) to facilitate:

  • business reorganizations involving siblings and
  • the transfer of businesses to family members.

Although these amendments are now law, on June 30th the Department of Finance expressed concern via a press release with the breadth and scope of the changes and has publicly and explicitly indicated its intention to modify the legislation by amendment and make the amendments that have already passed to be effective January 1, 2022 along with additional changes.  There is risk these changes will be retroactive.  Consequently, relying on the legislative changes effected by Bill C-208 has the risk that the rules will change to something that we are not yet aware of.  However, there may also be an opportunity to take advantage of these changes now with the argument any retroactive legislation would be unjust.  Of course, you should be to be willing to defend your good position in court.

Capital Gains and the Lifetime Capital Gains Exemption

Capital gains are taxed at half the individual’s personal tax rate.  The lifetime capital gains exemption (LCGE) was introduced in 1984 and allows tax exemptions altogether on the capital gain on the sale of shares of certain Canadian controlled private corporations.  The LCGE in 2021 is $892,218.

The tax inclusion at only one-half and the LCGE are but two incentives for taxpayers to earn capital gains over other types of income.  In its simplest terms, a capital gain is the difference between the sale of an asset and the cost of that asset.  Section 38 of the Act notes a taxpayer is subject to tax on half the capital gain for the year from the disposition of property.  The capital gain is calculated as the proceeds of disposition less the adjusted cost base.

With the introduction of the LCGE it was recognized the exemption could be used to effectively strip out funds form the corporation tax-free.  Section 84.1 was introduced to prevent this.  As a result of the preventing provision, there has been an anomaly in which sales to related party corporations result in deemed dividends while sale to third party corporations is treated as capital gains.

Before Bill C-208 June 29, 2021

Currently, if you transfer the shares of your small business to your child, you can claim the LCGE.  You would not have to pay the tax on the first $892,218 of the capital gain and amounts over this would be taxed at half your regular rate of tax.  However, your child would pay you funds from his or her after tax dollars.  Essentially, they would earn money, pay tax on those earnings, and use the remaining funds to pay you.

However, before Bill-C-208, if you sell your small business shares to your child’s holding company for cash, a promissory note or other non-share consideration, then the promissory note, cash paid, or other non-share consideration would be deemed to be a taxable dividend received according to the surplus stripping rules in section 84.1 of the Act.  This will recharacterize your capital gains to a dividend, resulting in the transaction not qualifying for the LCGE and a higher tax rate would be due on the dividend income in comparison to the capital gains.

However, if you were to sell the shares of your small business to another corporation that you or your child are not related to, you would still get to claim the LCGE, and the third party busines could earn tax free dividends from the business you just sold them and use those funds to repay you.

As a result of the tax rules under section 84.1 before Bill C-208, an unrelated corporation would have a tax advantage of paying for the shares with pre-tax dollars, whereas a corporation that is related to you would not get the same preferential tax treatment.  Furthermore, it would be more advantageous from an after-tax perspective to sell to a third party than to sell to your own family.  Prior to the bill, there wasa a disincentive for intergenerational transfers of small business corporations, farms and fishing corporations.

What does Bill C-208 Change?

Bill C-208 amends section 84.1.  This section will not apply if the purchasing company is controlled by one or more of the seller’s children or grandchildren and the children or grandchildren are over the age of 18.  The purchasing company also cannot dispose of the shares within 60 months of the date of purchase.  The amendments will allow cash or promissory notes to be paid by the related purchasing corporation, essentially allowing a tax-free surplus strip.

There are qualifiers that include the business must be a qualified small business corporation (QSBC), or a qualified farm or fishing corporation.  The taxable capital of the company and the associated group cannot exceed $10 million.

Why is the Department of Finance Concerned?

The Department of Finance press release outlines their concern that highlights while the spirit of the legislation in facilitating genuine intergenerational share transfers is met, there are now opportunities for misuse and abuse resulting in tax avoidance and inequity in taxation.

Furthermore, while the effective date of the legislation is the date the bill received royal assent (June 29, 2021), the Department of Finance has outlined its intent to have this changed to January 1, 2022 along with a series of amendments to address its concerns.  This retroactive legislation is rare, and the validity could be argued in court if you want to take it that far.

A significant concern with the new legislation is that it allows a surplus strip without a genuine intergenerational transfer.  Although the amended rules require the children or grandchildren to control the purchasing corporation at the time of the purchase, this control could be for a moment in time and revert to the parent selling the corporation to allow the surplus strip.  The details of control over the purchasing company may also be de jure (or legal) control, rather than the broader meaning given by de facto control that includes influence over the corporation.  These anomalies are likely to be addressed by the Department of Finance for the January 1, 2022 amendments.  However, it is unclear how far these amendments will go to limiting the surplus stripping and access to the capital gains treatment on the sale of shares to corporations owned by family members.


While the laws have changed, it may be prudent to wait for further direction form the Department of Finance, the CRA and anticipated additional legislation before taking advantage of the new rules, unless you are willing to take an aggressive position and defend that position in court.

This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action. © 2021 Shajani LLP.

Shajani LLP is a CPA Calgary, Edmonton and Red Deer firm and provides Accountant, Bookkeeping, Tax Advice and Tax Planning services.


Nizam Shajani, Partner, LLM, CPA, CA, TEP, MBA

I enjoy formulating plans that help my clients meet their objectives. It's this sense of pride in service that facilitates client success which forms the culture of Shajani CPA.

Shajani Professional Accountants has offices in Calgary, Edmonton and Red Deer, Alberta. We’re here to support you in all of your personal and business tax and other accounting needs.