Proactive planning to multiply access to the lifetime capital gains exemption ("LCGE") for shares of a qualified small business corporation ("QSBC") or qualified family farm property ("QFFP") remains of ongoing interest to taxpayers and their family members that may be eligible to benefit. There is no apparent general opposition to such planning by the Canada Revenue Agency ("CRA") where it is carefully implemented through a family trust. However, there continue to be targeted audit challenges that must be carefully planned for (e.g., the CRA may assert that certain shares do not satisfy the detailed criteria to constitute QSBC shares at the relevant times). Moreover, in recent years, new considerations have arisen that should be taken into account when planning to multiply access to the LCGE.
Enhanced CRA audit capability? The CRA should have significantly more access to data related to LCGE planning through trusts, once compliance is underway with the new trust reporting rules, which are effective for taxation years ending on or after December 31st, 2023. These rules impose a requirement to file annual T3 returns on a wider range of trusts, including most family trusts, and such returns will be required to contain considerably more information than in previous years. Further information about these enhanced reporting requirements can be found in our previous article. This additional data will presumably enhance the CRA's audit capabilities in respect of trusts. Consequently, it is prudent to carefully implement any planning involving trusts with an increased expectation that an audit may occur.
Limitations on trustees' powers to allocate eligible capital gains? Previously, when allocating capital gains realized by a trust on a disposition of QSBC shares or QFFP, planners may have expected that trustees of a trust enjoyed considerable freedom to allocate such gains amongst beneficiaries that could best utilize the LCGE. However, the CRA has recently adopted a more restrictive view on the extent to which a trustee may exercise his or her discretion to allocate gains, some of which are eligible for the LCGE and some of which are not (CRA View 2021-0922021C6, June 15, 2022). The end result was effectively a proportionate sharing by the beneficiaries of the capital gains eligible for the LCGE. The CRA's administrative position is a reminder that specific attention is required to ensure an individual's LCGE balance can be utilized as desired.
Risks in respect of hybrid sale transactions? Hybrid sale transactions are, in general, complex transactions intended to allow vendors to complete what in effect is an asset sale, but which allow individual vendors to access their LCGEs. The recent decision in Foix c. Canada, 2023 FCA 38 adds complexity to this type of planning, because subsection 84(2) of the Income Tax Act (Canada) was applied to deem a taxable dividend to result from the portion of the hybrid transaction that was intended to trigger a capital gain eligible for the LCGE of the selling shareholders. It is notable that this case distinguished the transactions at issue from those considered acceptable in Geransky v. The Queen, 2001 DTC 243. Thus, it appears that hybrid sales remain a viable alternative, albeit with careful structuring.
Layers of additional reporting requirements? In addition to the new trust reporting rules noted above, planners must now also contend with the new "reportable transaction" rules and "notifiable transaction" rules previously discussed here. As an example, based on the broad descriptions of the "sample" designated transactions previously released, the notifiable transaction rules potentially could apply to a range of circumstances involving family trusts (e.g., if a trust makes a tax-deferred distribution to a Canadian resident corporate beneficiary with a non-resident shareholder). Planning will require ongoing attention to designated transactions (as they are released), to ensure reporting requirements are not inadvertently triggered. While there currently is no suggestion these rules will directly target LCGE planning, we note that similar rules in Quebec have some direct relevance.
More attention required to the GAAR? Proposed changes to the general anti-avoidance rules ("GAAR") announced in the 2023 Federal Budget will require renewed attention, particularly given the proposed introduction of a penalty regime. In the past, the GAAR was relevant to LCGE planning where, among other things, the deduction was attempted to be extended to spouses in what generally is referred to as the "half-loaf" plan (see for example the decision in Gervais v. The Queen 2016, TCC 180; aff'd 2018 FCA 3 previously discussed here and more recently in Mony c. Le Roi, 2022 CCI 120).
Overall, strategies related to multiplying the LCGE would still seem of value when contemplating a future sale of QSBC shares or QFFP. However, planning needs to take into account a growing number of new considerations.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
