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The July 18, 2017 tax changes, if implemented, will make it harder for family members to benefit from the sale of a family business. The proposed rules suggest that children under the age of 25 will no longer be able to use the capital gain exemption when their shares are sold. As well, a spouse or any other related shareholder, who is “not active” in the business, also faces the risk of not being able to claim the exemption. Additionally, if the shares of the family business are held inside a trust, then the increase in value the shares experienced while in the trust cannot be sheltered with the capital gain exemption by anyone.
These rules do not come into effect until 2018, so if you were thinking that you were going to sell in the next couple of years, 2017 might be the time to get out. The tax climate for successful small businesses in Canada is deteriorating. Maybe you have had enough aggravation?
For those of us who are not ready to sell there is a potential reprieve. The government is suggesting there will be a tax election that could be made by the end of 2018. This election will allow a taxpayer to pretend they sold their shares and claim the capital gains exemption on the increase in the value of the business up to that point, likely sometime in 2017. The reason we would file this election is so that the gain will be taxed under the old rules. Any increase in value from 2017 forward will be taxed under the new rules.
Some of us remember all the excitement in 1994 when the $100,000 capital gain exemption was terminated and every Canadian taxpayer was able to pretend that they sold their cottage, or rental property or other investments and therefore increase the cost base of the investment. This is the same idea.
If we are going to be stuck with these bad tax changes then the election would be better than nothing. I would prefer, of course, that the July 18 changes not be made at all. Unfortunately it doesn’t sound like the federal government has any plans to listen to all the wisdom being sent their way.
If there is an election process, the July 18 provisions will avoid being retroactive taxation, the new rules will only apply going forward. The election would allow gains in the value of small businesses that have accrued while the more reasonable tax rules were in place to be protected. However, we are going to have to do some education - and soon. Business owners are going to need to know how and when to make this election.
These new rules are going to affect every family business. Imagine a family business with a married couple owning the shares. If the wife is more active in their home than she is in the business, then this business needs to file the 2018 election to protect the gain in the value of her shares which have accrued up to 2017. We need to estimate the value of the business so that we can do the election. Let’s imagine that the business is currently worth $100,000. $50,000 of that value may not be eligible for the capital gains exemption under the new rules, because those shares are owned by the spouse who works more in the home. This spouse is losing the ability to shelter the gain on her shares due to the 2017 tax changes. Every business owner is going to want to assess their situation and decide if they should just sell or make the election.
These proposed changes will have a negative impact on successful family owned businesses, but there will be some planning to be done.