To avoid triggering Section 84.1 of the Income Tax Act of Canada, which is designed to prevent surplus stripping (i.e., converting taxable dividends into tax-free capital gains), you need to carefully structure share transfers—especially when dealing with non-arm’s-length transactions, such as selling shares to a holding company or a related party.
🧠 What Triggers Section 84.1?
Section 84.1 applies when:
· An individual sells shares of a corporation to another non-arm’s-length corporation (e.g., a holding company).
· The seller receives non-share consideration (e.g., cash or promissory notes).
· The transaction attempts to use the Lifetime Capital Gains Exemption (LCGE) to avoid tax on the sale.
· The result is a deemed dividend, which is fully taxable and not eligible for the LCGE.
✅ Strategies to Avoid Section 84.1
1. Sell to an Arm’s-Length Party
· Section 84.1 does not apply to arm’s-length transactions.
· If possible, structure the sale to a third-party buyer.
2. Avoid Non-Share Consideration (Boot)
· Receiving cash or promissory notes from the purchaser corporation can trigger Section 84.1.
· Stick to pure share-for-share exchanges to avoid deemed dividends.
3. Use a Section 85 Rollover Instead
· A properly structured Section 85 rollover can transfer assets to a corporation without triggering Section 84.1, provided no boot is received and the elected amounts are reasonable.
4. Leverage Bill C-208 for Intergenerational Transfers
· Bill C-208 allows genuine intergenerational business transfers to children through corporations without triggering Section 84.1, if certain conditions are met:
o The child controls the purchasing corporation.
o The business continues to be actively operated.
o The seller does not retain undue control.
5. Use a Trust or Estate Freeze
· In some cases, using a family trust or an estate freeze can help pass future growth to the next generation while avoiding surplus stripping.
· Must be carefully structured to comply with CRA rules.
⚠️ Risks and Costs of Triggering Section 84.1
· Loss of LCGE: You may lose access to the capital gains exemption.
· Deemed Dividend: Entire proceeds may be taxed as a dividend (fully taxable).
· CRA Scrutiny: These transactions are closely monitored and audited.
Would you like help modeling a compliant intergenerational transfer or reviewing a proposed transaction to ensure it avoids Section 84.1?
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