How can a child’s company pay a parent over time in an intergenerational share transfer?

A parent selling shares to a company owned by a child does not have to be paid in full at closing. The unpaid part of the price can stay as a debt the child’s company owes the parent, which BDC calls vendor financing, also known as a vendor take-back. For tax, the question is how the parent reports the gain while payment is spread out. The Income Tax Act has a longer reserve for intergenerational business transfers that meet its conditions. This page covers federal tax only.

What the longer reserve does

The CRA says a capital gains reserve usually lets a seller report a portion of the gain in the year proceeds are received, based on the portion not yet received. Subparagraph 40(1)(a)(iii) of the Income Tax Act sets the usual reserve fractions. Subsection 40(1.2) reads them as 1/10 and 9 instead of 1/5 and 4 when shares of a corporation resident in Canada are sold to another corporation and the conditions in subsection 84.1(2.31) or (2.32) are satisfied. The CRA describes the result as a nine-year reserve period, with the total gain included in income over ten years.

Who has to control the buyer

The CRA says that generally a reserve cannot be claimed if the seller sold the property to a corporation the seller controls in any way. Both routes in section 84.1 instead require, among other conditions, a purchaser corporation controlled by one or more children of the taxpayer, each aged 18 or older, and shares that are qualified small business corporation shares or shares of a family farm or fishing corporation. For these transfers, subsection 84.1(2.3) defines a child more widely than a son or daughter, including a niece or nephew. The parent’s role after closing is set by the same subsections, so read them with your accountant before the price terms are fixed.

The debt itself and the election

Under the gradual route, s.84.1(2.32)(f) limits the interests, including debt, that the parent and spouse may own in the companies within 10 years after the sale and afterwards, so read it before the loan terms are fixed. BDC notes that vendor financing is almost always junior debt, subordinate to bank loans and other financing. If a bank is also lending, ask the lender how it will treat a debt owed to the parent. Each route also requires the parent and the child, or each child in the group, to jointly elect in prescribed form and file the election by the parent’s filing-due date for the year of the sale; the CRA’s form for this is T2066. Finance Canada’s explanatory notes describe the reserve as available over up to a ten-year period when the conditions are satisfied. For the wider picture, see transferring a business to your children.