Why can’t I just sell my shares to my own holding company?

Nothing stops you from selling shares of your operating company to a holding company you own. The trouble is the tax label on what you take back. Owners often expect a capital gain, perhaps sheltered by the lifetime capital gains deduction, and section 84.1 of the Income Tax Act can change that expectation.

When section 84.1 applies

It applies when a Canadian-resident taxpayer other than a corporation, such as an individual, sells shares that are capital property of a corporation resident in Canada to another corporation with which the individual does not deal at arm’s length and, right after the sale, the corporation sold is connected with the buyer corporation. A holding company you control is the standard case. The Act also deems people not to deal at arm’s length in some group situations, where the same small group controls both corporations.

What the rule does to your proceeds

If the holding company pays you only in its own new shares, the Act limits the paid-up capital it can add, so the new shares carry no more paid-up capital than the greater of the paid-up capital and cost base of the shares you gave up, reduced by anything else you take. If you also take cash or a promissory note, the portion above the greater of your shares’ paid-up capital and adjusted cost base (which subsection 84.1(2) adjusts for this purpose) is a deemed dividend paid by the holding company, taxed as a dividend rather than a capital gain.

The capital gains deduction does not apply to the deemed dividend

The Canada Revenue Agency describes the lifetime capital gains deduction as a deduction against taxable capital gains that an individual realizes on certain properties, such as qualified small business corporation shares. A deemed dividend is not a capital gain, so the deduction does not apply to that part.

Where to take it from here

The Business Development Bank of Canada notes that an accountant can help ensure a sale is structured to minimize tax liability, so model the transfer with one before signing anything. For the bigger structural choice, see should I sell shares or assets.