Selling the family business to the kids: the tax rules now require the parent to leave

A FOUNDER who sells the company to a corporation owned by her daughter can now claim the lifetime capital gains exemption on the sale — $1,275,000 for 2026 — instead of having the proceeds taxed as a dividend. To qualify for this preferential treatment the founder has to go: off the board, out of the bank signing authority, out of the decisions, and stay out for three years, or five, with the Canada Revenue Agency watching for up to thirteen.

For most of the Act’s history, section 84.1 made the family the worst buyer a founder could pick. Sell to a stranger’s holding company and the gain was capital. Sell to your son’s holding company and the same cash was a deemed dividend, because the purchaser was non-arm’s length and “connected” to the target. Larry Maguire’s private member’s Bill C-208 broke that in June 2021; Finance announced within a month that the bill let surplus out “without any genuine transfer of the business” and would be rewritten. The rewrite arrived in Bill C-59, Royal Assent June 20, 2024. It applies to dispositions on or after January 1, 2024, and Parliament patched it again in Bill C-15 this March. What Parliament produced is a set of conditions that define, in statute, what “genuinely handing the business to your child” means. They are strict — probably stricter than most families are.

Two ways out

The exception in paragraph 84.1(2)(e) deems the parent and the child’s purchaser corporation to be dealing at arm’s length, which switches off the deemed dividend. To get there the sale has to satisfy either subsection 84.1(2.31) — the “immediate” transfer — or 84.1(2.32), the “gradual” one.

The immediate path is the cleaner tax result. From the moment of closing the parent, alone or with a spouse, cannot control the target, the purchaser or any related business — not legally, through votes, and not in fact. She cannot hold half or more of any class of shares other than non-voting preferred. Within 36 months she must own nothing but those preferred shares. For those same 36 months the children have to control the purchaser, at least one of them has to be actively engaged in the business on a regular, continuous and substantial basis, and the business has to stay active. And by the end of the 36 months, or such longer period as is reasonable, the parent must have taken reasonable steps to hand over management and to permanently stop managing.

The gradual path relaxes exactly one thing. The parent must give up legal control at closing but may keep factual control — the ability to run things through influence rather than votes. In exchange, everything else gets longer and one new test appears: within ten years, the parent’s retained interest in the business, debt and equity together, must be no more than 30 per cent of what her interests in the business were worth immediately before the sale (50 per cent for a farming or fishing corporation). A vendor take-back note is debt, and it counts. The CRA told the APFF in October 2024 that a deal where the child pays only 20 per cent of the price over ten years does not get there. The children’s control and engagement test runs 60 months instead of 36, and so does the management-transfer window.

Both paths require a joint election on Form T2066 by the parent’s filing-due date for the year of sale, signed by the parent and every electing child. Both are available once. Subsection 84.1(2.31)(a) and its twin in (2.32) close the door if the parent has already used the exception for shares deriving their value from the same business, which means a founder who sells 60 per cent to the kids’ holdco this year and the other 40 per cent in three years gets capital gains treatment on the first tranche only (and a founder who keeps 60 per cent fails the first tranche as well, because she still controls the company). The CRA confirmed at the 2024 CTF Roundtable that selling to two children’s corporations on the same day is one transfer, not two.

What “leaving” means to CRA

The statute defines management as “the direction or supervision of business activities” and then says it “does not include the provision of advice.” Advisers, rightly, read the second clause as room for a consulting agreement. What the room does not include is a board seat. Asked at the 2024 APFF conference whether a parent could stay on as a director through the transition, CRA said that a parent who does not completely and permanently cease to hold office within the 36 or 60 months has not met the management-transfer condition, and that it makes no difference whether she is the sole director or one of three. Retaining a class of voting “control shares” fails a different paragraph for the same reason: they are not non-voting preferred shares.

The vendor note is the other place families assume the rule will not look. It does. Under the immediate path the question is whether a note large enough, on terms harsh enough, gives the parent de facto control of the purchaser under subsection 256(5.1). In a February 2025 technical interpretation CRA said a non-interest-bearing note payable over fifteen years, guaranteed by the child, “would not, in itself” do that — but it said so after examining the note’s share of the total financing, its terms, the guarantee and whether the purchaser could have borrowed elsewhere. A parent who is the company’s only lender, on demand terms, with a personal guarantee from a child who could not refinance, is closer to the line than the memo’s structure chart shows.

Bill C-15 added something useful and something ominous on the same page. The useful part: steps taken before the sale to transfer management now count, so a daughter who has run operations since 2022 does not have to be re-installed after closing. The ominous part is in Finance’s explanatory notes, which observe that where the indicators of a transfer already existed before the disposition, the general anti-avoidance rule may be considered. The Department is saying, in its way, that a sale designed to look like a succession will be read as a sale.

What happens when the family breaks the rule

If any condition fails at any point in the compliance period, section 84.1 applies as though the election had never been made. The parent’s capital gain for the year of sale becomes a deemed dividend, the exemption claim disappears with it, and — this is the part the children should hear before they sign the T2066 — the electing children are jointly and severally liable for the parent’s additional tax under subsection 160(1.5). The CRA has extra time to find the failure: the normal reassessment period is extended by three years for an immediate transfer and ten years for a gradual one, under paragraph 152(4)(b.9). Moodys’ arithmetic puts that at six and thirteen years respectively for an individual.

The relief provisions in subsection 84.1(2.3) cover the obvious catastrophes. If the children sell the whole business to an arm’s-length buyer, the ongoing engagement and management tests are deemed met from that date. So too if the active child dies or suffers a severe and prolonged impairment, if the business is transferred to a sibling who then carries the conditions, or if creditors take the assets. None of the relief provisions reach the ten-year 30 per cent test on the gradual path, and none of them relieve the parent’s own ownership caps. A gradual transfer where the business collapses in year seven, with the vendor note still at 45 per cent of the original value, has relief for the child’s side of the test and none for the parent’s.

Six things to settle before the tax memo is right

First, decide honestly which path the family can live inside. If the founder cannot imagine not being a director, the immediate path is a reassessment waiting to happen and the gradual path buys only two more years before the same question comes due.

Second, build the child’s file now. The engagement test cross-references the 20-hour-a-week TOSI safe harbour in paragraph 120.4(1.1)(a), and Finance’s notes say fewer hours “may” still qualify on the facts. A dated employment agreement, a written transition plan and a record of the child’s growing authority are what “the facts” will consist of when CRA asks in year nine.

Third, size the note against the 30 per cent test, not against what the parent needs to retire. On the gradual path the amortisation schedule is a compliance document.

Fourth, resign. Board, officer positions, bank signing authority, personal guarantees on the operating line — each of these is a lever, and the parent’s continued hold on any of them is evidence on the de facto control question. The consulting agreement should describe advice.

Fifth, put the joint liability in the shareholder agreement. The children are guaranteeing the parent’s tax bill for up to thirteen years; they should have the information rights, the covenants and the restrictions on their own sales to protect the election, and the parent should have a covenant from each child to stay engaged.

Sixth, plan the exemption as a one-shot. The once-only rule means the structure has to move the whole business, or the whole of what the parent intends to move, in one transaction. The ten-year capital gains reserve in subsection 40(1.2) exists for exactly this: the founder can sell everything now and recognise the gain over a decade.

The rules Parliament wrote in 2024 are a description of a founder who has actually retired. The tax result is available to any family that matches the description. The election is the family’s sworn statement that it does, and the children sign it too.

Koby Smutylo is a business lawyer and mediator at Smutylo Law+ in Ottawa, called to the Bar of Ontario in 2001. His practice is fixed-fee corporate and transactional work for founders and owner-managed companies. Author photo courtesy Koby Smutylo. 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. Title image: iStock ID 127544823. Author photo courtesy Koby Smutylo.