Intergenerational Business Transfer (Section 84.1)

Children who buy a family company rarely pay from personal savings. They usually incorporate a holding company, which buys the parent's shares with a promissory note repaid from dividends the operating company pays up to it. For years, that structure had a tax problem.

Section 84.1 of the Income Tax Act is an anti-surplus-stripping rule. When an individual resident in Canada sells shares of a corporation resident in Canada to another corporation they do not deal with at arm's length, and the two corporations are connected afterward, non-share consideration above the greater of the shares' paid-up capital and their adjusted cost base (modified for past capital gains exemption claims) is treated as a dividend, not a capital gain. A parent is related to a corporation their child controls, so they are deemed not to deal at arm's length. A parent who sold to a stranger's holding company got capital gains treatment and could use the lifetime capital gains exemption; the same sale to a child's company produced a taxable dividend.

Paragraph 84.1(2)(e) now fixes that for genuine transfers. If the conditions for an immediate transfer in subsection 84.1(2.31) or a gradual transfer in subsection 84.1(2.32) are met, the parent and the child's company are deemed to deal at arm's length, and the sale is taxed as a capital gain.

How the rule changed. Private member's Bill C-208 (Royal Assent June 29, 2021) introduced a first, looser exception. Bill C-59, the Fall Economic Statement Implementation Act, 2023 (Royal Assent June 20, 2024), replaced it with the current immediate and gradual paths for dispositions on or after January 1, 2024. Bill C-15 (Royal Assent March 26, 2026) made technical amendments retroactive to January 1, 2024.

• The seller is an individual, not a trust, and has not already used the exception after 2023 for shares that derive their value from the same business.
• The buyer is a corporation controlled by one or more of the seller's children, each at least 18. Child is defined broadly: children, grandchildren and great-grandchildren, step-children and children-in-law and, for these rules only, nieces and nephews of the seller or the seller's spouse, their spouses and their children.
• The shares are qualified small business corporation shares or shares of a family farm or fishing corporation at the time of sale.
• Control passes at closing. From the sale onward, the parent, alone or with a spouse, cannot control the operating company, the purchaser or related business entities, and cannot own 50% or more of any class of shares other than non-voting preferred shares.
• Growth shares go within 36 months. By then, the parent and spouse may own no shares of those corporations other than non-voting preferred shares.
• Joint election. The parent and the child, or each child in the controlling group, jointly elect on Form T2066, Election for Immediate or Gradual Intergenerational Business Transfer, by the parent's filing-due date for the year of the sale.

A child must be actively engaged on a regular, continuous and substantial basis. Working in the business an average of at least 20 hours a week, the safe harbour from the tax on split income rules, satisfies the test, but since the 2026 amendments it is not the only way. Management means directing or supervising the business; giving advice does not count, so a parent can remain a sounding board.

The immediate path suits a parent ready to step back within three years who may keep a note or non-voting preferred shares indefinitely. The gradual path suits a parent who wants up to five years to hand over management, in exchange for a firm ten-year deadline to reduce what remains, including notes owed to them. Relief is built in for some events outside the family's control, such as a child's death or severe and prolonged impairment, and for certain later arm's-length sales or transfers to another child.

When the conditions are met:

• The parent reports a capital gain, not a dividend, and can shelter it with the lifetime capital gains exemption, up to the limit for the year of sale.
• Where the price is paid over time, the gain can be spread over up to 10 years under subsection 40(1.2), instead of the usual five; see capital gains reserve.

If a condition later fails without relief, for example because no child stays actively engaged or the parent keeps running the business past the deadline, the CRA can reassess the parent as if section 84.1 had applied, producing a deemed dividend, and the extended reassessment windows mean that can happen years after closing. Every child who signed the election is jointly and severally liable for the parent's extra tax under subsection 160(1.5), which makes the children's own plans part of the parent's tax planning.

The transfer is a share sale and is documented like one:

1. A valuation of the shares, because the price must reflect fair market value, and confirmation of QSBC status before closing.
2. Often an estate freeze or articles of amendment first, to create the non-voting preferred shares the parent may keep.
3. Incorporation of the child's holding company and a share purchase agreement between the parent and that company.
4. A promissory note for the deferred price, with security and default terms that do not hand control back to the parent.
5. Resignations, new officer appointments and a dated transition plan in the minute book, as evidence of the management handover.
6. A shareholder agreement among siblings who buy together, covering what happens if one leaves the business during the qualifying period.
7. The T2066 election, prepared with the family's accountant and filed on time. The CRA may accept a late or amended election, but only at its discretion.

A family sale should also be weighed against a third-party sale or an employee ownership trust. Lamba Law's selling a business practice prepares the transaction documents and works with the family's accountant on the tax filings.

Harjit Gill, 64, owns all the shares of Gill Precision Machining Ltd., a Brampton machine shop. A valuator puts the shares at $3,000,000, their paid-up capital and tax cost are $100, and his accountant confirms they are qualified small business corporation shares. His daughter Simran, 38, has been plant manager for nine years and wants to buy the business.

In May 2026, Simran incorporates Simran Gill Holdings Inc., which buys Harjit's shares for a $3,000,000 promissory note payable over ten years from dividends the operating company pays up to her holding company. Without the exception, almost the entire note would be treated as a dividend to Harjit. They choose the immediate path: Simran's company controls the operating company from closing, Harjit keeps only the note, and he resigns as president at closing, staying on for two years as a paid adviser. Harjit and Simran file Form T2066 by April 30, 2027, Harjit's filing-due date for 2026.

Harjit reports a capital gain, claims his lifetime capital gains exemption, and spreads the rest of the gain over the note's term using the 10-year reserve. For 36 months Simran must keep control and stay actively engaged in the business, and the CRA can reassess Harjit's 2026 return until three years after the normal reassessment period ends. Simran understands that if the conditions fail, she shares liability for her father's extra tax.