- Section 84.1 can turn part of your sale proceeds into a deemed dividend when you sell shares to a corporation you do not deal with at arm's length.
- A group of fewer than 6 persons who controlled the subject corporation before the sale and the purchaser corporation after it can make you non-arm's length with the buyer.
- If the immediate or gradual intergenerational conditions are met, you and the purchaser corporation are deemed to deal at arm's length and the sale can be taxed as a capital gain.
- The conditions are strict and run for years, so get tax and legal review before you sign.
A parent who wants to pass a business to a son or daughter often does it by selling shares to a company the child controls. It feels like an ordinary sale, but the tax rules treat it differently from a sale to an outside buyer.
This article explains the section 84.1 rule in plain words, why it can cost you the lifetime capital gains exemption, and what the intergenerational transfer rules require. The details are technical, and this is a place where professional advice matters.
What section 84.1 does
Section 84.1(1) applies when a Canadian-resident individual sells shares that are capital property to a corporation with which the individual does not deal at arm's length. When it applies, a dividend is deemed paid to the seller equal to (A + D) minus (E + F), and paid-up capital is reduced under s. 84.1(1)(a).
Instead of a capital gain, part of the proceeds can be taxed as a dividend.
The rule also affects the cost base. Section 84.1(2)(a.1) reduces the adjusted cost base of shares acquired after 1971 from a non-arm's length person. The ordinary rule can apply even when the seller wanted to use their lifetime capital gains exemption, because the cost base and paid-up capital are limited. Have an accountant run the numbers.
When you are treated as not dealing at arm's length
Selling to a company your child owns is the typical case, but the statute also has a specific control test. Section 84.1(2)(b) deems the seller not to deal at arm's length with the purchaser corporation where a group of fewer than 6 persons controlled the subject corporation before the sale and the purchaser corporation after it.
That wording matters for family structures. If you and your children, or a small group of related people, controlled the business before and the buyer company after, the rule can be engaged even if the sale price was fair.
The intergenerational exception
Under s. 84.1(2)(e), if the immediate transfer conditions in s. 84.1(2.31) or the gradual transfer conditions in s. 84.1(2.32) are met, the seller and the purchaser corporation are deemed to deal at arm's length. That removes the deemed dividend and lets the sale be taxed as a capital gain, including for the lifetime capital gains exemption.
| Feature | Immediate transfer, s. 84.1(2.31) | Gradual transfer, s. 84.1(2.32) |
|---|---|---|
| Who controls the buyer | Children aged 18 or older | Control must pass for the later of 60 months and the final sale time |
| Seller's remaining interest | Within 36 months, you and your spouse or common-law partner must not own shares or equity, except non-voting preferred shares | Fully out of equity within 10 years of the sale |
| Retained interest cap | Confirm the current text with your advisor | Cannot exceed 50% of fair market value for family farm or fishing corporation shares, or 30% for qualified small business corporation shares |
| Other conditions | Control and active-engagement conditions run for 36 months | Reasonable steps to transfer management within 60 months |
For the immediate transfer, a joint election is due on or before the seller's filing-due date for the year of disposition. The exact conditions, including the thresholds for the gradual rule, should be checked against the current text with your advisor.
Other points to plan around
The exception only helps if the underlying shares qualify. For the lifetime capital gains exemption, the CRA lists a limit of $1,250,000 for dispositions after June 24, 2024, and $1,275,000 for dispositions in 2026. Your available amount may be lower if you have allowable business investment losses or a cumulative net investment loss.
Payment terms also matter. If your child's company will pay you over time, the capital gains reserve can spread the gain. Shares disposed of to another corporation where the s. 84.1(2.31) or (2.32) conditions are met qualify for the 10-year reserve. Because the control and ownership conditions run for years after closing, what you and your family do after the sale can affect the tax result, so treat the post-closing period as part of the plan.
What to do next
- List who owns and controls the business today and who will control the buying company.
- Confirm your child is 18 or older and will genuinely control the purchaser corporation.
- Decide whether you want to be fully out of the business quickly or stay involved for a time.
- Ask whether your shares qualify for the lifetime capital gains exemption and what your limit is for your year of sale.
- Calendar the joint election deadline with your accountant.
- Have a lawyer draft the share purchase agreement and the family arrangements to match the tax conditions.
A short meeting with a lawyer and an accountant before any price is agreed is usually far cheaper than repairing a structure after closing.
Frequently asked questions
Why would selling to my child's company be taxed as a dividend?
Section 84.1 applies when you sell shares that are capital property to a corporation you do not deal with at arm's length. A dividend is then deemed paid to you under a formula, and paid-up capital is reduced.
Can I still use my lifetime capital gains exemption?
Possibly. If the immediate or gradual intergenerational conditions are met, you and the purchaser corporation are deemed to deal at arm's length, and the sale can be taxed as a capital gain, including for the exemption. If they are not met, the ordinary rule may apply.
Does my child have to be an adult?
For the immediate transfer, the purchaser corporation must be controlled by children aged 18 or older. The gradual transfer has its own control conditions.
Do I have to leave the business completely?
Under the immediate rule, within 36 months you and your spouse or common-law partner must not own shares or equity in the corporation, except non-voting preferred shares. The gradual rule lets you remain for up to 10 years, with caps on what you retain. Your own facts decide which fits.
Sources
- CRA – Adjustment of personal income tax and benefit amounts — canada.ca
- CRA – Line 25400 Capital gains deduction — canada.ca
- Income Tax Act s. 110.6 (Justice Laws) — Justice Laws (federal)
- Income Tax Act s. 40 (Justice Laws) — Justice Laws (federal)
- Income Tax Act s. 84.1 (Justice Laws) — Justice Laws (federal)
Links go to official government, court and regulator pages. The law changes — confirm you are reading the current version.
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