Surplus stripping anti-avoidance — non-arm's-length share sales
Non-arm's length sale of shares
Section 84.1 prevents shareholders from using non-arm's-length share sales to extract corporate retained earnings as capital gains (which may be sheltered by the LCGE) rather than as dividends.
Plain-language explanation
Section 84.1 is an anti-avoidance rule targeting "surplus stripping" — transactions designed to turn taxable dividends (on corporate retained earnings) into capital gains, which either attract lower tax rates or may be sheltered by the Lifetime Capital Gains Exemption (LCGE).
The scenario s.84.1 targets: A business owner wants to sell their CCPC shares to a corporation they or a related person controls. The sale price exceeds PUC — the gain would normally be a capital gain (potentially sheltered by LCGE). But s.84.1 says that in non-arm's-length transactions, the gain is recharacterized as a deemed dividend to the extent of the seller's "hard ACB" (original cost, not inflated PUC).
How it works: If you sell shares of a CCPC to a related corporation for more than PUC, s.84.1 treats the excess as a dividend from the purchaser corporation rather than a capital gain — unless the sale is a genuine arm's-length transaction.
Interplay with LCGE: The LCGE requires the shares to qualify as QSBC shares and the sale must be to an arm's-length buyer. A sale to a corporation controlled by you or family members is non-arm's-length, triggering s.84.1 and defeating the LCGE.
Planning note: S.84.1 does not apply to genuine arm's-length sales (where a third-party buyer is involved), which is why true business sales to arm's-length purchasers can still use the LCGE fully.
Example
Opco owner sells shares to a new Holdco controlled by her child. Opco has ACB of $1,000 and PUC of $1,000 but FMV of $1,000,000. Without s.84.1, she might claim a $999,000 capital gain (sheltered by LCGE). With s.84.1, the excess over the lesser of ACB and PUC is a deemed dividend from Holdco.
Amendment history
Significant changes to this provision. Older versions help you understand rules that applied in prior tax years.
Finance Canada consulted on broad surplus-stripping proposals that would have significantly restricted the use of family trusts and estate freezes to multiply the LCGE. After significant pushback, the proposals were substantially modified before enactment, preserving most standard estate planning techniques.
Before
Broad LCGE multiplication through family trusts was widely used
After
LCGE multiplication narrowed for some family trust arrangements; substantive s.84.1 rules strengthened but core estate freeze planning preserved
Common questions
Does s.84.1 apply when I sell my business to a third party? +
No. S.84.1 only applies to non-arm's-length transactions (selling to a related party or a corporation you control). A sale to a genuine arm's-length purchaser is not affected by s.84.1, and you can use the LCGE on qualifying shares.
Can I use the LCGE on a family business sale? +
Yes, but only if the buyer is arm's-length. Selling to your child or a family corporation they control triggers s.84.1 and likely defeats the LCGE. Specialized planning techniques (like a true capital gains strip in arm's-length transactions) are needed to preserve LCGE in family succession.
Key terms
Related sections
CPA recommendation
Transactions involving non-arm's-length share sales should always be reviewed by a CPA or tax lawyer experienced in corporate reorganizations. S.84.1 consequences can be severe.
Source: Income Tax Act, RSC 1985, c. 1 (5th Supp.), section 84.1. — Read the official text on Justice Canada
These summaries are for educational purposes only and do not constitute legal or tax advice. Speak with a CPA for advice on your specific situation.