How does section 84.1 stop surplus stripping when my client sells shares to a related holding company?
Section 84.1 stops surplus stripping by treating boot above the greater of the shares' paid up capital and hard ACB as a deemed dividend when your client sells shares to a non arm's length corporation connected with the company afterward. It also grinds the PUC of any new shares. A qualifying intergenerational transfer made since 2024 can escape it.
When does section 84.1 apply to a share sale?
Section 84.1 applies when an individual (or a trust) resident in Canada sells shares held as capital property of a Canadian resident corporation to another corporation it doesn't deal with at arm's length, and the two corporations are connected right after the sale laws-lois.justice.gc.ca. Without it, your client could sell the shares of Opco to their own holding company for a note, report a capital gain (often sheltered by the exemption), and have Holdco repay the note out of Opco's retained earnings. That turns taxable dividends into a capital gain, which is the surplus strip 84.1 is aimed at.
| Condition | What the Act requires | Where it comes from |
|---|---|---|
| Seller | A taxpayer resident in Canada, other than a corporation | 84.1(1) |
| Shares sold | Capital property shares of a corporation resident in Canada (the subject corporation) | 84.1(1) |
| Buyer | A corporation the seller doesn't deal with at arm's length | 84.1(1), 251(1) |
| Connected afterward | The buyer controls the subject corporation, or owns more than 10% of its full voting shares and more than 10% of its value | 84.1(1), 186(4) |
| Deemed non arm's length | Seller was in a group of fewer than 6 persons controlling the subject corporation before, and in a group of those same people controlling the buyer after | 84.1(2)(b) |
| Trusts | A trust and a beneficiary, or a person related to a beneficiary, never deal at arm's length | 84.1(2)(d) |
Related persons are deemed not to deal at arm's length, and a corporation is related to the person who controls it and to anyone related to that person laws-lois.justice.gc.ca. So a parent selling to a holding company controlled by an adult son or daughter, or by a brother or sister, is caught. The connection test uses the 186(4) definition: control, or more than 10% of the full voting shares plus more than 10% of the fair market value
laws-lois.justice.gc.ca.
The fewer than 6 persons rule is the one that surprises unrelated shareholders. Three arm's length founders who each roll their Opco shares into a new Holdco they jointly control are deemed not to deal at arm's length with it, so 84.1 applies to each of them laws-lois.justice.gc.ca.
How much becomes a deemed dividend, and how much PUC is ground?
Two formulas run on the same sale. Paragraph 84.1(1)(a) grinds the paid up capital of any new shares Holdco issues by (A minus B) × C/A, and paragraph 84.1(1)(b) deems Holdco to pay your client a dividend of (A + D) minus (E + F) laws-lois.justice.gc.ca. The dividend amount is then taken out of your client's proceeds of disposition by paragraph (k) of the proceeds definition, so the same dollars aren't also a capital gain
laws-lois.justice.gc.ca.
| Term | Meaning |
|---|---|
| A | Increase in PUC of all Holdco shares from issuing the new shares, before 84.1 |
| B | The greater of the old shares' PUC and their ACB (as adjusted by 84.1(2)), minus the FMV of the boot, never below zero |
| C | Increase in PUC of the particular class of new shares, before 84.1 |
| D | FMV of the boot (any consideration other than Holdco shares) |
| E | The greater of the old shares' PUC and their ACB (as adjusted by 84.1(2)) |
| F | The total PUC grind under 84.1(1)(a) |
Worked example: your client owns all 100 common shares of Opco, with PUC of $100 and an ACB of $100. The shares are worth $1,000,000, and your client sells them to a Holdco controlled by their adult daughter. Here is the same sale with four different mixes of consideration, with a section 85 election where shares are part of the price.
| Consideration from Holdco | A | D | E | PUC grind (A minus B) × C/A | Deemed dividend (A + D) minus (E + F) | PUC of new shares after |
|---|---|---|---|---|---|---|
| Preferred shares only, stated capital $1,000,000 | $1,000,000 | $0 | $100 | $999,900 | $0 | $100 |
| Promissory note of $1,000,000 only | $0 | $1,000,000 | $100 | $0 | $999,900 | none issued |
| Note of $500,000 plus preferred shares, stated capital $500,000 | $500,000 | $500,000 | $100 | $500,000 | $499,900 | $0 |
| Note of $100 plus preferred shares, stated capital $999,900 | $999,900 | $100 | $100 | $999,900 | $0 | $0 |
Read the last row first. Boot up to E, the greater of PUC and hard ACB, comes out with no dividend, which is why planners cap the note at that number. In the note only row, the $999,900 dividend comes off the $1,000,000 proceeds, leaving proceeds of $100 and no capital gain laws-lois.justice.gc.ca. The exemption your client might have used on an arm's length sale is gone, and the whole value above $100 is taxed as a dividend instead of as a capital gain with half included.
With shares only, there's no dividend today, but the grind leaves PUC at $100, so Holdco can't later redeem the preferred shares as a tax free return of $1,000,000 of capital. When a later redemption produces a bigger deemed dividend under 84(3) because of the grind, subsection 84.1(3) adds that extra amount back to PUC, capped at the total ground laws-lois.justice.gc.ca.
Why does a crystallized capital gains exemption not count as cost?
Because paragraph 84.1(2)(a.1) strips out of ACB any gain on which the capital gains deduction was claimed, by your client or by an individual they don't deal with at arm's length, whenever the share came from a non arm's length person or was substituted for such a share laws-lois.justice.gc.ca. Subsection 84.1(2.01)(a) deems every share a corporation issues to be acquired from a non arm's length person, so shares received on a crystallization are always caught.
Say your client crystallized years ago by exchanging the $100 cost Opco shares for new shares at an elected amount of $1,000,000, and claimed the deduction on the $999,900 gain. The new shares have an ACB of $1,000,000 for every other purpose. For 84.1, their ACB is $1,000,000 minus $999,900, so $100. Sell them to the daughter's Holdco for a $1,000,000 note and E is still $100: the deemed dividend is $999,900, the same as if no crystallization had happened.
The same paragraph handles shares owned before 1972: their cost for 84.1 excludes the valuation day increase when the share was held by your client or a non arm's length person at the end of 1971 laws-lois.justice.gc.ca. Practitioners call what survives "hard ACB": cost your client actually paid for with taxed money. The planning for crystallization itself, and the 2026 exemption limit, are on the lifetime capital gains exemption 2026 page, and the rollover mechanics are on the section 85 rollover page.
How does the intergenerational business transfer exception work since 2024?
For dispositions on or after January 1, 2024, a sale to a corporation controlled by your client's adult children escapes 84.1 if it meets every condition of the immediate track in 84.1(2.31) or the gradual track in 84.1(2.32) canada.ca. When it does, paragraph 84.1(2)(e) deems your client and Holdco to deal at arm's length at the time of the sale, so 84.1 simply doesn't apply and your client reports a capital gain
laws-lois.justice.gc.ca.
| Condition | Immediate transfer, 84.1(2.31) | Gradual transfer, 84.1(2.32) |
|---|---|---|
| Shares sold | QSBC shares or shares of a family farm or fishing corporation | Same |
| Buyer | A corporation controlled by one or more children, each 18 or older | Same |
| Seller | An individual, not a trust, who hasn't used the exception for the same business after 2023 | Same |
| Control after the sale | Parent, alone or with spouse, never controls Opco, Holdco or a relevant group entity, in law or in fact | Parent, alone or with spouse, never has legal control of Opco, Holdco or a relevant group entity |
| Shares the parent keeps | Under 50% of any class other than non voting preferred shares at all times, and only non voting preferred shares from 36 months after | Same |
| Total value the parent keeps | No separate limit | Within 10 years, debt and equity no more than 30% (QSBC) or 50% (farm or fishing) of the value held before the sale |
| Child control and active engagement | From the sale until 36 months after | Until the later of 60 months after and the final sale time |
| Handing over management | Reasonable steps taken no later than 36 months after, or a longer reasonable period | No later than 60 months after, or a longer reasonable period |
| Election | Joint election by the parent's filing due date for the year of sale | Same |
| Extra reassessment time | 3 years past the normal period | 10 years past the normal period |
The extra reassessment window comes from paragraph 152(4)(b.9), and it's how the CRA collects if the conditions fail later laws-lois.justice.gc.ca. A qualifying sale also gets the longer capital gains reserve: subsection 40(1.2) reads the reserve formula with 1/10 and 9 instead of 1/5 and 4, so the gain can be spread over 10 years
laws-lois.justice.gc.ca. The reserve is reported on Form T2017, and the details are on the capital gains reserve page.
"Child" is wide here. It takes the 70(10) meaning, which covers grandchildren and a child's spouse, and adds your client's nieces and nephews, their spouse's nieces and nephews, the spouses of those nieces and nephews, and their children laws-lois.justice.gc.ca. Brothers and sisters are not on the list, so a sale to a sibling's Holdco stays inside 84.1.
The active engagement test changed in 2026. The version in force from June 20, 2024 to March 25, 2026 required the child to be actively engaged "within the meaning of" paragraph 120.4(1.1)(a) laws-lois.justice.gc.ca. The current text says "including within the meaning of" that paragraph, and the management handover now reads "no later than" 36 or 60 months
laws-lois.justice.gc.ca. Paragraph 120.4(1.1)(a) deems someone actively engaged if they work in the business an average of at least 20 hours a week during the part of the year it operates
laws-lois.justice.gc.ca. That deeming rule is now one way to pass, not the only way.
What do you do with Form T2066?
Form T2066 is the joint election for an immediate or gradual intergenerational business transfer under 84.1(2.31) or (2.32), signed by your client and each child who controls Holdco canada.ca. The Act says to file it with the Minister by your client's filing due date for the year of the sale
laws-lois.justice.gc.ca. The current 2026 version of the form tells you to complete it by that date and keep it in your records instead of sending it, in case the CRA asks
canada.ca. The CRA's capital gains guide also points to T2066 for the election and to T2017 for a new reserve on the sale
canada.ca.
Read the certification before your client's children sign. If the conditions aren't met, the parent and the electing children are jointly and severally liable for the extra tax the parent owes because 84.1(2)(e) didn't apply canada.ca. The form also asks whether there's a written agreement, whether there's an independent valuation of the shares, and whether the parent's spouse sold shares to the same Holdco in the year.
| On the T2066 | What to have ready |
|---|---|
| Part B | Which track: immediate under 84.1(2.31) or gradual under 84.1(2.32) |
| Part C | Written agreement, valuation report, spouse's sale, prior election, QSBC or farm or fishing status |
| Part D | Per class: FMV, PUC, ACB, boot and share consideration with redemption value and voting rights |
| Part E | Signatures of your client and every controlling child |
Sources
Does section 84.1 apply if my client takes back only shares?
Yes, but only the PUC grind bites. With no boot, D is zero and the deemed dividend works out to nil, while the new shares' PUC is ground down to the greater of the old PUC and hard ACB laws-lois.justice.gc.ca. The tax shows up later if Holdco redeems those shares.
What happens if the child sells the business within the 36 months?
The conditions are deemed met if the children sell all the shares of Holdco, Opco or every relevant group entity to an arm's length buyer, as long as each child's whole equity interest in the business goes in that sale laws-lois.justice.gc.ca. A transfer from one child to another child is also allowed, and the remaining conditions then apply to the new child.
Does 84.1 apply when one corporation sells shares to another?
No. Subsection 84.1(1) reaches only a taxpayer other than a corporation laws-lois.justice.gc.ca. Intercorporate dividends and sales run into section 55(2) instead.
Can a parent use the exception twice for the same company?
No. Both tracks require that your client hasn't sought the exception after 2023 for shares that derived their value from the same active business laws-lois.justice.gc.ca. Sequence the transfer so the one election covers the shares that matter.
General information for the tax year shown, not advice for a specific client. Confirm the facts before you file or remit.