Selling a Business Held in a Family Trust? A Recent Court Ruling Changes the Tax Math on Pre-Sale Dividends

If your operating company is owned through a family trust and a sale is on the horizon, a decision from the Federal Court of Appeal now settles a question that used to be open to argument and the answer can carry a six-figure price tag if your timeline isn’t planned around it.

The Case: Canada v. Vefghi Holding Corp.

In Canada v. Vefghi Holding Corp., 2025 FCA 143, the Federal Court of Appeal reversed the Tax Court of Canada and sided with the Canada Revenue Agency on a narrow but consequential timing question: when a family trust designates a dividend to a corporate beneficiary, at what point is that dividend treated as received for purposes of the “connected corporations” test under the Income Tax Act?

The facts followed a pattern that shows up often in owner-managed business sales. An operating company paid a dividend to a family trust. At that moment, the operating company and the corporate beneficiary named in the trust were connected corporations. The sale of the operating company then closed before the trust’s December 31 year-end. When the trust filed its return, it designated the dividend to the corporate beneficiary under subsection 104(19).

The Tax Court initially agreed with the taxpayer that the connection should be tested when the trust received the dividend. The Federal Court of Appeal disagreed. It held that a subsection 104(19) designation only takes legal effect at the trust’s year-end, so that is the date the connected-corporations test applies, not the date the cash moved. By year-end, the shares had already been sold. The two corporations were no longer connected. Part IV tax applied.

The Supreme Court of Canada declined to hear a further appeal in August 2026. The Federal Court of Appeal’s ruling now stands as settled law.

Why the Timing Gap Matters

Paying a dividend out of an operating company before a sale is a routine step. It strips redundant cash out of the business, which can reduce the purchase price allocated to shares and help the sale qualify for the Lifetime Capital Gains Exemption. Owners and their advisors have long treated the “connected” status of the paying and receiving corporations, checked at the time the dividend is paid as the relevant test for whether Part IV tax applies.

The Vefghi decision confirms that when the dividend flows through a family trust, that assumption doesn’t hold. The relevant date shifts to the trust’s year-end, which is fixed at December 31 for an inter vivos trust regardless of when the sale closes. A dividend that was tax-efficient on the day it was paid can become a Part IV tax liability months later, simply because the sale closed first and the trust’s year-end arrived second.

On a $1 million dividend, that gap can mean roughly $383,000 in Part IV tax, tax that is technically refundable once the holding company pays dividends to its own shareholders, but that still has to be funded out of pocket in the meantime, often in the middle of closing a transaction.

What This Means for Owners Selling Through a Trust Structure

The exposure here isn’t a planning failure in the usual sense. The dividend was properly paid, the corporations were genuinely connected at the time, and the sale itself may have gone exactly as intended. The issue is that the tax result depends on a date, the trust’s year-end, that has nothing to do with when the deal actually closes, and that date is easy to overlook until the return is filed.

This is precisely the kind of exposure that goes unnoticed when tax and transaction planning happen on separate tracks, or when a trust structure hasn’t been reviewed since it was first set up. A corporate structure that made sense years before a sale was contemplated can carry a hidden cost at the finish line if nobody has checked how a family trust, its year-end, and the transaction timeline interact.

If a sale is anywhere on your horizon and your shares are held through a family trust, the sequence matters as much as the substance. Questions worth asking now, well before a transaction is underway:

•Can the sale close after the trust’s year-end, rather than between the dividend date and year-end?

•Could dividends be paid in a year well ahead of the sale, so the designation and the sale don’t fall in the same taxation year?

•Does the corporate beneficiary need to hold shares through the trust at all, or would direct ownership avoid the issue?

•Has the Part IV tax exposure been modelled into the transaction’s cash flow, so funds are available at closing if the exposure can’t be avoided?

None of these questions have a generic answer. The right approach depends on your corporate structure, your trust’s terms, and your timeline to sale, which is exactly why this deserves a conversation with your advisor well before a letter of intent is on the table, not after.

The Bigger Picture

Vefghi is a reminder that structure decisions made years earlier don’t sit still, they interact with whatever transaction comes next, sometimes in ways that only surface at the worst possible moment. A family trust structure that served you well for income splitting or creditor protection can carry a cost at sale that has nothing to do with why it was set up in the first place.

If you’re planning to sell a business held through a family trust or you’re not sure whether your structure creates this kind of exposure, now is the time to have that reviewed, not once an offer is on the table.

Frequently Asked Questions

What is Part IV tax?

Part IV tax is a refundable tax, currently at a rate of approximately 38.33%, that applies to certain dividends received by a private corporation from another corporation. It is generally refunded once the receiving corporation pays taxable dividends to its own shareholders, but it must be funded upfront.

What did the Vefghi decision change?

The Federal Court of Appeal confirmed that when a family trust designates a dividend to a corporate beneficiary under subsection 104(19), the “connected corporations” test for Part IV tax purposes is applied at the trust’s year-end, not when the dividend was originally paid. This can convert a tax-efficient dividend into a taxable one if a sale closes before year-end.

Does this affect every business sale?

No. It specifically affects sales of a corporation whose shares are held through a family trust, where a dividend was paid to the trust and designated to a corporate beneficiary before the trust’s year-end. Owners without a trust in the ownership structure are not directly affected by this ruling.

Can this tax cost be avoided?

In many cases, yes, with advance planning. Options include timing the sale to close after the trust’s year-end, paying dividends in an earlier taxation year, or reconsidering whether shares should be held through the trust at all. The right approach depends on the specific structure and timeline involved.

When should I have my structure reviewed?

Ideally at least 24 months before an anticipated sale, given the holding periods and asset tests tied to the Lifetime Capital Gains Exemption. Earlier is better if the ownership structure itself needs adjustment.