The Lifetime Capital Gains Exemption and Your Business
Own shares in a Canadian corporation? A must read if you plan to sell...
Every Canadian is entitled to the Lifetime Capital Gains Exemption of $800,000 (indexed starting in 2015 to $813,600). The Canada Revenue Agency refers to the Capital Gains Exemption as the Capital Gains Deduction.
As a business owner, if you own shares of a Canadian non-public corporation and sold those shares, your first $813,600 of gains would be non-taxable (i.e. exempt from tax). This could amount to almost $200,000 in tax savings (depending on the province you live in).
What's great about this exemption is that the unused amounts are carried forward. This means that if you report a Capital Gains Exemption for less than the maximum allowed, the remainder carries forward and sticks with you should you need to use it again.
As with many tax benefits, there are rules that you must follow and criteria that you must fulfill to ensure you are eligible to claim the Capital Gains Exemption. We will discuss these briefly below.
*Please note that this topic can become extremely complex. Ensure that you seek professional advice before executing on any sale of your shares in order to qualify for the small business Capital Gains Exemption.
How Does It Work?
If your small business shares qualify for the exemption, the taxable capital gain is still included in income for tax purposes, however an offsetting deduction is allowed when computing your taxable income.
For example: If your shares were originally purchased for $100 and they were sold for $800,100, you would have a gain on sale of $800,000. Your taxable capital gain (50% of the gain) is $400,000. The $400,000 is what you would be paying tax on.
With the Capital Gains Exemption, your $800,000 gain and $400,000 capital gain are wiped away and all of that hard earned cash from the sale is yours to keep (just make sure to take your accountant out for dinner for helping you execute the filing).
How Do You Qualify?
1. Small Business Corporation Test
At the time of sale, the shares must meet the definition of a "qualified small business corporation" (QSBC). A QSBC is a Canadian-controlled private corporation in which all or most (90% or more) of the fair market value of its assets are being used in an active business in Canada. This means that if you have more than 10% of your assets in non-active business (i.e. cash, passive income such as interest income, rental income, royalties, etc.), your shares will not qualify.
2. Holding Period Test
Throughout the 2 years preceding the sale, the shares were not owned by anyone other than the shareholder or a person related to the shareholder.
3. Asset Test
Throughout the 2 years preceding the sale, at least 50% of the fair market value of assets in the company were used in active business in Canada.
To ensure that you are "on side" regarding all of these tests, it is important to review your balance sheet with an accounting professional regularly, so that you can purify your business (i.e remove the non-active assets from the corporation).
There are lots of ways to plan in advance and ensure that you take advantage of the Capital Gains Exemption. In fact, it is extremely important to know all of your options well in advance, since many events can trigger a disposition of shares (i.e. transfer of shares, death of a shareholder, etc.). Ensure that you take the time to seek out professional advice before it's too late!