In this blog post we will cover what the Lifetime Capital Gains Exemption is. There are very few instances in life where you can get away legally without paying taxes in Canada! The Lifetime Capital Gains Exemption offers such an opportunity to Canadian business owners.

What is the Lifetime Capital Gains Exemption?

The lifetime capital gains exemption allows you (the Canadian business owner) to shelter some of the profit you make from selling your business from tax. What does this mean in plain English?

Let’s take a look at a simple example below to understand how it works in a real-life scenario.

A Real Life Example

Without Lifetime Capital Gains Exemption

Joe has been running his business for 35 years and he is 65 years old today. He would like to sell his business and then ride off into the sunset. Joe has been approached by some interested buyers for his business who have offered him $2 million. Joe initiallystarted his business with an investment of $1,000.

If Joe was decides to accept the $2 million offer for his business, how much taxes would he have to pay to the CRA?

If the lifetime capital gains exemption didn’t exist, Joe would be on the hook to pay taxes on a taxable capital gain of $1,291,058.

With Lifetime Capital Gains Exemption

Incorporating the Lifetime Capital Gains Exemption, under the same scenario, Joe would pay much less tax.

This is because at the time of writing this post, the government has introduced legislation as of June 2024 that allows Canadian business owners to shelter up to $1,250,000 of the gain tax free and a 1/3 inclusion rate from $1,250,001 to $2,000,000. Using the same example above, this means that Joe’s gain of $1,999,000 will be sheltered by the exemption of $1,250,000 and any amounts above that up to $2,000,000 will have a 1/3 inclusion on which taxes will be paid.

The difference is significant

If you’ve been paying attention so far, you can see that the consequences of this can’t be ignored. Without the Lifetime Capital Gains Exemption, Joe would be paying tax on a gain of $1,291,058 and with the Lifetime Capital Gains Exemption, Joe would be paying tax on a gain of $249,667. Using the Lifetime Capital Gains Exemption would leave Joe with much more cash after tax because he will be paying taxes on a much smaller gain.
Who is eligible for the Lifetime Capital Gains Exemption?

In order to access the Lifetime Capital Gains Exemption, the shares you own in your company need to be Qualified Small Business Corporation (SBC) shares. An important note here: one question we get often from entrepreneurs is whether or not the Lifetime Capital Gains Exemption is available to corporations. It’s not. The Lifetime Capital Gains Exemption is available to individuals, not corporations. What are Qualified Small Business Corporation (QSBC) shares? Let’s park how these shares become “Qualified” and discuss what SBC shares are.

Small Business Corporation (SBC) shares

Small Business Corporation shares are shares owned in a:

• Canadian Controlled Private Corporation; and
• A company that is using or substantially all (i.e. at least 90%), of the fair market value of the corporation’s assets in an active business primarily in Canada.

Qualified Small business corporation (QSBC) shares

How do small business corporation shares become “Qualified” Small business corporation shares?

Three tests need to be met at the time of disposition of the shares (i.e. when you sell your shares).

1. Test #1: SBC Test

At the time of disposition, the shares need to be SBC shares. This simply means, that the shares must meet the criteria described in the Small business
Corporation (SBC) shares section above.

2. Test #2: Holding Period test

The shares of the corporation must be owned by the individual, or a person related to the individual, throughout the 24 months prior to the date of disposition; and

3. Test #3: Asset Test

The corporation must be an CCPC throughout the 24 months prior to the to the date of disposition and at least 50% of the assets must have been used
principally in an active business in Canada.

As you can tell, meeting the three tests above is absolutely crucial in order to access the Lifetime Capital Gains Exemption. If you fail to meet one of the tests above, you risk losing access to the Lifetime Capital Gains Exemption, and your taxable gain would be much higher. To complete this post, lets examine some common pitfalls that risk jeopardizing your ability to meet the tests for Qualified Small Business Corporation shares.

Common pitfalls

Too much cash on your balance sheet If you have excess cash or stocks held in the company you’re trying to sell, you might not be able to meet the 90% test to be eligible to be an SBC at the time of sale (Test #1) or the 50% test required for the past 24 months (Test #3). It is good practice to remove excess cash from your business by paying off debt, paying tax installments, or via dividends.

Shareholder Loans

Any amounts you (i.e. in your shareholder capacity) owe back to your company would not be considered an active business asset. Shareholder loans might cause you to fail to meet the 90% test to be eligible to be an SBC at the time of sale (Test #1) or the 50% test required for the past 24 months (Test #3). It is good practice to payoff these balances via increasing shareholder compensation or declaring dividends at the beginning of the year.

International operations

If your company owns a subsidiary with international operations, this would be considered an asset that is not used to earn active business income in Canada. If an international operation is significant enough, it could cause you to fail to meet the 90% test to be eligible to be an SBC at the time of sale (Test #1) or the 50% test required for the past 24 months (Test #3). It is good practice to restructure your holdings such that international operations are held by a separate corporation that is not a subsidiary.

Assets that are non-core

Real estate is a common asset that could cause you to trip up and fail the “QSBC” tests. If you own a building whereby 30% is actively used in your business but the remaining 70% is rented to unrelated parties, the asset would cause you to fail to meet the 90% test to be eligible to be an SBC at the time of sale (Test #1) or the 50% test required for the past 24 months (Test #3). Hence, with real estate, it is best that it the building or property is held by a separate corporation that is not a subsidiary.

Are you planning on selling your company at some point in the future? Let us help you. Get in touch with us here or sign up to get more accounting and tax tips in our newsletter here.

The accounting and tax information provided in this post does not constitute advice and is meant to be for general information purposes only. The information is current as at the date of this post and does not reflect any changes in accounting and/or tax legislation thereafter. Moreover, the information has been prepared without considering your company or personal financial/tax