Lifetime Capital Gains Exemption
Some capital gains are better than others. How much better? If the capital gains realized qualify for the Lifetime Capital Gains Exemption (“LCGE”), then the first $824,000 to $1,000,000 in gains are tax free. This means that when you dispose of shares as part of a sale of your business, you can get some of the sale proceeds free of tax. You may also be able to use the exemption as part of family planning or an inter-generational transfer of a business (or farming or finishing operation). The difficulty, as with most things, is qualifying for the exemption in the first place.
There are three types of gains that qualify for the LCGE. They are categorized by the type of property the disposition of which results in the gain in question. The first category of property that qualifies for the LCGE are Qualified Small Business Corporation Shares (“QSBC”). The second category are qualified farm properties, and the third are qualified fishing properties. As you can see, these categories mirror the types of property or activities that are the backbone of Canada’s economy, and therefore the types of property or activities that the government wants to incentivize. The incentive being an exemption of all or part of the gain from taxation.
The exemption is NOT available for disposition of other types of property such as publicly traded shares, and are not available to persons who are not Canadian tax residents (this is different than being a Canadian resident for immigration purposes). The LCGE is also not available to corporations (though it may flow through to individuals through partnerships or trusts), or to trusts (where the gain is not flowed through to individuals who are Canadian residents).
As with most things Tax, the devil is in the details. This article will focus on the conditions that have to be met for a share to be a QSBC. If you own a farm business or a fishing business, whether personally or through a corporation, the conditions are different. In order for a share to be a QSBC all of the applicable conditions have to be met. Some of the conditions have to be met at the time of the disposition, while others have to be met for a period of time before (24 months before).
The first condition is that the sale has to be of a share, and the share has to be that of a capital stock of a small business corporation (SBC). A SBC is a corporation that is Canadian-controlled, is private (not publicly traded or owned by a publicly traded company), and most (90% or more) of its assets (judged by fair market value), are used mainly (more than 50%) in an active business carried on primarily (more than 90%) in Canada by the corporation OR a related corporation. The assets may also be shares or debt of connected corporations that were SBCs (or a combination of the two). This is one of the “asset tests” that have to be met and makes it hard for a share to qualify where the corporation owns investments, has excess cash on hand, or has inactive assets. This 90% test has to be met only at the time of the disposition and is usually achieved by “purifying” a corporation before sale.
A second condition is that for the two years (24 months) preceding the disposition of the share, it was owned by you or a related person to you, and no one else. Also, during these preceding two years (24 months) more than 50% of the assets must have been used in an active business carried on by a Canadian-controlled private corporation or a corporation related to it, be a share or debt of a connected corporation, or a combination of the two. This is the second asset test that has to be met, and is easier to meet because the threshold is 50% and not 90%.
The above three conditions are just the tip of the iceberg. The conditions refer to relationships – such as “related” or “connected” or “resident”– that are themselves complex and have their own legal definitions. If this were not enough, the exemption amount can be reduced by certain other values that relate to a person’s “Cumulative Net Investment Losses” – yet another defined term. Given this complexity, it is always best to consult an expert to make sure that your sale of shares qualifies so you can benefit from the tax exemption.
Note: Articles are for general information only and do not constitute tax advice nor can they be relied upon. Call Faris CPA for assistance.
Sam Faris is a Toronto-based Chartered Professional Accountant who practices as an independent consultant on high-level Canadian tax matters and handling disputes with CRA.He also published an article recently in the business magazine: HERE.