"Unlocking the Small Business Capital Gains Exemption: Is Your Business Eligible?"
Selling Your Business Doesn’t Mean You Qualify for the Small Business Capital Gains Exemption
As a business owner, you may be aware that when you dispose of shares in your business, you could receive an exemption on all or a portion of the capital gains that ordinarily would be taxable. This is due to the Lifetime Capital Gains Exemption, which says that, for 2023, up to $971,190 of capital gains is exempt from taxation.
The Lifetime Capital Gains Exemption (LCGE) is available to individuals who are disposing of or deemed to have disposed of:
Qualified Small Business Corporation (QSBC) shares;
Qualified farm property; or
Qualified fishing property2.
For the shareholder of a small business corporation, this valuable benefit could reduce or eliminate the tax bill that otherwise would be payable upon the sale or succession of the company. However, the important thing to understand is that the exemption is not automatic. Some conditions must be met. For the business to be considered a QSBC and therefore qualify for the Small Business Capital Gains Exemption (SBGE) there are two main rules:
Rule # 1 – Ownership of Shares
During the 24 months immediately preceding the disposition the shares must not have been owned by anyone other than the individual taxpayer or a related person;
Rule # 2 – Use of Corporate Assets
Also, during this 24-month period;
50% or more of the fair market value of the corporate assets must have been used in an active business conducted primarily in Canada;
At the time of the disposition (sale or upon the death of shareholder), all or substantially all (defined as 90% by the CRA) of the fair market value of the assets must have been used to produce active business income. Some examples of corporate assets that could put a corporation offside for being a QSBC are cash, bonds, non-business related real estate and other investments.
When corporations do not qualify for the Small Business Capital Gains Exemption due to failing to meet the 90% rule, remedies are sometimes available, which may provide a solution. This will usually involve a “purification” of the corporation to distribute or transfer non-business-related assets.
Some examples of how this could be accomplished are:
Paying a taxable dividend to shareholders;
Paying down any bank debt or accounts payable;
Pre-paying corporate income tax instalments;
Purchasing new assets which will be used in the business to produce active business income;
Setting up a Personal Pension Plan, Individual Pension Plan or Retirement Compensation Arrangement for the business owner.
There is another area in which careful attention is warranted. For a business to be a Qualified Small Business corporation, it must first be a Canadian-controlled private corporation (CCPC). Should there be a sale of shares to either a non-resident or a public corporation, there may be a denial of the capital gains exemption as the corporation may no longer be a CCPC. This could also be where a non-resident executor is named in the shareholder’s will, and the shareholder dies.
The rules governing whether or not an individual who owns shares in a small business corporation receives a capital gains exemption are complex and often confusing. It is important to obtain professional advice when undertaking the appropriate planning.
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Notes:
The 2013 federal budget increased the LCGE to $800,000 for 2014, with indexing commencing in 2015. The indexed amount for 2023 is $971,190.
The 2015 federal budget increased the maximum LCGE for Qualified farm or fishing property to the greater of $1 million, and the indexed LCGE realized on the disposition of qualified small business corporation shares. When indexing increases the SBGE to $1 million, SBC shares and farm and fishing properties will enjoy the same LCGE.
