Capital gains tax originated back in the early 1970s when the Income Tax Act was revised. At that time, the federal government introduced a tax on gains realized from the disposition of capital property, which includes:
- trust units
- personal property
What is the Capital Gains Exemption?
Introduced in 1986, the capital gains exemption (CGE) is intended to save business owners tax on the disposition of qualified property so they can better save for retirement, or reinvest funds into other small businesses. The exemption initially applied to any type of capital property. This was curtailed in 1994 when it was restricted to shares of qualified small business corporations and/or qualified agricultural capital properties. That same year, individuals could file an election to crystallize unused amounts up to $100,000 under the original rules (meaning any capital property).
The lifetime capital gains exemption (LCGE) indicates the cumulative amount a person is allowed to deduct over their lifetime, as part of the exemption. This means that you can claim any part of it at any time in your life if you dispose of qualifying property until you reach the maximum. You do not have to claim the entire amount at once. An individual’s overall lifetime limit of $892,218 in 2021.
The amount of the exemption is based on the gross capital gain that you make on the sale of a qualified property.
Using the Lifetime Capital Gains Exemption in Business Succession
This exemption will be very attractive to any qualified business owner who is close to retirement and wants to sell their business to an independent third-party buyer. This could be used as a means to transfer the business to a child or family member. However, there are certain tax factors to consider when selling a business to family; to find out more, it is best to speak with a skilled business consultant and tax professional.
Let’s look at an example of how much tax can be saved. Let’s say you sold shares of your Canadian small business corporation in 2021 and this has generated a profit of $950,000. Without the LCGE, you would have to pay taxes on $475,000, or half of this amount (only half the value of a capital gain is taxed). By claiming the entire LCGE of $892,218, it results in you paying tax on $28,891 ($950,000 minus $892,218 times 50%).
What is a Qualified Property?
Who can claim use this claim deduction and on what property? The keywords to focus on are qualified individuals and qualified properties. Let’s look at qualified properties first.
There are three types of property that can give rise to the capital gains exemption:
- The first is the sale of Qualified Small Business Corporation shares. These are shares in a Canadian Controlled Private Corporation (CCPC); a private company that operates an active business and is owned, in the majority, by Canadians. You or someone related to you must have owned the shares for at least 24 months prior to the sale to qualify. Publicly listed corporation shares are not qualified properties.
- The second type of qualifying property is Qualified Farm Property. This property type includes buildings, land, and milk and egg quotas that are used in a farming enterprise. If the farm is operated through a company, the shares of that company also qualify.
- Finally, the third type of property that qualifies for the exemption is a Qualified Fishing Property, which includes real estate, fishing vessels, and fishing licenses. Here also, if the fishing business is operated through a company, the shares of the company qualify for the exemption.
If you have owned a property used in the farming or fishing industry for at least two years, and continue to use it on a regular basis, you might be able to use your capital gains exemption against an eventual sale. However, there are criteria that need to be met. For instance, the income earned from your farming or fishing business must be greater than any income that you earned from other sources.
Who Can Qualify for the Lifetime Captial Gains Exemption?
Now that we have talked about what property qualifies for LCGE, the next step is to review who qualifies to claim the exemption. Determining whether you are qualified for the LCGE is complicated, but the basic requirements are:
- Your business must be officially registered as a small business corporation (SBC) at the time of the sale.
- You must be selling shares of a corporation; sole proprietorships and partnerships do not qualify.
- More than 50% of your business’s assets must have been used in an active business in Canada for at least twenty-four months prior to the sale.
- The shares must not have been owned by anyone other than you or someone related to you in the twenty-four months leading up to the sale.
Contact Edelkoort, Smethurst Schein CPAs LLP in Burlington for More Information on the Lifetime Capital Gains Exemption
If you would like to discuss the financial and tax implications of selling your current small business, please contact the Chartered Professional Accountants at Edelkoort Smethurst Schein online or by calling 905-517-2297. Their corporate accounting and succession planning professional will help you make the best decision for you and your business.