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Lifetime Capital Gains Exemption: Tax Planning

What is the Lifetime Capital Gains Exemption?

Almost every small business owner dreams of one day selling their business, which is why they put their entire life into building it and, hopefully, making it salable. This involves considerable risks to the business owners, risks that are extremely valuable to the Canadian economy and non-entrepreneurial Canadians.

According to Statistics Canada, there are 1.21 million employer businesses and of these 1.19 million (97.9% – 2021) are small businesses. Said differently, 97.9% of the jobs in Canada are created by small business owners.

Our tax legislation encourages entrepreneurs to take the risk of incorporating, investing in, and running a small business, by exempting them from tax* on up to $1,250,000 of capital gain that they receive when they sell their shares of that small business corporation. At Achen Henderson CPAs. we believe that this is a fair trade-off for our risk takers creating 97.9% of the jobs in Canada!

There are several rules and tests that a company has to meet in order for its shares to be eligible. Therefore advanced planning is critical.

*Alternative Minimum Tax may still apply even if you’re claiming the LCGE.

Some of the basics on accessing the lifetime capital gains exemption (this is not meant to be an inclusive list) include:

  • The company must be a Canadian Controlled Private Corporation (CCPC), meaning the corporation cannot be controlled by non-resident individuals.
  • The individual(s) must have owned the private company shares for at least two years leading up to the sale.
  • The capital gains exemption applies once in a lifetime and only to capital gains arising from the sale of small business shares or farm and fishing property. It is not available to share sales from corporations; only individuals can use the deduction. Therefore, if you’re selling the shares of an operating company from a holding company (as opposed to personally), the sale will generally not qualify for the lifetime capital gains exemption.
  • The maximum gains exemption that an individual can claim on CCPC shares during their lifetime is $1,016,836, going to $1,250,000 on June 25, 2024 and is indexed upwards annually starting again in 2026. The lifetime farming and fishing property gains exemption is $1,000,000 going to $1,250,000 on June 25, 2024.
  • At least 90 per cent of the fair value of the net-assets in the business being sold must be engaged in active business at the time of the sale. (I.e., less than 10 per cent of the fair value of the net assets of a company can be ‘passive’ assets or the shares of the company will not qualify for the gains exemption.)
  • At least 50 per cent of the fair value of the net assets in the business being sold must be engaged in active business for the 24 months leading up to the sale. (I.e., less than 50 per cent of the fair value of the net assets of a company could have been ‘passive’ assets or the shares of the company will not qualify for the gains exemption.)

Capital Gains Tax Planning Strategies

There are several tax planning strategies that can be used to ensure your company’s shares qualify for the capital gains exemption and undertaking any of them requires the advice of tax experts. These can be tax accountants, tax lawyers, or both. Remember that every situation is unique so fully analyze the tax and business costs of implementing these strategies before making any decisions.

Following are two examples of tax planning strategies that may be used:

  • A “purification strategy” involves moving passive assets out of the CCPC before it is sold in order to meet the above 90/50 per cent tests.
  • In order for a family to multiply the number of lifetime capital gains exemptions it has access to on the sale of a CCPC, a corporate restructuring can be undertaken to include multiple family members in the ownership of the CCPC so that multiple family members can claim their gains exemptions on the sale of the business. For example, if a husband, wife, and two children own the shares of a CCPC at sale, it may be possible to earn around $3.39 million in capital gains (2018) on the sale of those shares without incurring any tax.

Get Expert Advice & Follow It

Talk to a tax specialist well in advance of the sale of your business to ensure that the proper structure is in place to maximize your family’s after-tax proceeds on the sale. It is imperative to ensure there is ample time to implement tax minimization strategies and position you and your business for a successful transition.

If you know you’re working with a professional tax accountant, ensure you follow his or her advice. If you’re told to wait at least 24 months before selling the business, it’s with good reason. If you’re not sure why your accountant is making specific recommendations, ask for a break down of the numbers so you can see how much tax you’re saving.