The Lifetime Capital Gains Exemption is a tax planning technique that is available to business owners who are selling shares of their private companies. This is an economic incentive to help raise the level of investment in small businesses, however, not everyone meets the criteria necessary to qualify for this exemption. In order to qualify for the enhanced capital gains exemption, an individual must dispose of a share that they have in a Qualified Small Business Corporation (“QSBC”).
A QSBC share is a share of a corporation’s capital that meets the following criteria:
- Small Business Corporation Test: At any time (the “Determination Time”) it is a share of a “small business corporation” owned by the individual. In order to qualify as a “small business corporation”, it is required that: (a) The corporation be a Canadian-controlled private corporation (“CCPC”); and (b) All or substantially all of the fair market value of the assets of which were used in an active business carried primarily in Canada. Note that the Canada Revenue Agency (“CRA”) has generally interpreted the phrase “all or substantially all” to mean 90%;
- Holding Period Ownership Test: In the 24 months preceding the Determination Time, the share was not owned by anyone who was not a relative of that individual; and
- Holding Period Asset Test: Where the situation involves only one corporation in the 24 months preceding the Determination Time, the share was part of a CCPC, more than 50% of the fair market value of the assets of which must have been attributable to assets used principally in an active business carried on primarily in Canada by the corporation or a related corporation, or certain shares or indebtedness of a connected corporation, or any combination of such assets.
Where the share being considered is a share of a holding corporation (i.e., where there is a tiered structure, with the individual directly owning shares in a holding company, which in turn holds shares in the operating company), additional considerations apply, and the 24-month business asset test may be more stringent. If 90% or more of the holding company’s assets are either active assets and/or investments in connected CCPCs, then the connected company or companies need only meet the 50% test. However, if the holding company does not meet this 90% test, then the connected company or companies must meet the 90% test throughout the 24-month period and the holding company must meet the 50% test. Essentially, it will be necessary for either the holding corporation or its connected subsidiary or subsidiaries to meet the 90% threshold throughout the 24-month period preceding the disposition of the shares.
Many small business owners utilize a Holdco for creditor proofing, which is often recommended, however, over the years the Holdco may end up owning substantial investment assets. This can be problematic for various reasons.
For dispositions in 2014 of QSBC shares, the capital gains deductions limit is $400,000 (half of the Lifetime Capital Gains Exemption of $800,000). It should be noted that the capital gains inclusion rate for 2014 is half; only 50 % of the capital gain from a disposition is taxable.
The limit on gains arising from dispositions of QSBC shares after March 18, 2007 and before 2014 is $375,000 (1/2 of the Lifetime Capital Gains Exemption of $750,000).
There are many mechanisms available to a taxpayer that allows for corporate purification.
For more information, contact Barrett Tax Law!