16 May 2016
Accessing the Lifetime Capital Gains Exemption
Written by: Bryan Hubbell, CPA, CGA
If you own a business you may have thought about whether you will be able to use the CRA lifetime capital gains exemption to save tax on a future sale of your business.
The lifetime capital gains exemption in Canada is available to individuals who realize gains on:
- Shares of a qualified small business corporation
- Qualified farm or fishing property which includes certain farm or fishing assets, interests in eligible family farm or fishing partnerships and shares of an eligible family farm or fishing corporation
The available lifetime capital gains exemption for 2016 on the sale of qualified small business corporation shares is $824,176*. This represents potential tax savings of $196,566. For qualified farm property the lifetime capital gains exemption limit is increased to $1,000,000**. This represents potential tax savings of up to $238,500.
In order to claim the capital gains exemption on shares of a private company the CRA has a number of conditions that must be met.
- The individual vendor must own the shares continuously for at least two years prior to sale***.
- During a period of at least two years prior to sale the value of the company’s non-active business assets must not represent more than 50% of the company’s total asset value.
- At the time of sale the value of the company’s non-active business assets must not exceed more than 10% of the company’s total asset value.
If non-active business assets represent more than 10% of the total asset value it will be necessary to “purify” the company and remove the non-active business assets from the company before sale. If non-active business assets represent more than 50% of the total asset value, it will be necessary to wait two years after purifying the company before the shares will qualify for the lifetime capital gains exemption.
Multiplying the capital gains exemption
A common strategy to multiply access to the lifetime capital gains exemption is through a discretionary family trust. Traditionally, a family trust is introduced into the corporate ownership structure through an estate freeze where the original shareholders exchange their common shares in the company for fixed value preferred shares that reflect the value of the company at that time. The family trust then subscribes for new equity growth shares in the company for a nominal amount.
Following the estate freeze the future equity growth in the company accrues to the benefit of the trust beneficiaries, which typically include the original shareholders, their children, grandchildren, and potentially other family members. When the company is sold the original shareholders are first entitled to the value of their preferred shares with the residual value going to the family trust. The trustees of the family trust can then allocate the capital gain realized by the trust to the beneficiaries who can each claim their capital gains exemption. This strategy can result in significant tax savings to the family while allowing the original shareholders to maintain control of the company and the distribution of value.
The lifetime capital gains exemption can provide substantial tax savings. However, advance planning is often required to ensure you can access the exemption and maximize its benefits.
To learn more, please contact a Manning Elliott tax advisor.
* Exemption limit on qualified small business corporation shares is indexed for inflation.
** Exemption limit on qualified farm property is not indexed for inflation.
*** In certain cases proprietorships or partnerships can be incorporated and bypass the two year holding period requirement.
The above content is believed to be accurate as of the date of posting. Canadian Tax laws are complex and are subject to frequent changes. Professional tax advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.