Does your Business Qualify for the Small Business 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 2016, up to $824,176* 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 property **.
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. The important thing to understand, however, is that the exemption is not automatic. There are some conditions that must be met. In order for the business to be considered a QSBC and therefore qualify for the Small Business 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 tax payer 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 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 which could put a corporation offside with respect to its being a QSBC are cash, bonds, non-business related real estate and other investments.
In situations where corporations do not qualify for the SBGE 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 the non-business related assets. Some examples as to 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 installments;
- Purchasing new assets which will be used in the business to produce active business income.
There is another area in which careful attention is warranted. In order 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 the case 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.
If I can be of assistance to you, please do not hesitate to contact me. As always feel free to share this article by using the share buttons below.
* The 2013 federal budget increased the LCGE to $800,000 for 2014 with indexing commencing in 2015. The indexed amount for 2016 is $824,176.** 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 then both SBC shares and farm and fishing property will enjoy the same LCGE.