Selling a small business can trigger big tax questions. The Capital-gains-exemption-qualified-small-business-corporations helps lower taxes on these sales. This blog will explain how it works and who qualifies.
Key Takeaways
- The Lifetime Capital Gains Exemption (LCGE) helps small business owners reduce taxes when selling qualified shares.
- To qualify, shares must belong to a Canadian-controlled private corporation (CCPC) with over 50% of assets supporting active business in Canada for at least 24 months.
- At least 90% of CCPC’s assets must support active businesses in Canada to meet tax rules.
- QSBC shareholders follow limits; from 2014 onward, the deduction limit is $400,000 with a 50% inclusion rate on gains.
- Corporate purification ensures LCGE eligibility by removing inactive assets and restructuring ownership.
Understanding the Lifetime Capital Gains Exemption
The Lifetime Capital Gains Exemption helps reduce taxes on certain gains. It encourages investment in small businesses and specific properties.
Purpose of the exemption
The exemption helps small business owners keep more money from selling their businesses. It supports entrepreneurs by reducing taxes on capital gains.
It encourages investment in Canadian businesses, boosting growth and job creation. Family trusts can also use it to spread tax benefits among family members.
Qualifying criteria
A person must meet specific rules to qualify for the Lifetime Capital Gains Exemption (LCGE). These ensure only eligible small business shares or properties get the benefit.
- The company must be a Small Business Corporation (SBC) when selling the shares.
- Shares must belong to a Canadian-controlled private corporation (CCPC).
- Over 50% of the company’s assets have to support active businesses in Canada for at least two years before the sale.
- Shares cannot be owned by anyone other than the seller or their family during the 24 months leading up to the sale.
- Only share sales, not asset sales, can qualify under this rule.
- Each qualified person is allowed a cumulative LCGE on gains from selling qualified property.
- Consult with accountants or lawyers to confirm eligibility and avoid mistakes.
Criteria for a Qualified Small Business Corporation (QSBC) Share
To qualify as a QSBC share, specific rules must be met. These rules ensure the business is active and privately owned in Canada.
Small Business Corporation Test
The Small Business Corporation Test checks if a corporation qualifies as a QSBC. The Canada Revenue Agency (CRA) requires the company to be a Canadian-controlled private corporation (CCPC).
At least 90% of its fair market value assets must serve an active business in Canada.
Also, at Determination Time, the individual must own shares in this small business corporation. The test ensures the company engages mainly in Canadian business activities and meets set standards.
Ownership by the individual
Shares must be owned by the individual at the time of sale to qualify. For 24 months before this, ownership must stay within the family.
This rule ensures shares meet LCGE criteria. It helps maintain control within families and supports small business corporation goals.
Canadian-controlled private corporation (CCPC)
A Canadian-controlled private corporation (CCPC) is a business incorporated in Canada. It must be controlled by Canadian residents. To qualify, its shares cannot be listed on public stock exchanges.
Over 50% of the CCPC’s assets must actively support a business in Canada for at least 24 months before a sale. At least 90% of its asset value should come from active business assets based in Canada.
Excess cash, real estate for investment, or nonessential assets do not count as active business assets.
Active business primarily in Canada
At least 90% of the company’s assets must support an active business in Canada. These assets should help run the core business activities that contribute to the Canadian economy.
The business must stay actively engaged in operations within Canada to meet eligibility rules. This ensures compliance with Lifetime Capital Gains Exemption (LCGE) requirements and aids tax-planning strategies.
Holding Period Ownership Test
Shares must be held by the individual for at least 24 months. Only shares owned by the person or their family during this time meet the test. This rule excludes ownership outside of these limits before the Determination Time.
The share must still belong to the individual when sold. These rules ensure control stays within families and help qualify for LCGE.
Holding Period Asset Test
More than 50% of the fair market value of the company’s assets must come from assets used in an active business in Canada. This rule applies throughout a 24-month period before selling QSBC shares.
The corporation or any connected corporation must engage actively in business within Canada using these assets. Meeting this test ensures compliance with LCGE rules and proves active engagement.
Additional Requirements for Shares in a Holding Corporation (Holdco)
Shares in a holding corporation have extra conditions to meet. These focus on active assets and connected companies.
Active assets or investments in connected CCPCs
At least 90% of a holding company’s assets must be active business assets or investments in connected CCPCs. This ensures the company stays focused on active business activity, not passive income.
Connected CCPCs must also meet the 50% active asset test to qualify. The holding company’s asset composition plays a key role in meeting LCGE rules and keeping shareholder eligibility intact.
90% threshold for connected companies
The holding corporation must meet the 90% threshold for connected companies. This means at least 90% of its assets or investments in connected CCPCs must be active and engaged in business.
If the holding company fails to meet this test, connected entities still need compliance throughout a 24-month period. Failing that, it can qualify under a 50% asset test instead. Asset composition and sustained activity during this time are key for LCGE eligibility.
Limits and Rates for Capital Gains Deduction
The capital gains deduction has specific limits based on QSBC shares. Understanding the inclusion rate is crucial for tax planning.
Limits for QSBC share dispositions
For QSBC share dispositions made in 2014, the deduction limit is $400,000. Dispositions happening after March 18, 2007, but before 2014 have a lower limit of $375,000. The Lifetime Capital Gains Exemption for sales before 2014 stands at $750,000.
Staying within these limits ensures proper tax compliance and helps taxpayers plan their gains well. These thresholds directly impact tax benefits under small business corporation rules.
Capital gains inclusion rate
The capital gains inclusion rate has been 50% since 2014. This means only half of your capital gain is taxable during a share disposition.
This rate applies to QSBC share dispositions and directly impacts how much tax you owe. Following the inclusion rules ensures proper tax compliance and better tax planning for reduced liability.
Mechanisms for Corporate Purification
Corporate purification keeps a business eligible for the LCGE. It involves restructuring to meet tax and asset rules.
- Remove inactive assets. Sell or transfer extra investments or property not used in the business. This meets active business requirements.
- Shift excess cash or investments. Move non-business funds to another entity to stay under the 90% threshold rule.
- Reorganize share structure. Change shares if ownership does not align with eligibility rules for QSBC shares.
- Separate different businesses. Move unrelated ventures into new corporations to simplify compliance with active business criteria.
- Review connected companies’ assets often. Ensure assets in linked CCPCs meet tests and match LCGE needs.
- Work with experts for legal advice. A legal consultant ensures your plan follows tax laws and optimizes benefits fully.
Conclusion
The Capital Gains Exemption offers great tax benefits for small business owners. It encourages investment and helps with financial growth. Following the rules is key to qualifying.
With careful planning, you can save money while selling your shares. This exemption supports both businesses and individuals alike.