Lifetime Capital Gains Exemption: Will I Be Able To Claim It?
Updated: Sep 30, 2020
Starting and growing a business requires years of hard work, time, and dedication. When you’re ready to exit or retire from your business, you want to ensure you’ll retain as much of the cashflow from the sale as possible. The Lifetime Captain Gains Exemption (LCGE) is a great way to significantly shelter the capital gain taxes generated from the sale of Qualifying Small Business Corporation (QSBC) shares. Let us show you how this exemption can result in thousands of dollars of savings for you!
As a business owner, you’ve probably heard these terms before but never fully understood what they meant or whether they apply to your business. In today’s post, we’ll dive into this topic to help clarify the LCGE and discuss some of the common pitfalls, benefits and planning techniques that should be considered when qualifying for this exemption. Please explore our resources below and let us know your thoughts.
Lifetime Capital Gains Exemption
The LCGE has helped many people save tax since it was introduced many years ago. It enables individuals to shelter capital gains relating to the sale of QSBC shares of up to $866,912 (2019). This provides the individual with more cash flow from the sale of the business as a portion or all of the capital gain can be eliminated. For example: Let’s go through a situation where Bill qualifies for the LCGE vs. a situation where he does not. Below are the following facts for presentation purposes:
Bill holds shares in ABC Inc.
Bill sells his shares in ABC Inc. in 2019
The selling price of his shares is $800,000
The Adjusted Cost Base (ACB) of the shares is $400,000
Bill’s personal tax rate is 50%
As you can see, Bill could save $100,000 in taxes which sheltered his entire gain from the sale and enabled him to walk away with $400,000 vs. $300,000 by using the deduction. If Bill's shares triggered a net taxable capital gain of $433,456 in the example above, he would have a total savings of $216,728 (assuming he had a personal tax rate of 50%).
How Do I Qualify For The LCGE?
Now that you have an idea of the benefit the exemption can have on your overall tax position, we will go through the eligibility criteria of who and how to qualify for this deduction. To qualify, you must meet both criteria:
1) You were a resident in Canada for at least a part of the year you are claiming the exemption. Using the previous example above, Bill would have had to be a resident for at least a part of 2019.
2) You were a resident throughout the tax year prior to or after you plan on claiming the exemption. Using the previous example above, this would mean that Bill must be a resident throughout either 2018 or 2020.
What are Qualified Small Business Corporation (QSBC) Shares?
Determining and maintaining the QBSC share status can become complex and difficult. This is an exercise that should be the done with the assistance of a professional to ensure everything is on-side and in line with the specific rules. As shown in the previous example above, there is a significant benefit from the LCGE and losing it can result in a notable tax liability.
There are three (3) tests that must be met for shares to qualify as QSBC shares.
1. The Small Business Corporation Test
2. The Holding Period Test
3. The Basic Asset Test (50% Test) The Small Business Corporation (SBC) Test
To meet the criteria under the SBC test, the following needs to hold true at the time of disposition/sale (“determination time”):
Shares must be owned by the individual, the individual’s spouse or by a partnership related to the individual
The individual must hold capital stock or shares in a corporation that meets the definition of a small business corporation at the time of sale
A small business corporation, as defined in the income tax act, can be summarized by the following key points:
A Canadian-controlled private corporation
All or substantially all the fair market value of the assets (includes unrecorded assets but excluding liabilities) were:
used principally in an active business carried on primarily in Canada by the corporation; OR
A related corporation; OR
Shares or debt of an SBC that was connected with the particular corporation
Some common areas that can impact the SBC or QSBC classification are:
Investments in the business due to excess cash
Rental income from buildings or assets of the business to non-associated companies
Vehicles used for personal use more than 50% of the time
The terms “substantially all”, “principally” or “primarily” are not specifically defined in the act and professionals look to various case law for guidance on how to interpret these amounts. There is a great deal of professional judgement that is required in the determination of a small business corporation which is why a professional should be consulted when making this determination considering there are no hard and fast rules here.
The Holding Period Test
To meet the holding period test, the shares must be owned by the individual selling the shares or anyone related to this individual throughout the 24-month period prior to the sale. This can include personal trusts or partnerships related to the individual.
The Basic Asset Test
The basic asset test is met when the following conditions hold true:
The share was held throughout by the individual, individuals’ spouse or person or partnership related to the individual during the 24-month period before the sale/disposition
The shares held belong to a Canadian-controlled private corporation
More than 50% of the fair market value of the corporation’s assets were used principally in the active business carried on primarily in Canada by the corporation or a related corporation
There are conditions when modifications to the basic asset test can be done. This is referred to as the “stacking rule” which uses connected corporations to meet the criteria under the basic asset test. When determining these, please consult a professional as it can get fairly complex.
As you can see, the determination of whether your shares are QSBC shares can be complex. Quite often clients miss out on this exemption as their either offside with active business assets or haven’t structured their balance sheet accordingly. Advanced planning and review of your balance sheet can help save significant taxes for you in the future. If you don’t think you qualify initially, remember there are strategies that can be put in place to help you “purify” your business to get you on-side for the purposes of the SBC or QSBC status. For example, excess cash on the balance sheet can be used to pay down debt, liabilities, or pay dividends to shareholders.
In addition to this, strategies can be used to “crystallize” or “lock in” your LCGE through triggering a capital gain through filing an election so you do not have to worry about meeting the status in the future and you can bump up your adjusted cost base.
Overall, there is a significant benefit to individuals that hold shares that qualify as a QSBC share as you can shelter up to $433,456 (2019) of taxable capital gains in your lifetime. If you require any assistance or professional guidance navigating through the above, please feel free to contact us for a free consultation. At Pratik Mehta Professional Corporation, we are always here to help you grow your business and advise you on every step of your journey. Disclaimer: The above summaries and information are key highlights into the Lifetime Capital Gains Exemption. The information provided above can change based on your specific situation and a professional should be consulted when making complex determinations. PM Professional Corporation is not to be held liable for the use of this information without consulting a professional.