Selling Shares of Your Successful Business and Accessing the Lifetime Capital Gains Exemption

Authored by Jack Kuzyk

JD Candidate 2023 | UCalgary Law

As entrepreneurs in Canada, it is important to understand how to arrange your affairs to minimize the amount of tax payable by utilizing the tax tools provided in the Income Tax Act (“ITA”).[1] Successful business owners may wish to sell their shares in a private corporation, but what are the tax implications upon the sale of the appreciated shares? This blog post will provide a brief overview of the lifetime capital gains exemption (“LCGE”) and how entrepreneurs can use this generous tax planning tool to decrease their tax payable.

What Is The Lifetime Capital Gains Exemption?

As one of the most important tax policies for entrepreneurs and small business shareholders, the LCGE is a tax incentive that can, within limits, apply at the tax payer’s option to exempt all or part of the taxable capital gains realized when disposing of qualified small business corporation shares (“QSBCS).[2] Essentially, it acts as an economic incentive to help raise investments in small businesses, as entrepreneurs and prospective investors can potentially pay less tax when they eventually sell their shares. Upon such disposition,[3] the LCGE may be used against the tax payer’s taxable capital gain, eliminating some or all of the taxable capital gain. While calculating taxable capital gain is beyond the scope of this blog, it is important to note that taxable capital is 50% of the capital gain realized when disposing of shares.[4]

How Much Is the Lifetime Capital Gains Exemption?

The LDGE amount changes annually and is indexed to inflation. For dispositions in 2022 of QSBCS, the LCGE limit has increased to $913,630.[5] In comparison to 2021, this increase of $21,412 provides tax payers with a greater opportunity to save when disposing QSBCS that have accrued in value.

How To Qualify? What Are Qualified Small Business Corporation Shares?

While acting as an economic incentive to help raise the level of investment in small businesses, not everyone meets the criteria to qualify for the LCGE. To access the LCGE, the tax payer must meet be a Canadian resident at the time of the disposition. Moreover, it is imperative that the shares qualify as QSBCS. In order to constitute QSBCS, must meet several conditions under subsection 110.6(1) of the Income Tax Act:[6]

The corporation is a Canadian Controlled Corporation;[7]

At the time of sale, the corporation must use more than 90% of its assets (computed on a fair market value basis) principally in an active business operations carried on primarily in Canada by the corporation or a related corporation, or be shares or debt of an connected corporation that meets the 90% test;

The shareholder(s) must have owned the shares for a 24-month period preceding the sale, subject to some exceptions; and

Additionally, during a 24-month period preceding the sale, at least 50% of the fair market value of the corporation's assets must be used principally in an active business operations carried on primarily in Canada by the corporation or a related corporation, or be shares or debt of a connected corporation that meets the 90% test described above.

If all of these criteria are satisfied, the Canadian resident taxpayer may claim the LCGE on their tax return and maximize their after-tax income.

Conclusion:

In Summary, the LCGE is a valuable tool for entrepreneurs to reduce their tax liabilities when selling QSBCS. By understanding the criteria for accessing the LCGE and using it strategically, entrepreneurs can potentially save up to the full amount of the LCGE. For more information regarding eligibility under the LCGE, or maximizing tax savings while staying compliant with Canadian tax laws, please contact the BLG Business Venture Clinic.

[1] Income Tax Act, RSC 1985, c 1, s 110.6(2.1) [ITA].

[2] Bryce C. Tingle, Start-up and Growth Companies in Canada: A Guide to Legal and Business Practice, 3rd ed (Toronto: LexisNexis Canada Inc., 2018) at 82-84.

[3] ITA, supra note 1, s 248 “disposition”.

[4] ITA, supra note 1, s 38(a).

[5] Canada Revenue Agency. “T4037 Capital Gains 2021.” Government of Canada, 18 January 2021, https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/t4037/capital-gains.html.

[6] ITA, supra note 1, s 110.6

[7] ITA, supra note 1, s 125(7).