Wealth Management Solutions for Business Owners
Lifetime Capital Gains Exemption
Effective for 2014, the Lifetime Capital Gains Exemption (LCGE) is increased to $800,000.
Qualification for the Exemption
The capital gains exemption exempts up to $800,000 in capital gains from tax on dispositions of Qualified Small Business Corporation (QSBC) shares, qualified farm property and qualified fishing property. The exemption also applies to capital gains that are flowed to individuals through partnerships, trusts and certain other types of investment vehicles. The exemption is available to individual taxpayers while resident in Canada.
The exemption is not available to offset capital gains realized by a corporation. Nor is it available to offset capital gains retained by a trust, i.e., capital gains that are not paid or payable in the year to a beneficiary.
Qualified Small Business Corporation Shares
In order to qualify for the LCGE, shares of a corporation must be QSBC shares. To qualify as QSBC shares there are several complex tests that must be met with respect to the type of assets owned by the corporation and the length of the period during which the shares are held. The first test to qualify as QSBC shares is at the time of disposition the shares must be shares of a Small Business Corporation (SBC). An SBC is a Canadian Controlled Private Corporation (CCPC) of which all or substantially all (90% or more) of the assets, on a fair market value basis, are used principally in an active business, carried on primarily (50% or more) in Canada by the corporation or a related corporation. The assets meeting the “all or substantially all” test may be shares or debt in another SBC which is controlled by the CCPC or of which the CCPC owns at least 10% of the voting shares and value.
The second test is a holding period test. To meet this test, no one other than the shareholder (or a related person or partnership) must own the shares for two years. During this period, at least 50% of the fair market value of the corporation’s assets must have been used in an active business. The test becomes very complicated where holding companies are involved.
Planning Considerations Regarding Availability of the Exemption
If a corporation holds non-active assets, transferring those assets to separate holding companies may be considered. The anti-avoidance rules contained in the Income Tax Act should be reviewed prior to entering into any transactions that attempt to extract assets from a corporation on a tax-deferred basis.
Planning Considerations Relating to Timing of Use of Exemption
There are planning techniques available to accelerate the realization of capital gains in order to use the capital gains exemption. One of the more common reasons to realize a gain is to lock in the capital gains exemption while the QSBC shares qualify; for example, before the corporation accumulates investment assets.
Impact of Corporate Owned Life Insurance
Holding a cash value life insurance policy in a corporation may affect whether shares of a corporation qualify as QSBC shares. Whether the corporate-owned life insurance policy held while the life insured is alive is considered an active business asset and whether the death benefit proceeds from a life insurance policy are used in an active business must be determined. Further, the “value” of the policy must be determined for purposes of the asset tests (for both the prior two years and at the time of disposition).
It is important to note that any type of passive investment asset may cause the corporation to be offside for purposes of the QSBC test. Generally, funds not required in the active business operations are used to purchase the insurance policy. Therefore, the corporation would likely have failed the QSBC tests regardless of whether the insurance policy was purchased, since the funds would likely have been invested in a different passive asset.
The capital gains exemption creates additional opportunities (and complexities) in tax planning. Taxpayers should consult their tax advisors when they are attempting to utilize their exemption.