If you’re a Canadian business owner thinking about selling your business, you’ve probably heard about the Lifetime Capital Gains Exemption (LCGE). This powerful tax benefit can help you keep more of your hard-earned money when you sell shares of your business. Here’s what you need to know if you’re planning to sell your business for $1,000,000.

What Is the Lifetime Capital Gains Exemption?

The LCGE allows Canadian individuals to shelter up to a certain amount of capital gains from tax when they sell qualifying shares of a small business corporation. For sales after June 24, 2024, the exemption limit is $1,250,000. This means that if your sale qualifies, you could pay little to no tax on the first $1,250,000 of capital gains from the sale of your business shares.

How Does It Work?

When you sell shares of your business, the difference between what you paid for the shares (your “adjusted cost base”) and what you sell them for is your capital gain. Normally, 50% of that gain is taxable. But if your shares qualify for the LCGE, you can claim a deduction to offset all or part of the taxable portion of your gain, up to the exemption limit.

Example:
If you sell your business shares for $1,000,000 and your adjusted cost base is $100,000, your capital gain is $900,000. Normally, $450,000 (50%) would be taxable. With the LCGE, you can deduct up to $625,000 (50% of $1,250,000) from your taxable capital gains, potentially reducing your tax bill to zero.

Who Qualifies for the LCGE?

Not every business sale qualifies. Here are the main requirements:

1. Qualified Small Business Corporation Shares

  • The shares you’re selling must be of a “qualified small business corporation” (QSBC).

  • At the time of sale, the company must be a Canadian-controlled private corporation (CCPC), and at least 90% of its assets must be used in an active business carried on primarily in Canada.

  • Throughout the 24 months before the sale, more than 50% of the company’s assets must have been used in an active business in Canada or invested in shares or debt of other connected small business corporations.

2. Ownership Test

  • The shares must not have been owned by anyone other than you or someone related to you during the 24 months before the sale.

3. Residency

  • You must be a resident of Canada throughout the year you sell the shares.

Steps to Take Before Selling

1. Confirm Your Shares Qualify

  • Review your company’s balance sheet to ensure the asset tests are met.

  • Make sure the company has been a CCPC for at least 24 months before the sale.

  • Check that the shares have not changed hands outside your family or related parties in the last 24 months.

2. Purify the Company if Needed

  • If your company has too much cash or investments not used in the business, you may need to “purify” it by paying out excess cash or transferring non-qualifying assets before the sale.

3. Keep Good Records

  • Maintain documentation showing how the company meets the QSBC criteria, including financial statements and records of asset use.

4. Consider Tax Planning

  • If you have family members, you may be able to multiply the exemption by having them own shares (with proper planning and advice).

  • If you have unused capital losses from previous years, these may reduce your taxable capital gains.

5. Get Professional Advice

  • The rules are complex, and mistakes can be costly. Work with a tax advisor to ensure you qualify and to maximize your exemption.

Important Factors and Caveats

  • Asset Tests: The “all or substantially all” and “more than 50%” tests are based on fair market value, not book value.

  • Holding Period: The 24-month holding period is strict. Shares issued from treasury must generally be held for at least 24 months before they qualify.

  • Capital Gains Reserve: If you don’t receive all the sale proceeds right away, you may be able to spread the gain over up to five years, but the exemption is still limited to the lifetime maximum.

  • Cumulative Net Investment Loss (CNIL): If you have claimed large investment expenses in the past, your exemption may be reduced.

  • Alternative Minimum Tax (AMT): Claiming the LCGE may trigger AMT in some cases, but this is often recoverable in future years.

What If You Don’t Qualify?

If your shares don’t qualify, you may still be able to reduce your tax bill through other means, such as using capital losses, structuring the sale as an asset sale, or considering a sale to family members under special rules for intergenerational business transfers.

Final Thoughts

The Lifetime Capital Gains Exemption is a valuable tool for Canadian business owners. If you’re selling your business for $1,000,000, and your shares qualify, you could save hundreds of thousands of dollars in tax. But the rules are detailed, and planning ahead is essential. Start early, get professional advice, and make sure you’re set up to take full advantage of this opportunity.

-Disclaimer: This post is for informational purposes only and does not constitute tax advice. Please consult a qualified tax professional for advice tailored to your specific situation.