Immigrants to Canada who own an existing business or intend to start a new business in Canada may benefit from a significant tax advantage. Such tax advantage, commonly referred to as a “lifetime capital gains exemption”, offers up to $220,000 in tax savings to owners and their family members when the business is sold or transferred to the next generation.
Every individual is entitled to a lifetime capital gains exemption of $824,176 when the individual disposes of “qualifying small business shares”. Very generally, “qualifying small business shares” include shares of a corporation that at the time of the sale substantially all (meaning 90% or more) of the value of the business assets must be used for carrying on an active business in Canada or the assets must be shares or debt of other qualified small business corporations. Also, the individual, or a related person, must have owned the shares for two years prior to selling them. And throughout the two years, more than 50% of the corporation’s assets must have been used principally in an active business carried on in Canada or invested in other small business corporations.
The exemption applies to total gains realized by the individual during his lifetime. However, the exemption does not have to be claimed at once and portions of the $824,176 limit can be claimed overtime in respect of different transactions involving a sale of qualifying small business shares.
Assume that Mr. X, a new Canadian immigrant, decides to start a new business in Canada which will operate retail stores. Mr. X invests $1,000,000 in setting up a Canadian corporation (Xco) and acquiring retail locations. The business is operated successfully and in a 10 years’ time it is worth $5,000,000. At that point, Mr. X decides to sell the business to a competitor. The sale of the shares of Xco will produce a $4,000,000 capital gain to Mr. X. Provided that all the required conditions are met, $824,176 of that amount is exempt from taxation. Depending on the province of Mr. X’s residence, can realize savings between of up to $220,000. Tax savings by province are presented in Table A below.
|Province||Capital Gains Rates||Tax Savings|
|Prince Edward Island||25.69%||$211,730|
It is possible to effectively increase the available exemption if the owner’s spouse and children also own shares in the corporation. Rather than family members owning shares directly, many business owners use a family trust, with beneficiaries that may include a spouse and both minor and adult children. If such a trust is used, each family member may be able to take advantage of the exemption, thereby increasing the total tax savings, as long as the trust takes the appropriate actions. Thus, in the above example, if in addition to Mr. X, Mr. X’s wife and 3 children also owned shares of Xco, the capital gains exemption could be used five (5) times (total amount of the exemption for the family would be $4,120,880) and the entire capital gain would be non-taxable.
The advantages of the lifetime capital gains exemption can be realized not only when the business is transferred by the owner to third parties, but also when the business is transferred within the family or to the next generation on death. Various techniques can be used to crystalize and multiply the capital gains exemption while the business remains in the family. The life time capital gains exemption is a powerful tool in minimizing taxes payable by small business owners operating in Canada. However, careful tax planning is required in order to ensure that the benefits of the capital gains exemption are available in particular circumstances.
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