The lifetime capital gains exemption on the sale of a business is one of the most favourable tax breaks in Canada. If you own a small business and are thinking about selling it, it’s a smart idea to know how to organize the sale so that you benefit fully from the exemption.
What Is the Exemption?
As a general rule, the sale of the shares of a company that operates a small business is a capital gain. Anyone realizing a capital gain must include 50% of it in their income and pay taxes accordingly. However, there is an exception that allows the capital gains on qualifying shares to be completely exempt from tax up to $813, 600 (in 2015). The actual amount is indexed annually. The exemption is cumulative, so you do not have to use it on a single transaction. For example, if you claimed $100,000 as an exempt gain in 2004, you have $713,600 still available today.
What Shares Qualify for the Exemption?
To qualify for the exemption, your business must be incorporated. Only the sale of shares qualifies, not the sale of business assets. If you are not incorporated but still want to use the exemption, you may be able to roll the assets over into a corporation. If this is your situation, it’s a good idea to consult a professional. Furthermore, the shares you sell must be Qualified Small Business Corporation Shares (QSBCS) as that expression is defined in the Income Tax Act. To be considered as QSBCS, the shares must be owned by you, your spouse, or common-law partner, or a partnership of which you were a member. As a rule you must have owned the business for more than 24 months and the assets of the company must have been used mainly in an active business carried on primarily in Canada. This last rule excludes companies that have only passive investments. There are other technical rules that may apply to your specific case, so it’s a good idea to check with the Canada Revenue Agency or a tax professional prior to finalizing a sale of shares.
How to Claim the Exemption
To claim the exemption on the disposition of qualifying shares, you will need to complete Schedule 3 and attach it to your income tax return. In this schedule, you will need to indicate, among other things, the name of the company, the number and class of the shares you sold, the year of acquisition, the proceeds of disposition (price sold), the adjusted cost base (price paid), and any costs, such as legal fees, associated with the sale. You will also need to know if you have claimed a part of the exemption in the past. If you are unsure, you can find your cumulative balance in the Canada Revenue Agency My Account portal or contact the Canada Revenue Agency to have them look it up in your file.