After many years of consistent hard work and sweat equity put into your company, your goal may be to sell your business to a third party or pass it down to a family member. This can be a very rewarding but frustrating process as you try to navigate the sale in the most tax efficient manner possible. We will get into passing down your company to family members in another post titled “Estate Planning”.
However, when selling your business, one of the tools utilized is the Lifetime Capital Gains Exemption (LCGE). Every Canadian citizen is entitled to receive this beneﬁt which enables you to receive up to $866,912 of capital gains tax-free. (1)
However, there are many diﬀerent eligibility criteria that you need to meet in order to qualify for the LCGE and careful planning needs to be taken in order to prevent the loss of this beneﬁt. Section 110.6 of the ITA deals specifically with this issue. There is quite a few different eligibility criteria that you need to meet, however, the basic rules state that at time of sale all or substantially all of the assets within your corporation need to be used in active business.
Let’s talk about active vs passive assets for a second here:
- Steve owns an electrical company with trucks, tools, a warehouse, mutual funds, rental properties and excessive cash in the corporation.
- The trucks, tools, and warehouse would be considered active business assets as they are pertinent to the active business operations of the electrical company.
- The mutual funds and rental properties would be considered passive assets as they are not pertinent to the active business operations of the electrical company.
- The cash COULD be considered a passive asset to the corporate if it was deemed to NOT be pertinent to the active business operations. There have been 2 court cases in which the CRA challenged a business owner claiming the LCGE in which their corporation had excess cash in it. In both cases unfortunately the CRA won and they now have substantial precedent to back up their argument.
Suffice to say it takes careful planning to ensure you remain eligible for this fantastic benefit.
Furthermore, there is a strategy where you can multiply the LCGE via the use of a discretionary family trust. This can be extremely beneﬁcial to business owners who are selling their company for much more than the LCGE limit, resulting in a large capital gain being declared.
(Note 1): Current as of 2019 – LCGE is indexed and increases each year.