This article is primarily focused on those who own a company, farm property, or fishing property. Structuring assets appropriately can result in significant tax savings that we will address below.
Before we dive into this article too deeply, here are some key abbreviations that are often used in taxation for this topic, and will be use throughout this article.
• Canadian Controlled Private Company — CCPC
• Small Business Corporation — SBC
• Qualified Small Business Corporation — QSBC
• Lifetime Capital Gains Exemption — LCGE
• Qualified Farm or Fishing Property — QFFP
• Operating Company — OpCo
• Standard Company — StanCo
• Holding Company — HoldCo
• Professional Company — ProCo
• Tax on Split Income — TOSI
For all our clients who own a CCPC, SBC, or QFFP we will have at one time, or another, discussed QSBC and LCGE. In fact, we have likely had multiple conversations about this topic as it is so important. It is one of the main planning goals that we want our corporate clients to fully understand well before their retirement date.
Lifetime Capital Gains Exemption (LCGE)
What is the Lifetime Capital Gains Exemption? When individual shareholders sell their shares of a CCPC, they may be entitled to claim the LCGE to reduce potential capital gains on the sale, provided that the Professional Corporation (ProCo) or Standard Corporation (StanCo) qualifies as a Qualified Small Business Corporation (QSBC).
Qualified Small Business Corporation (QSBC)
To qualify as a QSBC, the following criteria must be met:
• Must sell the shares of the company and not the assets
• At the time of the sale, the QSBC shares were owned by the owner of the QSBC (or their spouse, common-law partner, or partnership through which they were a member)
• For the 24 months before the sale of shares, the corporation was considered a CCPC and over 50 per cent of the fair market value of the assets were used in either active business, certain shares/debts of connected corporations, or a combination of the two.
Buying shares of the company
The shareholder of a company will typically want to sell shares. The purchaser may prefer to purchase assets. As a result, in the negotiation stage a business may have two price tags: One smaller price tag if the shares of the company are purchased and a larger price tag if the assets of the company are purchased.
The buyer of a company will know that there may be a benefit for the seller to sell shares in order to claim the LCGE. There is also a risk to buyers for purchasing the shares of a company as they assume all liabilities and the tax characteristics of the assets within the corporation. This may not be as favorable as purchasing the assets.
Purchasers typically prefer buying assets as it allows them to pick which assets they want and which liabilities they are willing to assume. This minimizes their risk while reducing the complexity of the transaction.
When assets are purchased directly, the tax book cost of the asset will be the amount paid for the asset (provided the buyer is dealing at arm’s length). It is possible to structure a hybrid deal that does a combination of asset and share sale to satisfy both parties.
Creation of Holding Company
When our clients incorporated their businesses years ago, they created an operating company (OpCo). Over time, the business has successfully grown and retained earnings are built up within OpCo. When we have clients with excess retained earnings within OpCo, we will often bring up the topic of setting up a holding company (HoldCo).
There are many benefits of the HoldCo — one is the ability to pay tax-free inter-company dividends. Below is an illustration.
We will assume the OpCo has been operating for many years and has excess retained earnings of $800,000. The owner of the OpCo has the funds invested in an investment account and funds within a bank account. Together, the OpCo is generating $50,000 of passive investment income. The client is approximately four years away from retirement and a new HoldCo was recently set up.
After the HoldCo is set up, the owner is able to declare a tax-free inter-company dividend of $800,000 from the OpCo to the HoldCo. This effectively moves the excess funds out of the OpCo to the HoldCo and helps reduce risk in the event that the OpCo is ever involved in litigation.
The passive investment income is shifted out of the OpCo to the HoldCo making the OpCo more likely to qualify as a QSBC and utilize the LCGE. By shifting the $800,000 out of OpCo, it also makes the selling price significantly lower, and easier to sell. Lastly, the $800,000 can be invested appropriately to generate additional returns with the HoCo.
Important point from illustration: We highlighted one of the criteria to qualify as a QSBC. For the 24 months before the sale of shares, the corporation was considered a CCPC and the 50 per cent of the fair market value of the assets were used in an active business in ÎÚÑ»´«Ã½.
By shifting the $800,000 out of the OpCo, this company will more likely qualify for the LCGE, 24 months after the inter-company dividend. The tax savings from an individual claiming their full LCGE can be as high as $445,833 in ÎÚÑ»´«Ã½ (see calculations below).
With proper planning it may be possible to take advantage of the LCGE with other family members which would multiply the tax savings (example below).
Communication with professionals
We encourage our clients who have a CCPC, and are looking to retire in a few years, to arrange a joint meeting with their tax advisor and Portfolio Manager. At a minimum, working toward the LCGE can be the ultimate payout for clients wishing to get money out of a corporation and into their personal hands.
For business owners we will have joint meetings with our clients’ accountants. Often we are outlining more advanced tax planning opportunities such as freezing, refreezing, thawing your estate, as well as insurance strategies within a holding company to enhance an estate.
Budget 2024 LCGE
Prior to the most recent federal budget announcement, an individual could claim a LCGE of up to $1,016,836 for 2024 with respect to capital gains realized on the disposition of qualified small business corporation (QSBC) shares and qualified farm or fishing property (QFFP).
Budget 2024 proposes to increase the LCGE amount to $1.25 million, effective for dispositions that occur on or after June 25, 2024. The $1.25 million will be indexed to inflation after 2025.
The maximum tax savings of an individual claiming $1.25 million of LCGE in a capital gain regime, now that 2/3 of a capital gain is taxable (ignoring the $250,000 capital gain bracket for 1/2 inclusion rate) is $445,833 ($1,250,000 x 2/3 x 53.5 per cent - top marginal combined federal plus ÎÚÑ»´«Ã½ tax rate).
Prior to budget 2024 and the changes to the capital gains inclusion rate, the LCGE resulted in maximum tax savings of $272,004 per LCGE ($1,016,836 x 1/2 x 53.5 per cent - top marginal combined federal plus ÎÚÑ»´«Ã½ tax rate). Utilizing the LCGE exemption is even more important since the change in the inclusions rate.
Decades of ownership
Many farmers, fisherman, and business owners are not happy with the change in the inclusion rate. In many cases the slight increase from $1,016,836 to $1,250,000 pales in comparison to the overall increase in taxes they will have to pay.
Using farmers as an example, many have worked hard for little income for decades. Over this time, they have built up equity through land ownership. Many farmers will be unfairly hit by this extra tax when they one day want to transition the farm. We feel many medical and dental professionals will also get hit hard with these changes.
Family trust multiplies LCGE
Since QSBC capital gains are not subject to the tax on split income (TOSI), our clients are generally permitted to “multiply” the LCGE entitlement if they have properly employed family trust planning in their ownership structure. Therefore, the increase of the LCGE limit to $1.25 million could add up to a very material tax saving for business owners who are able to sell qualifying shares of their business in their family trusts.
LCGE indexed to inflation
In some situations we have noted that individuals may have done a LCGE exemption ten years ago when the limit on gains arising from a disposition of qualifying property was $400,000 (one half of the LCGE limit of $800,000 in 2014). The LCGE limit has increased over the years, and it may be possible to do another election, to top up to the maximum, if the opportunity arises.
Year and LCGE
2014 — $800,000
2015 — $813,600
2016 — $824, 176
2017 — $835,716
2018 — $848,252
2019 — $866,912
2021 — $892,21
2022 — $913,630
2023 — $971,190
2024 — $1,016,836
2024 — $1,250,000 (Budget 2024)
Planning ahead with professional guidance
With most tax minimization strategies, planning is the key component. The earlier you begin planning, the more options that are available. Business owners have worked hard to earn the money and build up retained earnings.
As much as it was important to work hard to build up the savings, it is equally important to make sure that you plan to ensure you are taking advantage of all opportunities to pay the least amount of tax possible over your lifetime.
Kevin Greenard CPA CA FMA CFP CIM is a Senior Wealth Advisor and Portfolio Manager, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138, email [email protected], or visit .
