The Capital Gains Exemption

“Capital gains exemption planning is complicated.”

A Canadian individual is generally eligible for an $800,000 exemption (indexed to inflation after 2014) on capital gains on the sale of qualified small business corporation (QSBC) shares, as well as certain fishing or farming property.
There are a number of requirements that must be met for the shares of a QSBC to be eligible for the exemption. One of the rules is often misinterpreted to state that the shares of the QSBC must be owned by the individual for at least 24 months prior to their sale.

That interpretation is not correct. The actual condition states that the individual or a related person or partnership can be the only owners of the shares in the 24 months prior to sale. This does not mean that the individual claiming the exemption had to own the shares for 24 months. The test can be met if a combination of the individual and a related person or partnership hold the shares in the 24 months prior to sale. Another twist on the 24-month rule is explained in Tax Tip 08-01).

Suppose mother owns 100% of the shares of a QSBC and would like to bring her daughter into the business. In order to do so, mother could gift the desired portion of her shares to her daughter. Mother will have a deemed disposition, at the time of the gift, at the fair market value of the shares at that time. Mother can use her exemption to avoid tax on the deemed gain, and the daughter will have a cost base equal to the value of the shares when she received them from Mother. If the mother’s shares qualify for the exemption, the transfer will likely not trigger any income tax for the other.

If mother and daughter sell their shares 18 months later and all of the other QSBC conditions are met, the daughter’s shares will be eligible for the exemption even though the daughter did not own the shares throughout the 24 months prior to the sale. The daughter’s shares will have met the condition of not being owned by any person or partnership that was unrelated to the Daughter in the 24 months prior to the sale.

The result would have been different if 18 months prior to sale, Daughter instead subscribed for new shares of Opco rather than receiving them as a gift from Mother. If the daughter subscribed for shares, the daughter would have held the shares for only 18 months and would not qualify for the exemption.

This example has logistical and practical limitations and is for illustration purposes only. There may be other ways to achieve the illustrated results.

Capital gains exemption planning is complicated. We would be pleased to discuss your options with you further.

TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

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