If you sell shares of SMALL CANADIAN CORPORATION, you may be able to take advantage of 750,000 capital gains exemption!

Section 110.6 of the Income Tax Act (ITA) allows 750,000 tax-free capital gains to individuals. This exemption is valid for the gain on sale of shares of small business i.e. "qualified small business corporation share", as defined by ITA S.110.6(1) to be considered as such, the business has to meet several criteria:

"… means a share of the capital stock of a corporation that,

(a) at the determination time, is a share of the capital stock of a small business corporation owned by the individual, the individual’s spouse or common-law partner or a partnership related to the individual,

(b) throughout the 24 months immediately preceding the determination time, was not owned by anyone other than the individual or a person or partnership related to the individual, and

(c) throughout that part of the 24 months immediately preceding the determination time while it was owned by the individual or a person or partnership related to the individual, was a share of the capital stock of a Canadian-controlled private corporation more than 50% of the fair market value of the assets of which was attributable to

(i) assets used principally in an active business carried on primarily in Canada by the corporation or by a corporation related to it…"

Example:

Mr. Holder owns 30% of shares of Holding Corp. The shares were acquired two years ago for 500,000. Holding Corp. is a Canadian-controlled private corporation that uses its assets in active business done in Canada. This year Mr. Holder sells his shares to Mr. Rich for 1,150,000. Thereby, Mr. Holder will receive a taxable capital gain from sale of his shares in the amount of 650,000. Upon satisfying all criteria for Capital Gains Deduction, the gain of 650,000 will not be taxable. Mr. Holder will also be able to use the remaining 100,000, left from previously available 750,000 to use in future years.

There are several provisions in the Act that leave CRA some freedom of discretion to prevent abuse of the provision by aggressive tax planning. Sections 110.6(7) and 110.6(8)deal with corporation’s cost manipulation issue, the second, however, might present an issue to the honest taxpayer as well, by the way it disqualifies the companies that did not distribute dividends in the amounts comparable with their earnings in the past years.

A petty arises when the business is sold and the buyer leans more towards making asset transfer instead of transferring ownership of the Corporation. The buyers are often advised by their lawyers that buying the assets of the business alone safeguards them from any problems from the corporation's past, such as audits, creditor's or customer's claims. In that case the corporation stays with the owner, and the advantage of the capital gains exemption is foregone.

The way to satisfy both buyer and seller in that case may be that the owner sells the corporation to third party and takes advantage of available 750,000 capital gains exemption, and later the third party sells the assets of the business to the intended buyer. The third party retains the corporation.

As the matter is complicated it is highly desirable to obtain professional advice and business deal planning ahead of time. Here, the authors only aimed to grasp the general idea.

Important notice: The information above may reflect a subjective interpretation by the author(s), who, by no means may accept any responsibility or liability whatsoever for the results of proper or improper use of the above information, whole or in part, it as well is explicitly stated that whatever information provided by authors, may not suit specific purpose of specific reader, and it alone may not be relied upon to produce decision. In each individual case professional advice must be obtained.