Claim the capital gains exemption

The capital gains exemption is one of the most valuable tax incentives provided to shareholders of private corporations in Canada.

It allows a private company shareholder to sell shares or have shares deemed sold and eliminate income taxes on up to $750,000 of lifetime capital gains triggered by the sale.

Read: Capital gains mean tax-efficient investing

Actual tax savings vary by province or territory. Clients living in Ontario can save up to $180,000.

Of course, the availability of the exemption is subject to a number of conditions. In order to claim the exemption, the private company shares must be considered a Qualified Small Business Corporation (QSBC) and meet three tests: the 90%, the 50% and the holding period.

• The 90% test: At the time of sale the private company must be using a minimum of 90% of its assets in carrying on an active business in Canada.
• The 50% test: At least 50% of the company’s assets must have been used in the active business throughout the two-year period prior to sale.
• The holding period test: In the two-year period prior to sale, the shares must not have been owned by anyone other than the seller or a person related to the seller.

The CRA recently commented on the holding-period test in a situation where an inter-vivos personal trust owned QSBC shares for a period of more than two years and presumably met the 90% and 50% tests.

Read: Five ways to pay capital gains tax

A trustee intended for a personal trust to sell the shares and then designate the resulting taxable capital gain to the Canadian resident beneficiary. However, the trustee had named the beneficiary less than 12 months ago.

Was the holding-period test satisfied, and was the owner entitled to claim the capital-gains exemption?

The CRA said yes: As long as a personal trust has held the shares for a period of 24 months, a beneficiary can personally claim the capital-gains exemption, even if he or she hasn’t been a beneficiary throughout the entire period before the sale.

This is great news for business owner clients because it provides them the ability to allow family members to share in the growth and value of an incorporated active business without losing control of the operations. It also allows them to multiply the number of capital gains exemptions available by including family members as beneficiaries of the trust.

As a result of CRA’s ruling, it’s clear a beneficiary who wasn’t originally appointed in the trust but is added as a beneficiary within two years before the sale can be allocated some or all of the capital gain. They can then utilize a capital gains exemption to reduce the tax liability.

Read: Incorporation tax benefits for professionals

While this ruling isn’t binding, it provides some level of comfort to business owners who wish to add beneficiaries to the trust without being concerned about whether they meet the holding-period test.

The trust would still have to hold the shares for a two-year period, and meet the eligibility criteria for claiming this tax benefit. In addition, the terms of the trust would have to authorize the addition of beneficiaries.

Frank Di Pietro

Tax & Estate

Frank Di Pietro, CFA, CFP, is assistant vice-president of tax and estate planning at Mackenzie Investments. He can be reached at fdipietr@mackenzieinvestments.com.