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Lifetime Capital Gains Exemption: What You Need to Know!

By January 24, 2013April 28th, 2021Corporate

In this blog, I’ll be talking about the lifetime capital gains exemption. This is one of the most valuable tax incentives provided to dentists who are selling the shares of their dentistry professional corporation.

Capital Gains Tax

Let’s say a dentist owns shares of a dentistry professional corporation (“DPC“).  The dentist decides he wants to sell those shares.  If the selling dentist receives more money for those shares than what the shares cost him, there will be a “capital gain”. The Income Tax Act imposes a capital gains tax that is equivalent to one-half of the capital gain multiplied by the selling dentists’ top tax bracket.

Example: If the dentist receives $500,000 for shares of his DPC that cost him $100,000, then there is a capital gain of $400,000, half of which (i.e. $200,000) is taxable at the dentist’s top tax bracket.

Lifetime Capital Gains Exemption

Thankfully, the Income Tax Act provides relief to dentists who sell shares of their DPCs.  That relief is called the Lifetime Capital Gains Exemption (the “LCGE“).  Basically, if a dentist qualifies for the LCGE, they can avoid paying tax on up to $750,000 of capital gains tax on the sale of shares of their DPC.

Example: If a dentist has a gain of $750,000 on the sale of shares of their DPC, they can offset any capital gains tax by using their LCGE.  Assuming the dentist would have been paying tax in the top marginal tax bracket (46% combined federal and Ontario tax rate), the dentist could save roughly $172,500 in taxes by using the LCGE.  Note: come January 1, 2014, the LCGE will be increased to $800,000.

History of the LCGE

The LCGE was originally enacted in 1985. In its original form, an individual was permitted to claim a $500,000 lifetime capital gains exemption. In 1988, the exemption was cut back to $100,000 for property other than certain farm property and certain shares of a small business corporation (which we will discuss in greater detail below). In February 1992, the exemption was eliminated for most real property.  The exemption is currently at $750,000 but will increase to $800,000 on January 1, 2014.

Multiplying the LCGE

Another benefit of using the LCGE is that it can be multiplied!  If a dentist has a spouse who owns growth shares (i.e. shares that grow in value as the dental practice operates over time), then that spouse can also sell their shares and take advantage of the LCGE.  This way, the dentist and his or her spouse can multiply the LCGE and avoid paying tax on the sale of their shares if there is a $1.5-million capital gain.  A dentist’s parents and adult children can also own growth shares in a DPC, which allows for further multiplication of the LCGE.

Note: if a dentist is planning on making their immediate family members shareholders of growth shares, it’s vital to have a shareholders agreement in place.  This agreement will deal with things like the dentist’s ability to purchase their family member’s shares in certain circumstances – such as death, disability, divorce, or if the relationship turns sour.  The dentist should always be protected from family members who may try to claim oppression of their minority interests or if they do not want to sell their growth shares (whereas the dentist does!).  The moral of the story is this: get a shareholders agreement in place to deal with these pesky problems in advance and by doing so you can avoid them and the ensuing litigation!

Qualifying for the LCGE

So now that you know the benefits of using the LCGE, how does a dentist qualify for it?  Well, in this regard, there are a number of tests that must be met.  In a nutshell, to qualify for the LCGE, the shareholder (i.e. dentist or their spouse, child or parent) must meet three tests:

  1. The shareholder must be resident in Canada throughout the year.
  2. The shares must have been for a qualifying small business corporation.
  3. The shares must satisfy a 24-month holding period.
  4. The dentist shareholder must satisfy an asset test during the previous 24-month period and on the date of sale as well.

Let’s look at the last three things in turn, shall we?

Test #1: Small Business Corporation

The first test that must be met for a shareholder to qualify for the LCGE is that the DPC must be a “small business corporation” at the time of the sale.

A “small business corporation” is a “Canadian Controlled Private Corporation” for which “all or substantially all” of the fair market value of its assets are “used principally” in an “active business” carried on primarily in Canada: section 248(1)of the Income Tax Act.

Wow, that’s a mouthful.  Let’s take a closer look at this definition and see what “Canadian Controlled Private Corporation”, “all or substantially all” and “active business” mean, shall we?

Canadian Controlled Private Corporation

Suffice it to say, a DPC will meet the definition of a “Canadian Controlled Private Corporation”.

A Canadian Controlled Private Corporation is a private corporation that is a Canadian corporation that is not controlled by one or more non-resident persons or by one or more public corporations.  Now, looking at DPCs, it becomes clear that they clearly meet this test.  First, DPCs MUST be Ontario corporations.  Second, only dentists can be on the board of directors of DPCs and at least 25% of the directors must be Canadian residents under the Business Corporations Act.  Typically, there is only one director on the board of a DPC: the sole dentist shareholder, officer and director.  Finally, DPCs can only be controlled (i.e. the voting shares can only be held) by the dentist.  Hence, DPCs will be considered “Canadian Controlled Private Corporations”.

Now that we’ve covered the first part of the definition of a “qualifying small business corporation”, we need to move on to the second part of that definition…

All or substantially all

Now you probably noticed in the definition of “small business corporation” that there was a requirement that “all or substantially all” of the fair market value of the DPC’s assets be used in an active business on the date that the shares are sold.  The Canada Revenue Agency has interpreted this to mean at least 90%.  So in other words, on the day the shares are sold, the non “active business” assets must not account for more than ten percent (10%) of the fair market value of the DPC’s assets.

Active Business

OK, so what is an “active business”?

Well, “active business” basically includes operating a dental practice (e.g. scheduling, treating, and billing patients, etc.).

If you wanted to be more technical, the definition of “active business” is “any business carried on by the taxpayer other than a specified investment business or a personal services business”.  Specified investment business generally means a business the principal purpose of which is to derive income from property (e.g. rent, royalties, dividends, etc.), but this doesn’t include, for example, a corporation that has at least 6 full-time employees. A personal services business is essentially an incorporated individual who resembles an employee of a client, but this doesn’t include, for example, a corporation that has at least 6 full-time employees (section 125(7) of the Income Tax Act).  So again, it shouldn’t be difficult for a dentist to qualify for the LCGE when they go to sell the shares of their DPC  – so long as all or substantially all of the DPC’s assets on a fair market value basis are being used in an active business carried on primarily in Canada.

Problems with Active Business

Some dentists may accumulate retained earnings (i.e. money which the corporation has paid tax on) and use that excess cash to purchase real estate or investment products.  These would not be considered “active assets” and could put the shareholder in jeopardy of not qualifying for the LCGE if these assets constitute more than ten percent (10%) of the fair market value of the DPC’s assets!  If that’s the case, the DPC will need to purify itself by transferring these assets out BEFORE the shareholder sells the shares of the DPC.   This may involve, for example, declaring taxable dividends.  Unfortunately, this purification process may be expensive and time-consuming.  And the corporation may end up paying capital gains taxes on the sale of these assets.  Techniques available to non-dentistry professional corporations – such as paying dividends to a taxable Canadian holding corporation on a tax-deferred basis – are not available to DPCs since only dentists can be shareholders (note, however, that the law says that a dentist can hold his shares “indirectly” – which presumably means through another corporation they control – but the Royal College of Dental Surgeons ignores that part of the law).  The bottom line is that you need to make sure your DPC uses 90% of its assets in active business on the date of sale.

Used Principally

As noted in the definition above, all or substantially all (i.e. at least 90%) of the fair market value of the corporation’s assets must be “used principally” in an active business carried on primarily in Canada at the time the shares are sold.  So what does “used principally” mean in the context of land and building which is owned by the corporation?  Here’s the situation: the corporation owns land, a building, and a dental practice (which is situated in the building). So the question is: is the land and building considered an active business asset of the corporation?  Or could the value of the land and building which is owned by the corporation be considered a non-active business asset?  And if it is a non-active business asset worth more than 10% of the fair market value of the corporation’s assets at the time of the sale,  then this could disqualify the shareholder from being eligible to use the LCGE.

The CRA takes the view that the term “principally” generally means more than 50%.  An asset that is used more than 50% in an active business is one that is “used principally in an active business”.  Generally, an asset is considered to be used principally in an active business if its PRIMARY or MAIN use is in that business.  The “used principally” test is applied on a property by property basis.

According to the CRA, it is a question of fact whether a property is “use principally in an active business”.  But they do go on to say the following:

“Although there are no set guidelines as to which factors to use in different situations, there are two aspects to be considered in determining the nature of use of a building – quantitative factors (e.g. the total square footage occupancy in the building) and qualitative factors (e.g. the original intent for purchasing the building, actual use to which the building is put in the course of the business, the nature of the business involved and the practice in the particular industry).

The square footage use of a building is generally accepted as a factor to be given significant weight in the determination of the particular use to which the building is put.  However, qualitative factors need also be considered.  If the fair rental value of the space rented to tenants is greater than the fair rental value of the space used in an active business, this may indicate that a building is not used principally in an active business.  Whether such a factor would be decisive in relation to the square footage test would have to be determined on a case by case basis.”

See CRA Views, Interpretation – external, 2009-0307931E5 – Assets used principally in an active business (Date: November 5, 2009)

Court Cases

A few court cases help to shed light on the issue of whether a person will qualify for the LCGE on the basis that the corporation (which they own shares in) is a small business corporation for which “all or substantially all” of the fair market value of its assets are “used principally” in an “active business” carried on primarily in Canada.

In Ensite Limited v. The Queen, [1986] 2 S.C.R. 509, the issue was whether interest received from certain U.S. dollar deposits in the Philippines was income from property or from property used in the course of carrying on a business. The corporate taxpayer argued that the interest in question was only income from property. When deciding against the corporate taxpayer, the Supreme Court of Canada stated at paragraphs 14 and 15:

14 … A business purpose for the use of the property is not enough. The threshold of the test is met when the withdrawal of the property would “have a decidedly destabilizing effect on the corporate operations themselves”: March Shipping Ltd. v. Minister of National Revenue,77 D.T.C. 371, supra, at p. 374. This would distinguish the investment of profits from trade in order to achieve some collateral purpose such as the replacement of a capital asset in the long term (see, for example, Bank Line Ltd. v. Commissioner of Inland Revenue (1974)  49 T.C. 307 (Scot. Ct. of Session)) from an investment made in order to fulfill a mandatory condition precedent to trade (see, for example, Liverpool and London and Globe Insurance Co. v. Bennett, [1913] A.C. 610 (H.L.), and Owen v. Sassoon (1951) 32 T.C. 101 (Eng. H.C.J.) Only in the latter case would the withdrawal of the property from that use significantly affect the operation of the business. The same can be said for a condition that is not mandatory but is nevertheless vitally associated with that trade such as the need to meet certain recurring claims from that trade: see, for example, The Queen v. Marsh & McLennan, Ltd.,  [1983] F.C. No. 150 supra, and The Queen v. Brown Boveri Howden Inc., 83 D.T.C. 5319 (F.C.A.)

15. It is true that in this case the taxpayer could have done business and fulfilled the Philippine requirement that foreign currency be brought into the country by a means not involving the use of property. It could have borrowed the U.S. currency abroad and brought it into the Philippines. But this consideration is irrelevant to our inquiry. The test is not whether the taxpayer was forced to use a particular property to do business; the test is whether the property was used to fulfill a requirement that had to be met in order to do business. Such property is then truly employed and risked in the business. Here the property was used to fulfill a mandatory condition precedent to trade; it is not collateral but is employed and risked in the business of the taxpayer in the most intimate way. It is property used or held in the business.

In the case of Skidmore v. Canada, [2000] F.C.. No. 276, Mr. and Mrs. Skidmore owned the shares of a family corporation carrying on an active business but which had substantial cash reserves.  When Mr. and Mrs. Skidmore sold their shares in the family corporation to a company owned by their children, they claimed a capital gains exemption.  The Court decided against the taxpayer and cited the Supreme Court’s decision in Ensite (above).  The Federal Court of Appeal affirmed the lower court’s decision wrote the following in paragraphs 9 and 10:

9      The Tax Court Judge held that the Appellants had failed to demonstrate that “all or substantially all of Birchill” assets were used in an active business within the meaning of Section 248(1) of the Act.

10      He found that the Appellants had failed to prove that the cash reserves that Birchill kept were reasonably required as backup assets or that Birchill relied on the term deposits as an integral aspect of its business operation. He heard the evidence of the Appellants and was unable to conclude that there existed a relationship of financial dependence of some substance between the amounts in issue and the seedling nursing business. He found that Birchill had never had to draw upon the reserves and that the possibility of the reserves being drawn upon to sustain Birchill’s business was remote.

Finally, in Reilly Estate v. Canada [2007] T.C.J. No. 271, the executrix of a deceased’s estate (i.e. the person responsible for administering the estate of a person who has died) claimed a capital gains exemption with respect to the value of the deceased’s shares in a corporation (called “Ventures”).  The government disallowed the use of the exemption on the basis that not all or substantially all of the fair market value of Venture’s assets could be attributed to assets used principally in active business carried on primarily in Canada.  The Tax Court of Canada agreed with the government and wrote the following in paragraphs 15 and 16:

15     I conclude that the appeal by the Reilly Estate is on all fours with the decision in Skidmore. There is no evidence that the cash and marketable securities held by Ventures were necessary or even important for the carrying on of its small active businesses. Or in the words of Ensite, there is no evidence that the cash and marketable securities were held “to fulfill a mandatory condition precedent to trade”.

16     In the five years from 1996 to 2000, the fair market value of the cash and marketable securities as a percentage of the total book value of all Ventures’ assets was never less than 27% and, in the year of Mr. Reilly’s death (2000), was 38%. On these facts, I cannot find that all or substantially all of the fair market value of the assets of Ventures was attributable to assets used principally in an active business. I find that Ventures was not a “small business corporation” within the meaning of subsection 248(1) of the Act. And, if Ventures was not a “small business corporation”, then the shares of Ventures or Holdco could not be “qualified small business corporation shares” within the meaning of subsection 110.6(1). The appeal is dismissed, with costs.

Test #2: Holding Period Test

The second test that a shareholder must meet in order to qualify for the LCGE deals with who owned the shares and for how long prior to the sale.  Basically, throughout the 24 month period immediately prior to the sale, the only persons who can own the shares are the shareholders or someone related to the shareholder (e.g. a spouse or common-law partner).

In the case of Twomey v. The Queen, 2012 DTC 1255, the Tax Court of Canada had to decide whether the 24 month holding period test had been met.  In that case, the taxpayer sold seventy-seven (77) shares in a qualifying small business corporation in 2005 and wanted to claim the LCGE.  But the problem was that the corporation had only issued the taxpayer one (1) share when it was incorporated.  The taxpayer believed that one hundred (100) shares should have been issued at incorporation, not one (1) share.  Financial and tax records had consistently documented the taxpayer as holding one hundred (100) shares right from the start.  But the corporate minute book showed only that the taxpayer received one (1) share.  When this clerical error was discovered in 2005, a correcting resolution was entered into the corporation’s minute book and ninety-nine (99) new shares were issued.  When the Canada Revenue Agency reviewed the transaction, they took the very technical position that the 24 month holding period had not been met because the ninety-nine (99) new shares were only issued in 2005.  The Court, however, rejected the Canada Revenue Agency’s argument on the basis that it was always the intention for the corporation to have issued one hundred (100) shares, the taxpayer acted as though one hundred (100) shares had been issued, and when the mistake was discovered, the corporate records were updated.  This was all done in keeping with the corporation’s requirement to maintain true, complete, and accurate records.  As such, the taxpayer was allowed to use the LCGE because he met the 24-month holding period test (i.e. the court considered the one hundred (100) shares to have been issued to the taxpayer upon incorporation). The moral of the story: make sure your minute book is properly structured and updated regularly.

Now, realistically, for those dentists who have already incorporated and held onto their shares for a while, this won’t be an issue.   But what about those dentists who have not incorporated and who want to now incorporate to take advantage of the LCGE?  Well, they can sell their dental practice (assets, goodwill, etc.) to a DPC on a tax-deferred basis, receive shares in the DPC in exchange for transferring those assets, and then sell those shares all on the same day in order to take advantage of the LCGE!  This is permitted by section 110.6(14)(f)(ii))(A) of the Income Tax Act.  This section says that shares issued by a DPC to a dentist in exchange for the dentist selling all or substantially all of their dental practice assets (e.g. equipment, furniture, supplies, goodwill, etc.) WOULD be considered to have been owned by that dentist immediately prior to them being issued.

Just keep in mind that this rule would only apply to the DENTIST who is “rolling in” their assets (that’s what lawyers and accountants call it when a dentist sells their assets to their own corporation and doesn’t pay taxes on that sale).  So a dentist’s spouse or child or parent would not be able to satisfy the hold period rule using the above exception because they generally don’t own the dental practice prior to it being rolled in before the sale.  That’s why it’s best to set up a DPC with your family members well in advance of the sale if your aim is to multiply the LCGE.

Test #3: Asset Use Test

As we saw above, a “small business corporation” has assets that are used principally in an “active business” carried on primarily in Canada: section 248(1)of the Income Tax Act.

But to qualify for the LCGE, a shareholder will have to jump through one more hoop: they must show that, for the 24 month period immediately prior to the sale of the shares, more than 50% of the fair market value of the DPC’s assets are used principally in an active business carried on primarily in Canada: section 110.6(1) of the Income Tax Act.

There is a minimum threshold that must be met – namely, at least 50% of the fair market value of the DPC’s assets be used in an active business.  And there is also a timing requirement: that this must have been the case for the past 24 months leading up to the sale of the shares (during which time the shareholder owned the shares).


If you’re thinking about taking advantage of the LCGE, you should definitely consult a dental accountant and dental lawyer to ensure that you, your family, and your corporation are all eligible to allow the shareholders to take advantage of the LCGE. There are many minefields along the way, so proceed with caution!