So here’s the situation. You’re a dentist and you want to sell your practice. You’re on your own, operating as a sole proprietorship or perhaps with others and operating through a partnership. The time has come to sell your business and your accountant advises you of taking advantage of the lifetime capital gains exemption you can get on the sale of shares of a qualifying small business corporation. The idea here is that if you initially bought the shares of a corporation for $1 and then sold them for $1,000, you would have a capital gain of $999, half of which is taxable at your full tax rate. Now, the government of Canada is providing a $375,000 lifetime capital gains exemption – so you end up paying no taxes – on qualifying shares of a small business corporation. Sounds pretty sweet, eh? In order to take advantage of this lifetime capital gains exemption, you need to set up a professional corporation that is a small business corporation and then sell the shares. Is it that easy? Hmmm….You guessed it: Nope. In order to qualify for the lifetime capital gains exemption, you also need to meet two other criteria: one relates to the ownership of the shares and the other relates to the use of the corporation’s assets.
Small Business Corporation
Only the sale of shares of small business corporations will qualify for the lifetime capital gains exemption. A “small business corporation” is a “Canadian Controlled Private Corporation” (“CCPC“) that uses “all or substantially all” (90% is the accepted standard) of the fair market value of its assets in an “active business” carried on primarily in Canada (s. 248(1) of the ITA). Importantly, a corporation that was a small business corporation at any time in the 12 months before the disposition of the share will be considered to be a small business corporation.
So what’s a CCPC?
The Income Tax Act defines a CCPC, among other things, as 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 (or a combination thereof) (s. 89(1) of the ITA). OK so now we have more terms to define…
- Here, a “private corporation” includes a corporation “resident in Canada” that is not a “public corporation” and is not controlled by a public corporation (s. 89(1) of the ITA). OK, more terms to define.
- Corporations deemed to be “resident in Canada” include corporations that were incorporated in Canada after April 26, 1965 (this includes corporations originally incorporated in a foreign jurisdiction which are continued in Canada), corporations resident in Canada under the common law “mind and management” test at any time, and corporations carrying on business in Canada in any taxation year ending after April 26th, 1965 (s. 250(4)(a) and (c) of the ITA).
- A “public corporation”, among other things, is defined as a corporation whose shares of capital stock are listed on a prescribed stock exchange both in Canada and abroad (s. 89(1) and 125(7)(c) of the ITA).
- The term “Canadian corporation” includes a corporation that is currently resident in Canada and that was either “incorporated in Canada” or was resident in Canada throughout the period that began on June 18th, 1971; a “corporation incorporated in Canada” includes “a corporation incorporated in any part of Canada before or after it became part of Canada” .
So that takes care of the definition of “CCPC”. Phew!
Recall that, a small business corporation is a CCPC that uses all or substantially all (90% is the accepted standard) of the fair market value of its assets in an “active business” carried on primarily in Canada. So what does “active business” mean? Well, it’s defined as “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 5 or more 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 5 or more full-time employees (s. 125(7) of the ITA).
So assuming that you have a small business corporation (as per the definitions above), you still need to jump through 2 more hoops!
Ownership of Shares
First, throughout the 24 months immediately before the sale of the shares, the shares must not have been owned by anyone other than the individual or person or partnership with which the individual was affiliated with. The shares may be newly issued (i.e. not owned for a full 24 months) but they must not have been owned by anyone else in that timeframe. OK. That’s an easy enough requirement to meet.
Use of Assets
This requirement is a bit more tricky. Basically, throughout the 24 months prior to the sale of the shares, more than 50% of the fair market value of the assets of the corporation must have been used principally in an active business carried on primarily in Canada by the corporation or a corporation related to it. Furthermore, at the time of the sale of the shares, all or SUBSTANTIALLY ALL of the fair market value of the assets must have been used in the active business. According to the CRA, SUBSTANTIALLY ALL means at least 90%!
So there you have it in a nutshell, definitions and all.