This is my second blog about selling shares of a dentistry professional corporation. In this blog, I’ll be talking about qualifying for the lifetime capital gains exemption (“LCGE“) on the sale of shares of a dentistry professional corporation.
There are a number of rules that a dentist will need to satisfy to qualify for the LCGE.
- The dentist shareholder must be resident in Canada throughout the year.
- The shares must have been for a qualifying small business corporation.
- The shares must satisfy a 24-month holding period.
- The dentist shareholder must satisfy an asset test during the previous 24-month period.
Lets look at the latter 3 things in turn, shall we?
Qualifying 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 (i.e. at least 50%) in Canada (s. 248(1) of the ITA). I’ve previously defined a CCPC here. Sufficed to say, you’ll need to make sure that the articles of incorporation and minute book reflect the fact that the corporation is a CCPC.
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 (i.e. at least 50%) 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 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 (s. 125(7) of the ITA).
Now, assuming that you have a small business corporation, 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 of 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.
What about the whole idea of multiplying the LCGE by using a trust? Well, the Income Tax Act says that a related trust can qualify for it; hence, it may be possible to multiply the LGCE for dentists by involving their immediately family (e.g. spouse and children) through a trust. The trust would hold the shares of the dentistry professional corporation, receive the proceeds upon the sale of those shares and distribute the gain to the beneficiaries. While the Income Tax Act would appear to allow this to happen (under sections 110.6(1), 110.6(14)(c), 104(21) and 104(21.2)), the Canada Revenue Agency recently indicated that it might apply the GENERAL ANTI AVOIDANCE RULES (GAAR) to transactions designed to multiply the LGCE by using a trust (2010 APFF, CRA Round Table, Question 34). This means that the use of trusts to multiply the lifetime capital gains exemption may be viewed as abusive and challenged by the CRA. That still leaves upon the possibility, however, of issuing shares directly to family members (note: these would have to be common shares that you can attribute value to; redeemable shares are essentially dividend sprinkling shares that are worthless because of their redemption conditions).
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 (i.e. more than 50%) 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%!
Now, importantly, using business assets to generate non active business income (e.g. renting space, renting equipment, personal use, etc.) can cause the asset to be counted as a NON BUSINESS ASSET if the use is 50% or more. That’s why it’s important to consider each individual asset when determining if the corporation meets the 50% or 90% tests.
Remember: if you need help with understanding these tax rules, contact a professional accountant or tax lawyer.