The Canadian government has taken steps to encourage small businesses in Canada. One of such steps is allowing relatively lower business tax rates and providing ways to minimize business taxes.
If you are planning to sell your business in the immediate future or pass on the torch to a family member, here are some tax initiatives that can benefit your business.
The lifetime capital gains exemption
Capital gains arise when you sell your shares in an investment property for more than the acquisition cost (minus selling costs).
Generally, the Canada Revenue Agency will tax half of your capital gains. If you have shares in a business or any other type of investment, when you dispose (sell or transfer) of your investment shares, the CRA will tax 50 percent of your capital gains.
If, as a Canadian resident, you sell or transfer shares of a qualified small business corporation (QSBCS), a qualified farm or fishing property (QFFP), or reserves, you can claim the lifetime capital gains exemption (LCGE).
A reserve is simply capital gains you have staggered over one year. For example, if you sell a business or any other capital property and you receive installment payments over a year, you can defer the capital gains from the sale and spread it over the years of instalment payments.
As of 2022, the lifetime capital gains exemption amount for qualified small business corporation shares is $913,630. However, because the CRA will tax 50 percent of your capital gains, only half of this LCGE ($456,815) can be claimed as a cumulative capital gains deduction.
If you dispose of a qualified farm or fishing property, the lifetime capital gains exemption is $1,00,000. Like the disposal of a qualified small business, only half of this amount ($500,000) can be claimed as a cumulative capital gains deduction.
It is important to note that these capital gains exemption amounts are subject to change due to inflation and has increased over the years.
When you sell or transfer the shares in your qualified small business corporation or a qualified farm or fishing property, you need to report your capital gains on lines 10699 and 10700 of Schedule 3.
You will also need to report your taxable capital gains on line 12700 of your income tax return.
Intergenerational transfers of small business shares
Previously, the Canadian government treated the transfer of family-owned or small business shares between family members as fully taxable income. However, due to the 2021 Bill C-208 amended law, which addresses taxation for intergenerational transfers, your business transfer to a qualifying family member can be treated as an arm’s length transaction valued at a fair market price.
This allows your intergenerational business transfer to be a capital disposition; thus, only half of the capital gains will be taxed in the hands of the family member or corporation owned by the family member.
You must provide an affidavit and valuation report to support your business disposal, which is classified as an intergenerational transfer.
To apply for the intergenerational transfer when disposing of your qualifying business, you must use a valuation professional unrelated to you or your family member, with no financial benefits from the business disposal. Also, the valuation professional must be knowledgeable and have industry experience.
If you file your tax return through paper form, you will need to submit the supporting affidavit and valuation reports. On the other hand, you do not need to provide these documents when you file your taxes online. However, you need to keep these supporting documents for at least six years.
To ensure that Canadians do not take advantage of the intergeneration transfer provision, the CRA reviews the following:
- how much legal and factual control you have transferred to your child or grandchild as a result of the business transfer,
- how long you can remain involved in the business’s operations and the level of ownership that you can maintain after you have transferred the company to your family member, and
- how much your child or grandchild is involved in the business after the transfer.
Looking for guaranteed ways to reduce your taxable income by claiming the capital gains deduction or utilizing tax breaks from an intergenerational business transfer?
Contact the team at DW & Associates, Chartered Professional Accountants to help you navigate your small business and personal income taxes.