Lifetime Capital Gains Exemption: Advantages of Incorporation
Contact Neufeld Legal for your incorporation legal work at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
The Lifetime Capital Gains Exemption (LCGE) is a tax benefit that is claimed by individuals (and certain trusts for the benefit of individuals), with corporations being central to taking advantage of the LCGE because the shares being sold must meet the strict criteria for Qualified Small Business Corporation (QSBC) Shares. The core strategies that utilize corporations (specifically, Canadian-Controlled Private Corporations (CCPCs)) enable the shareholders (the individual owners) to better optimize the availability of the LCGE.
Core Strategy: Ensure the Corporation Qualifies
The primary way a corporation facilitates the LCGE is by meeting the stringent tests to be considered a Qualified Small Business Corporation (QSBC) when its shares are sold.
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The 90% Asset Test (At the Time of Sale)
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Requirement: At the time of the sale, at least 90% of the fair market value of the corporation's assets must be used in an active business carried on primarily in Canada.
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The Advantage: This test is the most critical hurdle right before a sale. Corporations take advantage by employing a strategy called "purification."
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The 50% Asset Test (The 24 Months Before Sale)
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Requirement: Throughout the 24 months immediately preceding the sale, more than 50% of the fair market value of the corporation's assets must have been used in an active business carried on primarily in Canada.
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The Advantage: This test emphasizes the need for proactive, long-term planning. Companies must manage their investments to ensure they don't accumulate too many passive assets (like excess cash, marketable securities, or passive rental properties) for an extended period.
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Key Planning Strategies Using the Corporation
Corporations employ specific tax planning strategies to ensure their shares (held by individuals) will qualify for the LCGE upon sale.
"Purifying" the Corporation
The most common strategy is purification to meet the 90% active asset test before a sale. This involves removing or reducing passive assets from the corporation, such as:
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Paying Dividends or Bonuses: Using excess cash to pay dividends to the shareholders (who then pay personal tax) or paying deductible bonuses to shareholder-employees.
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Transferring Assets to a Holding Company (Holdco): Non-active assets (like excess investments or passive real estate) can be transferred from the Operating Company (Opco) to a separate Holding Company (Holdco) using a tax-deferred reorganization (like a Section 85 rollover). This "cleans up" the Opco, making its shares LCGE-eligible.
Multiplying the LCGE (Using Family Trusts)
Since the LCGE is available per individual, corporations are structured to allow multiple family members to claim their exemption, maximizing the total tax-free amount.
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Strategy: The shares of the operating corporation are often held by a Family Trust. The Trust names family members (spouses, children, etc.) as beneficiaries.
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The Advantage: When the shares are sold, the capital gain can be allocated by the Trust to each eligible family member/beneficiary. Each person can then claim their own separate LCGE, potentially sheltering millions of dollars in total capital gains on a single business sale. This structuring must be done well in advance.
Estate Freeze for Succession Planning
This is a corporate reorganization often used when transitioning a business to the next generation while allowing the current owner to use their LCGE.
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Strategy: The current owner's common shares, which hold all the historical growth, are exchanged for "freeze" shares (preferred shares with a fixed value). New growth shares are then issued to the next generation or a Family Trust.
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The Advantage: The current owner can then trigger a capital gain on their fixed-value shares (a "crystallization" of the gain) and claim their LCGE, locking in the tax benefit. All future growth in the business accrues to the new growth shares, allowing the next generation to potentially use their LCGE on the eventual sale.
Because the LCGE rules are complex and require a 24-month look-back period, advance tax planning with an experienced tax lawyer is crucial to ensure the corporation is structured and managed correctly.
So if you are looking to incorporate a new corporation or deal with the corporate legalities impacting your company, contact our law firm to schedule a confidential consultation with a lawyer experienced in the legal intricacies of business incorporation and commercial business development at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or via email at Chris@NeufeldLegal.com.
