THE CAPITAL GAINS EXEMPTION
Qualified small business corporation shares
The lifetime capital gains exemption allows individuals investing in shares in small business corporations to earn a significant amount of tax-exempt capital gains when they sell the shares. The lifetime limit is indexed annually for inflation. For 2019, the limit is $866,912. Since only one-half of capital gains are included in income as taxable capital gains. the exemption effectively exempts $433,456 of taxable capital gains.
In order to qualify for the exemption, the shares must be qualified small business corporation (QSBC) shares. Various conditions must be met for the shares to qualify. The main conditions are:
• At the time of the disposition of the share, the corporation must be a “small business corporation”. In general terms, this means that the corporation is a Canadian-controlled private corporation (CCPC), and at least 90% of its assets on a fair market value basis consist of property used in an active business carried on primarily in Canada, shares or debt in other small business corporations, or a combination of such assets. A CCPC is a private corporation resident in Canada that is not controlled by non-residents or public corporations or a combination of the two. Thus, for example, if you are a Canadian resident and you control a private corporation resident in Canada, it will be a CCPC. “Control” typically means ownership of shares entitling you to more than 50% of the votes.
• Normally, the shares must have been owned by you or a related person throughout the 24 months before you dispose of the shares. There are some exceptions to this rule. For example, if you incorporate your existing business and transfer substantially all of the business assets into the corporation, the 24-month period does not apply to your shares in the corporation.
• Throughout the two-year period before you dispose of the shares, more than 50% of the corporation’s assets must have been used in a business carried on primarily in Canada. Special rules apply where the corporation owned shares or debt in other corporations in this period.
CNIL and ABILs Affect Exemption
The amount of taxable capital gains that qualify for the exemption is reduced by the amount of your cumulative net investment losses (CNIL), going back as far as 1988. Basically, these are your investment losses in excess of your investment income over that entire 30+ year period.
Additionally, the exemption is reduced by the amount of your allowable business investment losses in the year and in previous years. In general terms, an ABIL is one-half of a capital loss realized on the disposition of shares or debt in small business corporations under specific circumstances. Unlike regular capital losses, ABILs are deductible from all sources of income, which is a good thing. The bad thing, as noted, is that they reduce your capital gains exemption.
In 2016, you claimed a $60,000 ABIL. In 2019, you have a $100,000 taxable capital gain from the disposition of QSBC shares. Only $40,000 of the taxable capital gains will qualify for the exemption.
Since the $60,000 ABIL reduced your exemption on this disposition, it will not affect your exemption in the future. For example, if you have a further $30,000 taxable capital gain from a disposition of QSBC shares in 2020, the 2016 ABIL will not affect your exemption in 2020.
Qualified Farming or Fishing Property
A separate exemption applies to capital gains realized on the disposition of qualified farming or fishing property. The lifetime exemption covers $1 million of capital gains on such property.
The properties that are eligible for this exemption include assets carried on by an individual personally in the business of farming or fishing, as well as certain shares in farming or fishing corporations or interests in farming or fishing partnerships. Various conditions apply, including holding periods and business-activity tests.