Chapter 15: Purchases and sale of a Business - Share Transaction

Lifetime capital gains exemption (LCGE)

A sale of a business that results in a capital gain on disposition may be eligible for a life time capital gains exemption

Eligible individuals for the LCGE

Canadian resident individual throughout the year of sale.

Qualified property for the LCGE

qualified small business corporations (QSBC) shares, Fishing property & Farming property.

The cumulative LCGE limit on qualified property is

Before June 25, 2024 $1,016,836

On or after June 25, 2024 = $1,250,000

what is deducted against the taxable portion of net capital gains of qualified property.

The LCGE* capital gain inclusion rate = capital gains deduction

Part 1 of 3 Part tests for: Qualified Small Business Corporation (QSBC) share: (All three parts of the test must be met)

a) Entity is and SBC on the date of sale:

b) It is a CCPC

All or substantially all (≥ 90%) of the FMC of assets were:

I. Used principally in an active business carried on primarily (>50%) in Canad

II. Share or debt of a connected SBC (>10%)

C) combination of A or B

Part 2 of 3 Part tests for: Qualified Small Business Corporation (QSBC) share: (All three parts of the test must be met)

Holding Period test
The shares were not owned by anyone other than the individual or related person through the 24- month period preceding the sale (Can’t buy or sell)

Part 3 of 3 Part tests for: Qualified Small Business Corporation (QSBC) share: (All three parts of the test must be met)

Basic Asset test:

Throughout the 24-month holding period before sale, >50% of the FMV of the corporate assets were used in an active business carried on primarily in Canada

Shares or debt that are connected do not count

Active: Cash

Portion used in the company's business operation on a regular basis

Non- Active: Cash

Excess portion not used in business activities

Active: Marketable securities

When corps are involved in regular trading of marketable securities

Non-Active: Marketable securities

When considered part of a portfolio, not part of the corporation's regular business activities

Active: Loans to Employees and Shareholders

Employee loans/ SH loans that are exempt (Vehicle, Home and Shares)

Non-Active: Loans to Employees and Shareholders

All other SH loans

Active: Business Assets

AR, PPE, Goodwill, prepaid expenses & Inventory

Non: Passive assets

PPE used to earn property income

Active: Shares of Connected SBCs

Active for the SBC test

Non-Active: Shares of Connected SBCs

Basic Asset test but may apply modification

When is Modification of Basic Asset test (Stacking Rule) used?

Where a parent corporation does not meet the > 50% test on its own active business assets but has a subsidiary that is connected (>10% votes and value)

Requirements for Modification of Basic Asset test (Stacking Rule)

Then throughout 24 prior to sale:

Both the parent and connected subsidiary must each meet the 50% test with a combination of their own active business and shares and debt of connected corporation; AND

One of either the parent or the connected subsidiary must meet the 90% test with a combination of its own active business assets and shares and ebt of a connected corporation.

What is the Purification Strategies (SBC test) used for?

If the SBC test is not met, corporations can implement purification strategies to remove non-active assets from the corporation

Examples of Purification Strategies (SBC test)

Using the excess cash to pay off liabilities of the corporation

Replace non-active assets with active assets

Pay out excess cash via a dividend or bonus

Computation of Capital Gains Deduction (CGD)

• Calculated as the least of:

1. Unused Lifetime deduction [(LCGE-previous capital gains exemption used) * CG inclusion rate]

2. Annual gain limit (limit to TCG that is recognized

• Less of: 

  • Net TCG for the year (all property) 

  • Net TCG for qualified property only) 

• MINUS: NCL deducted (adjusted for current inclusion rates) and ABILS realized

3. Cumulative Gains limit No adjustment for inclusion rate 

• Cumulative “annual gains limit” 

• Less: cumulative CGD claimed 

• Less: CNIL

Calculation of :Cumulative Net Investment loss (CNIL)

Investment expenses - Investment income

Purpose of :Cumulative Net Investment loss (CNIL)

Exists to prevent double dipping of benefits

What is included in the calculation of Cumulative Net Investment loss (CNIL)

• Investment expenses include: 

  • All property expenses deducted 

  • Losses from all properties 

  • NCL carried over and deducted against TCG not eligible for CGD

• Investment income includes: 

  • Income from all property (including recaptures) 

  • Rental property income 

  • Net TCG not eligible for CGD

Acquisition of Control occurs when

Legal (de jure) control (>50%) of a corporation is acquired based on voting rights 

Acquisition of Control occurs Purpose

To avoid “tax-loss trading” transactions

Purchase of a Business through Shares - Acquisition of Control (AOC) Result:

After an AOC, losses accumulated in an acquired corporation are heavily restricted

Acquisition of Control Step 1: 

Deemed year-end day before AOC

• The acquired corporation is deemed to have a taxation year-end the day before the AOC. Normal filing deadlines result from deemed year-end. 

  • Example: If AOC happens on April 1, deemed year-end is March 31. 

  • If a short taxation year results, CCA and SBD must be pro-rated 

Acquisition of Control Steps: Step 2

Determine any accrued losses and unrealized gains

• Any loss must be realized on the deemed year-end return 

• This includes unrealized losses from: 

  • Inventory 

    • Cost less NRV or FMV = non-capital loss

  • Accounts receivable 

    • Actual bad debts = non-capital loss

  • Non-depreciable capital property 

    • ACB less FMV = net capital loss 

  • Depreciable property 

    • UCC less FMV is claimed as CCA = non-capital loss

Acquisition of Control Steps: Step 3

Determine Tax Position of Corp After Realization Accrued Losses

• The following excess losses expire at deemed year-end if not used 

  • Net Capital losses 

  • Property losses 

  • ABILs 

  • Unclaimed donations 

(i.e., all losses expire except business losses) 

• Business losses survive but may be restricted

Acquisition of Control Steps: Step 4

Consider Election to Create Income 

Election is allowed under ITA 111(4)(e) and applies to capital property (depreciable & non-depreciable) —> accrue

Deemed disposal at lesser of: 

1. FMV of poetry 

2. Greater of: 

   1. ACB of the property, and 

   2. Designated (elected) amount

• Result: 

  • Triggers recapture/ CG at deemed year end. 

  • Uses up losses that might expire now or in the future 

  • May protect non-capital losses. 

  • Increases cost for tax purposes

Acquisition of Control Steps: Step 5

Recalculate Division B and Taxable Income After Election

Determine how much expiring losses can be used up.

Acquisition of Control Steps: Step 6

Recalculate the cost base of the properties the purchaser

Inventory → FMV or NRV

Accounts Receivable → Cost less bad debts

Capital property ACB → ACB, FMV, or elected amount

Depreciable Capital Property UCC → capital cost + taxable capital gain

Acquisition of Control Steps: Step 7

Determine whether excess business losses can be used after AOC.

Acquisition of Control Steps: Step 8

Determine steps needed to use up business losses that have survived 

• Non-capital losses carried forward after AOC are deductible if 

1. Loss of business carried on throughout the year and a reasonable expectation of profit 

2. Losses are only deductible against income from the same business or sale of similar product/services.