The Financial Planning Association of Canada | E131

The Financial Planning Association of Canada | E131

Wondering if selling your Canadian business will incur significant taxes? Learn about the Lifetime Capital Gains Exemption (LCGE) and how it can save you up to $1.25 million in tax-free capital gains as of 2025. Jason Pereira, senior partner and financial planner at Woodgate Financial, breaks down the eligibility criteria and tests your business “must meet” to qualify, and how improper planning can lead to costly tax liabilities. Discover actionable steps for structuring your business to maximize tax savings and multiply exemptions across family members. 

Tune in to ensure your hard-earned success isn't overshadowed by unexpected tax surprises. 

Full Transcript

FPCBO 131 - Is Your Share Structure Making Your Business Sale Taxable?

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Jason Pereira: [00:00:00] Is your share structure making your business sale taxable? Here's a question that every successful Canadian business owner should be asking. If I sold my company tomorrow, would I pay tax on all of it, or could I walk away with a huge chunk, completely tax free? Because if your share structure isn't set up right, you could be leaving hundreds of thousands, maybe even millions on the table, and worse, you won't even know until it's too late.

I'm Jason Pereira, senior partner and financial planner, Woodgate Financial, and I'm gonna break down one of the most powerful tax planning tools available to Canadian business owners, the Lifetime Capital gains exemption, or LCGE, and how poor planning can blow it up entirely. This video's gonna walk you through how the exemption works, what tests your business needs to pass, how cash and holding companies can quietly disqualify you, and how the right structure can not only protect your exemption, but also multiply it.

So first, let's start by answering the question of what is the lifetime capital gains exemption. If you sell shares of a qualified small business corporation in Canada, you [00:01:00] may be eligible to claim the exemption, which as of 2025, is as much as $1.25 million in capital gains, completely tax free. And every year, that amount is increased as its index to inflation.

That means that the value of the shares in your company have increased by at least $1.25 million. You qualify for potential tax savings of 300 to $347,000 in tax as of 2025, and that's just the beginning. If your spouse and kids are also shareholders, you can multiply these exemptions across your entire family.

One quick note before I go any further For fishing and farming businesses, these rules are completely different and a lot more generous. I won't be covering these kinds of businesses in this episode. Now, of course there is a catch. Actually, there's a few of 'em. First, your business has to qualify as a Canadian controlled private corporation, or CCPC for short.

Then your CCPC has to qualify as a qualified small business corporation or A-Q-S-B-C to be eligible, [00:02:00] knowing if your business is a Canadian control private corporation is actually pretty easy 'cause it's basically spelled out in the name. The first test is that your business must be incorporated sole proprietorships and partnerships do not qualify.

Second, your business must be Canadian, meaning it's resident of Canada. That means not only registered in Canada, but also capital management and decision making must take place in Canada. That also means that it can't be controlled by corporations that wouldn't qualify as CPCs like foreign private corporations or publicly traded companies.

Lastly, it must be private. Meaning that it cannot be publicly listed on any stock exchange. If your business is A-C-C-P-C, then it also has to be a qualified small business corporation or QSBC for short at the time of sale. In order to qualify, your corporation has to pass three tests, fail even one of these, and the can of revenue agency can deny your exemption.

So let's break it down. The first test is the shareholding test. This one's simple enough. A shareholder or their [00:03:00] spouse who inherited shares on the death of the shareholder. Must have owned the shares for at least 24 months prior to the sale, either directly or through a trust in order to qualify. That means you can't change things at the last minute in order to qualify.

This is why it's really important to set up the right structure long before you might need it. The second test is known as the Active Business Asset Test. To qualify for the last 24 months, your business has to have employed more than 50% of its assets in active Canadian business. And the last test is the point of sale test.

At the exact moment of sale, 90% or more of the company's assets must be employed in active Canadian business. There are also a few other common misconceptions I need to call out here before we go any further. First, the lifetime capital gains exemption is only available to an individual shareholder of an active corporation.

What that means is in simple terms, that the shares of your business must be sold by a person either directly or by way of a trust. You can't claim the exemption if your holding company sells the shares because your holding company isn't a person. If your holding company owns the [00:04:00] operating company, then you will need to sell both the holding and the operating company shares in order to qualify.

Second, the sale has to be a share Sale. Businesses will often get purchased by way of asset sale where they sell the assets but not the shares of the corporation. This kind of sale does not qualify. Lastly, an active business has to be sold. This means the company has to actually be doing business selling products or services, and not just investing on behalf of shareholders.

It's these last two tests where many business owners get tripped up. You're growing fast, making good money, but instead of paying it all out, you're sitting on a pile of retained earnings that you've been investing in stocks, bonds, real estate, or other investments in order to earn return. And that's great until it isn't.

Or your account advised you that for credit protection, you should have a holding company in place where you can put all of your retained earnings. So they help you roll over your shares into a holding company, and now your operating company is owned by your holding company, where all of your retained earnings and investments are piled up if you reorganize your [00:05:00] corporation.

This way it can solve one problem while simultaneously creating another. Here is the problem of both of these excess cash investments and even real estate not used in the operation of your business can cause you to fail these tests. Remember, if more than 10% of your business assets are passive at the time of sale, you lose the exemption or 50% for two years prior.

And if your holding company owns your operating company, it can get even trickier. Remember how I said that you have to personally sell shares in order to qualify, and that your holding company doesn't qualify for the exemption? Well, in order to qualify, you need to sell both companies and their combined balance sheets must now pass both tests.

I have seen entrepreneurs do all the right things, build a great company, grow its value, and even think ahead by creating a holding company, but then they find out that their shares don't qualify, and now they're staring down the barrel of a seven figure tax bill. Let's look at some examples of how this can go wrong.

Let's say you're ready to sell your business for $2 million, but you also have $2.5 million of investments in the same company, and it's been there for the last [00:06:00] two years. Now your corporation's total value is 4.5 million, and you're offside for the 50% rule. Or let's say your operating company is worth 2 million and is owned by your holding company, which is owned by you directly, and that holding company owns half a million dollars in investments.

Well, in this example, you pass a 24 month test, but you fail a 10% test at the time of sale. And as a reminder, it has to be you who sells those shares, not your holding company. Now that we've gone over the test, you need to pass to qualify. Let's go over how you can plan for success. There's no one perfect corporate structure that fits everyone because what's right for you depends a lot on your business, your goals, your family, and your current situation.

But here's what you should consider. One, review your corporate structure. Sit down with your financial planner, your accountant, and your lawyer, and make sure what you have is organized in a proper way to make sure you're taking advantage of the exemption at any time. Like I said, you have to do this in advance of the sale at least 24 months, otherwise you won't qualify.

So it's best to be ready before the time. Comes two [00:07:00] separate passive and active assets. Don't mix. Operating cash and investment assets. Use your hold code wisely, but don't let it jeopardize your opcos status. And make sure you set up in a structure where your holding company is sitting off to the side with your investments, not jeopardizing your ability to pass the two tests in the event of you selling your active business.

Three, purify your corporation regularly. Once you have the right corporate structure in place, give an excess cash from your operating company to your holding company. This is called a purification strategy, and if done properly, it's a tax free transfer. This will not only keep those funds out of the way in order to purify it in case you sell your business, but it has the added bonus of potentially credit proofing those assets.

Four. Consider using a family trust or a state freeze. Structuring your ownership through a family trust or estate freeze can not only let you purify your corporation regularly, but can also multiply the exemption across multiple family members if you include them in the new corporate structure or as beneficiaries of the trust.

That will allow you to multiply the lifetime capital gains exemption by the number of people in the [00:08:00] structure. That's up to 1.25 million in capital gains tax free as of 2025 per family member. So what can you do today to make sure you're not on the wrong side of this first review your corporate structure.

Who owns what and how? Then check your balance sheets. How much of your money is passive versus the value of your active business? Talk to a planner who knows how to coordinate this with your accountant and lawyer. Consider freezing shares and bringing other family members into the structure through a trust or directly get clear on your exit plan so you're not reacting at the last minute.

Remember, it has to be in place for at least 24 months in advance. Look, you've built something great. You've earned every bit of success that you have, and when the time comes to exit or sell, you deserve to keep as much of it as possible. But the truth is, none of this happens without planning a lifetime.

Capital gains exemption is an incredible planning opportunity, but only if you qualify. That's why your share structure matters so much. [00:09:00] And if you haven't looked at it in a while, or if you've been assuming your account is on top of it, now is the time to take control and make sure of it. 'cause this is one of those rare moments in life where a bit of planning can be worth millions.

If you're not sure where you stand or you wanna see if there's room to improve your setup, reach out. Let's take a look at it and make sure that your future sale doesn't come with a big tax surprise. Remember to like and subscribe this video and leave a comment. Or if you're not watching us on YouTube, listening on a podcast, leave a review wherever you get your podcasts.