Changes in the Canadian Capital Gains Laws

Thank you to Jonathan Conlin, Chris Ross of Fasken, and James Pettigrew for their input and review of this article.

This year the Canadian government proposed a number of changes to the capital gains laws. If you are a Canadian resident and the owner of a Canadian tech company you should be aware of these changes and their implications ‒ especially if you are considering, or in the process of selling, your business.

What is a capital gain?

A capital gain is the gain earned on the sale of a capital asset which has increased in value over the holding period. This includes the gain earned on the sale a business as well as a gain earned on the sale of stocks, bonds, mutual funds, real estate, cars, jewelry, collectibles, and digital assets such as cryptocurrency. For example, when you sell a business, this means the gain you realize from the sale, that is, the selling price of the business minus the cost basis of the business assets. The cost basis is the original price of the business assets plus any costs associated with buying the assets, where business assets generally include property, equipment, intellectual property, and furnishings. Any losses from the sale of those assets would be deducted from the capital gains from those assets to determine the net capital gain from the sale.

Capital gains also apply to share sales, where a business owner sells shares of the company rather than the company's assets. For example, if you do a share sale, the net proceeds of the sale, that is, the amount you received for the shares minus what you originally paid for the shares, is considered a capital gain.

Increase in the capital gain inclusion rate

The capital gain inclusion rate is the percentage that is multiplied against the gain realized from the sale of a taxable asset that is included as income subject to taxes for that year. The change increases the rate at which annual capital gains realized by an individual after June 25, 2024 are taxed. Previously, an annual capital gain above CA $250,000 was taxed at a 50 percent rate. That has increased to 66.7 percent. The inclusion rate for corporations and trusts is also increased to 66.7% for capital gains realized after June 25, 2024. However, the CA $250,000 exclusion does not apply to them, that is, corporations and trusts must include 66.7% of all their capital gains (not simply capital gains above CA $250,000) as taxable income.

Here is a simple example. Imagine as an individual, you sold your business and realized a gain of CA $8 million. Previously, half of that gain above CA $250,000 ‒ in this case, CA $3,875,000 (CA $7,750,000 x 50%) ‒ would be considered income subject to taxes in that year. However with the change to the inclusion rate, two thirds of that gain above CA $250,000 would be considered income if the gain was realized after June 25, 2024. This means CA $5,192,000 (CA $7,750,000 x 66.7%) would be considered income for tax purposes. If the gain was realized before June 25, 2024, the 50 percent inclusion rate still applies. This is summarized below.

Increase in the lifetime capital gains exemption

The lifetime capital gains exemption (LCGE) enables Canadian owners of qualified small business corporations (QSBCs) to reduce the capital gains realized on the sale of shares of their corporations. To be considered a QSBC, the corporation must be a Canadian-controlled private corporation, use all or substantially all of the fair market value of its assets in an active business, and conduct business primarily in Canada.

In 2023, the LCGE was CA $971,190 (the amount is indexed annually for inflation). This meant if you sold shares of your QSBC and realized a gain, you could reduce the capital gain up to a lifetime limit of CA $971,190.  For gains realized after June 25, 2024, the LCGE is proposed to be increased to CA $1,250,000 (to be indexed annually for inflation). Suppose you sell shares of a QSBC after June 25, 2024 and realize a gain of CA $2 million. You could reduce your capital gain from CA $1.33 million (CA $2 million x 66.7%) to CA $500,250 ((CA $2 million - CA $1,250,000) x 66.7%). Recall that the CA $250,000 exclusion from the higher capital gain inclusion rate does not apply to corporations.

To take advantage of the LCGE, the capital gain needs to come from the sale of qualified shares of a QSBC that in general you have owned for at least 24 months prior to the sale, and more than 50% of the business’s assets must have been used in an active business in Canada for 24 months prior to the sale. This means that a sale of your company's assets (as opposed to a sale of its shares) would not qualify.

New Canadian Entrepreneurs' Incentive

The Canadian government also announced a new Canadian Entrepreneurs' Incentive (CEI) that applies to capital gains realized on the sale of shares in QSBCs in certain industries (provided certain eligibility criteria are met). The incentive will reduce the capital gain inclusion rate to 33.3 percent up to a lifetime maximum of CA $2 million of eligible capital gains.  The CEI will be phased in over a five year period starting in January 2025, at CA $400,000 per year, until it reaches CA $2 million in 2029.

Note that the CEI can be applied in addition to the LCGE, .but contains additional eligibility criteria. For example, to qualify for the CEI, the owner generally must have held at least five percent of the shares of the corporation for at least two years and been actively engaged on a regular, continuous, and substantial basis in the business for at least three years. 

Also note that certain business sectors are excluded from the CEI such as entertainment and hospitality. However, tech businesses are eligible.

Get professional advice

The proposed changes to the Canadian capital gains laws ‒ including the CEI that will be phased in over time ‒ may have significant implications if you are a Canadian resident in the process of (or considering) selling your Canadian company. It is important that you get professional advice regarding these changes from a qualified tax advisor. Also know that Corum has worked alongside Canadian accounting and law firms, advising on the sale of more technology companies than any other firm in history ‒ an unrivaled record driven by a highly professional, detailed M&A process designed to get sellers an optimal outcome. An optimal outcome includes maximized valuations, a properly negotiated transaction structure, minimized liability, and optimized taxes. So if you are considering selling your Canadian tech company, contact Corum. Corum's team of experienced CEOs who have run, sold, and bought companies will advise and help you and your stakeholders achieve an optimal outcome.