Capital Gains Exemptions and Trusts
If you’re a Canadian business owner looking to sell your company or plan your estate, using trusts and capital gains exemptions can be a valuable strategy. By tax planning for sales of qualifying shares, you can keep more of what you’ve earned. Placing your assets in a trust make them legally separate from your personal estate. This approach doesn’t just help if you decide to sell your company—it also offers flexibility for future transactions, enabling you to sell parts of your business rather than the entire enterprise at once. In addition, trusts can help with passing down the business to the next generation.
1. Tax Planning for Business Sales
One of the primary benefits of capital gains exemptions is their role in tax planning for business sales. For instance, under subsection 110.6(2.1) of the Income Tax Act, an individual can claim a capital gains deduction for the disposition of qualified small business corporation shares (QSBCS).
To qualify as QSBCS, the shares must meet three main tests:
Small Business Corporation (SBC) Test: At the time of disposition, the corporation must be a Canadian-controlled private corporation (CCPC) where all or substantially all (generally 90% or more) of the fair market value of its assets is attributable to assets used principally in an active business carried on primarily in Canada, shares of connected SBCs, or a combination of these assets.
Holding Period Ownership Test: The shares must not have been owned by anyone other than the individual or a related person or partnership throughout the 24 months immediately preceding the disposition.
Holding Period Asset Use Test: Throughout the 24 months immediately preceding the disposition, more than 50% of the fair market value of the corporation's assets must be attributable to assets used principally in an active business carried on primarily in Canada, or shares or indebtedness of connected corporations that meet the same criteria.
Consider a scenario where a client sells their business for $30 million. By setting up a trust and family structure, the client can utilize multiple capital gains exemptions, potentially sheltering about half of the $10 million share of the proceeds.
2. Creditor Protection
Holding assets in a trust rather than personally can provide better creditor protection. Trust law principles dictate that assets held in a trust are legally separated from the personal assets of the settlor and beneficiaries. This separation means that if an individual faces liability or creditor issues, the assets in the trust are not exposed. This layer of protection is crucial for individuals looking to safeguard their wealth from potential claims.
3. Flexibility for Future Business Sales
A well-structured arrangement involving different entities, such as operating companies (Opcos) owned by a trust with a holding company (Holdco) as the beneficiary, offers flexibility for future business sales. This structure allows for the selective sale of individual subsidiaries rather than the entire business held in a single Holdco.
Such flexibility is advantageous for tax planning and strategic business decisions. It enables the client to maximize the use of capital gains exemptions under subsection 110.6(2) of the Income Tax Act.
4. Estate Planning
Family trusts are also valuable tools for estate planning, particularly for individuals who are married, have children, or are planning for the future. Trusts facilitate the transfer of wealth to future generations in a tax-efficient manner and help manage and protect family assets.
Subsection 110.6(2) of the Income Tax Act allows for the capital gains deduction on the disposition of qualified farm or fishing property. This provision can be particularly beneficial in estate planning scenarios, enabling families to pass on significant assets while minimising tax liabilities.
5. Additional Capital Gains Exemptions
Beyond the QSBCS, the Income Tax Act provides other capital gains exemptions that can be leveraged for tax planning:
Qualified Farm or Fishing Property: Under subsection 110.6(2), individuals can claim a capital gains deduction for the disposition of qualified farm or fishing property. This includes real or immovable property used in the course of carrying on a farming or fishing business in Canada, shares of the capital stock of a family farm or fishing corporation, and interests in a family farm or fishing partnership.
Additional Deduction for Farm or Fishing Property: Subsection 110.6(2.2) provides an additional deduction for the disposition of qualified farm or fishing property after April 20, 2015, allowing for further tax relief beyond the standard capital gains deduction .
THE INFORMATION PROVIDED IN THIS ARTICLE IS FOR GENERAL INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE LEGAL ADVICE. FISZMAN TAX LAW RECOMMENDS CONSULTING A QUALIFIED LAWYER FOR ADVICE PERTAINING TO YOUR SPECIFIC SITUATION.
