Timing Is Everything
The Taxman Might Be Using A Different Clock Than The Rest Of Us
Perhaps one of the biggest benefits of operating your small business as a Canadian controlled private corporation is the potential to access the lifetime capital gains exemption that, under the right set of circumstances and with appropriate planning, may be available to shelter up to $750,000 of capital gains, per shareholder, on the sale of qualified small business corporation (QSBC) shares.
Simply stated, QSBC shares are shares of a Canadian controlled private corporation (CCPC) in which "all or substantially all" (interpreted to mean 90% or more) of the value of the corporation's assets is used in an active business at the date of sale or transfer. In addition, either you or someone related to you must have owned the shares for at least 24 months prior to their disposition and more than 50% of the corporation's assets must have been used in an active business during that entire period.
In traditional sale planning, business owners and their advisors often focus on this last test, ensuring any investments made through a small business corporation do not inadvertently disqualify them from ultimately claiming the lifetime capital gains exemption (LCGE) upon sale. This is often referred to as "keeping the operating company pure" and the methods to do so are called purification strategies.
But the Canada Revenue Agency late last year issued a disturbing technical interpretation that focused on what many practitioners thought was obvious: How do you measure the 24-month holding period? In this case, a taxpayer on Feb. 5, 2009, purchased 100 common shares of a CCPC that operated a small business. On Feb. 5, 2011, the taxpayer sold the shares, realizing a substantial capital gain. The taxpayer wanted to know whether that gain would qualify for the $750,000 LCGE.
The CRA responded that for the purposes of calculating the 24-month period, the determination time would be Feb. 5, 2011. As a result, the 24 months preceding Feb. 5, 2011, would start on Feb. 5, 2009, and end on Feb. 4, 2011. Since the shares belonged to an unrelated party on Feb. 5, 2009, the CRA's view was that the 24-month holding period requirement was not satisfied and the LCGE could not be claimed.
It's arguable whether the CRA's interpretation of the 24-month holding period will stand up in court, but the ruling demonstrates the importance of being vigilant when it comes to sale planning to ensure that you aren't cutting the deadline too close for the taxman's comfort.