LCGE Briefly Explained

In the concept of “tax savings through operating a business with a corporation,” there are two fundamental tax-saving strategies:

1. SBC under s.125:
   • This allows CCPCs to benefit from a lower tax rate under certain conditions
2. LCGE under s.110.6:
   • This provides a tax exemption on capital gains from the sale of qualified small business corporation shares when the business owner sells the business.

Let’s illustrate this with an example:

• Many years ago, an individual taxpayer established a small company from scratch with a share capital of $100.
• In 2022, after achieving success, the taxpayer decided to retire and sold all the shares of the company to his neighbour, Mr. Wang, for $913,730.
• Therefore, the capital gain in 2022 would be $913,630 ($913,730 – $100).
• Coincidentally, CRA allows an exemption under LCGE up to the same amount as the capital gain, which is $913,630.
• As a result, the entire amount of $913,630 is exempted from taxation, therefore, half of this amount, $456,815, does not need to be included as income for tax purposes in 2022.
• (If the taxpayer has been operating a farming or fishing business, the exemption amount could be even higher)

To qualify for LCGE, taxpayers need to meet two tests:

1. 50% and 90% tests for Qualified Small Business Corporation (QSBC) shares:
   • To be eligible for LCGE, the shares of the corporation must be considered QSBC shares. This means that, at the time of selling the shares, the corporation’s assets must meet the following criteria:
     1. At least 50% of the assets were used in active business for the preceding 24 months.
     2. At least 90% of the assets were used in active business at the time of selling the shares.
2. Holding period test:
   • The shares must be held by the taxpayer for at least 24 months before selling them.
     • This means selling shares acquired within the last two years would not qualify for LCGE.

Now, let’s address a question that may arise:

Suppose a taxpayer has multiple businesses operated through different operating companies. These operating companies are held by a holding company (Holdco). When the taxpayer retires, if they sell individual operating companies, they can qualify for LCGE. However, if they directly sell Holdco, can they still qualify for LCGE since Holdco does not meet the requirement of having more than 50% of active business income?

Relax. The legislature of ITA has covered this. When explaining the definition of QSBC in subsection 110.6(1), paragraph (c)(ii) states that the attributes of “connected” companies can be taken into account. Therefore, as long as the associated companies meet the 50% requirement, it would suffice.

Lastly, we want to address a specific scenario:

Suppose a taxpayer holds shares of a CCPC. As the CCPC grows and eventually becomes a public company through an initial public offering (IPO), one might assume that the taxpayer would no longer qualify for LCGE under s. 110.6. However, this is not entirely accurate.

s.48.1 ITA states that the taxpayer can still make a tax election to enjoy the benefits of LCGE even after selling shares of the public company.

• The taxpayer has two years (or a floating time frame) from the year of the share sale to make this election. For instance,
  • if the taxpayer sells the shares of the company in December 2023, and
  • the deadline for filing their T1 personal tax return is April 30, 2025,
  • the window for making the election would be approximately 16 months.
• There would be a late-filing penalty of $100 per month, up to a maximum of $2,400 if the election is filed late after the company has gone public.