Capital Gains Exemption
Accumulated passive investments and holding company structures disqualify capital gains exemption claims. Custom-written for CPAs preparing claims and advising on structure planning.
Hugh Woolley
Learn when shares qualify as QSBC shares, how the 90% asset test works with goodwill calculations, and when corporate structures prevent exemption access. You will understand purification techniques, crystallization strategies, and the anti-stacking rule that catches holding company arrangements.
A company sells for $2 million. The capital gains exemption claim is denied. The corporation held passive investments equal to 12% of asset value. The 90% active business asset test failed.
The exemption requires three tests simultaneously: shares held 24 months, 90% of assets in active business at sale, and over 50% active throughout the prior 24 months. Fail any test and the entire exemption is lost.
This session shows you how to identify disqualification issues and plan structures that preserve access:
- QSBC requirements: 24-month holding period with exceptions, 90% active assets at sale, 50% active throughout prior 24 months
- Bad assets: surplus cash beyond working capital needs, shareholder receivables, corporate life insurance, non-connected shares
- Pro forma balance sheet using FMV including goodwill calculated from sale price
- Anti-stacking rule: only one corporation in chain can fail 90% test at any time in 24-month period
- CNIL balance erodes exemption, eliminate through grossed-up taxable dividends before sale
- Previously claimed ABIL must be recaptured before exemption available
Common mistakes destroy exemption claims. A holding company owns an operating subsidiary. The subsidiary accumulates surplus cash during the year exceeding 10% of value. Once annually it pays dividends up to the parent. Both corporations fail the 90% test simultaneously. The anti-stacking rule applies. Exemption denied. The solution is paying dividends quarterly to stay within tolerance.
The material covers purification techniques when successful businesses accumulate surplus cash causing them to fail SBC status. The trust sandwich structure allows operating companies to pay dividends to a trust which allocates to a beneficiary company keeping the operating company pure. On sale the trust allocates capital gain to individual beneficiaries who claim the exemption. Crystallization strategies lock in the exemption before corporations cease to qualify as SBC through setting up US subsidiaries or accumulating passive investments. Examples show when crystallization using a holdco transfer works and when it creates worse tax results than doing nothing.
This program will help you understand capital gains exemption requirements, identify disqualification issues before sale, and structure arrangements preserving exemption access. Learn at your own pace with instant access.
Capital Gains Exemption
Course Syllabus
Capital Gains Exemption Overview and Benefits
Understanding the exemption mechanics and why it matters
Basic Requirements and Mechanics
- $1,250,000 exemption limit for 2025 on capital gains
- Claimed by natural individuals, not corporations or trusts (trusts allocate to beneficiaries)
- Deduction against taxable capital gain in computing taxable income
- Lifetime total, can claim multiple times up to available limit
- Check CRA records for prior claims and related amounts (CNIL, ABIL)
Three Main Benefits
- No regular tax on capital gain (savings approximately $331,250 on $1,250,000 exemption in Ontario)
- AMT treatment: 30% included in AMT base versus 100% for regular capital gains
- TOSI exemption: capital gain not subject to tax on split income rules if SBC shares regardless of amount
Critical Anti-Netting Rule
- Cannot simply "net" capital gain and exemption by leaving off return
- Must report gain and claim deduction separately
- Anti-avoidance rule denies exemption if gain not reported
Structure and 24-Month Holding Period Challenges
When corporate structure or holding period prevents exemption access
Structure Requirements
- Capital gain must be realized by natural individual at personal level
- Sale of SBC shares, not assets
- Trust must distribute taxable capital gain to individual beneficiaries
- Corporate structure can completely prevent access (example: butterfly needed to remove unwanted subsidiary before sale)
24-Month Holding Period Rule
- Shares must be held 24 months before sale
- Cannot be owned by unrelated person in previous 24 months
- Unissued shares (pre-incorporation) deemed owned by unrelated person
- Ordering rule: identical shares deemed sold FIFO for purposes of 24-month test
Exceptions to 24-Month Hold
- Incorporation of active business carried on by individual or partnership
- Rollover to holding company by related person
- Transfer to trust by person related to all beneficiaries
- Transfer from trust to beneficiary
- Shares purchased from related person who held 24 months
ACB Averaging Problem with Mixed Holdings
- Shareholder buys additional shares from unrelated person within 24 months of sale
- Only shares held 24 months qualify for exemption
- ACB averages across share class creating poor result
- Planning: buy through separate holding company or convert to separate class before purchase
The 90% Asset Test and Bad Assets
Determining whether the corporation meets active business asset requirements
QSBC Share Definition and 90% Test
- Shares must be qualified small business corporation shares at time of sale
- All or substantially all (90%) of FMV of assets used in active business in Canada
- Must meet over 50% test throughout previous 24 months
- Test based on FMV including goodwill not on balance sheet
Constructing a Pro Forma Balance Sheet
- Determine FMV of all assets including goodwill
- Goodwill calculated working backwards from sale price
- Calculate percentage active versus bad assets
- Prudent to be significantly over 90% to avoid disputes
Identifying Bad Assets
- Surplus cash beyond working capital requirements (case-by-case analysis)
- Shareholder debit balances (invariably bad, often overlooked)
- Loans receivable unless to connected SBC
- Shares of other corporations unless connected SBC (U.S. subsidiary example)
- Corporate life insurance valued at cash surrender value (generally bad unless key person or banking requirement)
Purification Planning Before Sale
- Pay dividend to reduce bad assets below 10% threshold
- Use surplus cash to buy inventory or active assets
- Pay down liabilities
- Taxable dividend also reduces CNIL if an issue
Anti-Stacking Rule for Corporate Chains
Preventing bad asset spreading across parent and subsidiary
Anti-Stacking Rule Purpose and Mechanics
- In a corporate chain, only one corporation can fall below the 90% test at any time in the 24-month period
- Prevents sprinkling bad assets across a corporate group
- If operating subsidiary meets 90% test throughout 24 months, parent only needs 50% test (but 90% at sale)
- Otherwise parent must meet 90% test throughout 24-month period
Common Trap: Annual Dividend Payments
- Subsidiary accumulates surplus cash during year (over 10%)
- Pays dividend to parent once annually
- Both subsidiary (surplus cash) and parent (received cash) fail 90% test simultaneously
- Exemption denied
- Solution: pay dividends quarterly to stay within tolerance, or accumulate only at parent level
CNIL and ABIL Complications
How investment expenses and prior losses reduce exemption claims
Cumulative Net Investment Loss (CNIL)
- CNIL balance erodes ability to claim capital gains exemption
- Cumulative total from 1988 onwards of investment expenses minus investment income
- Investment expenses: deductible interest, property losses including rental, 50% resource deductions
- Investment income: property income, 50% resource income, taxable capital gains, grossed-up dividends
- Check CRA records for running total
CNIL Planning
- Determine CNIL balance at year-end
- Check if CNIL reduces exemption claim (may not if capital gain large enough)
- Create investment income before year-end if needed
- Taxable dividends best solution (grossed-up amount included)
- Capital dividends do not affect CNIL
- Taxable benefit on low interest loan creates CNIL accumulation
Allowable Business Investment Loss (ABIL)
- Previously claimed ABIL reduces capital gains exemption (must "recapture" before exemption available)
- No discretion to claim capital loss instead of ABIL if qualifies
- Rule goes back to 1985, check CRA records
- If capital loss does not qualify as ABIL, no problem
Purification Techniques
Strategies to meet the 90% test and maintain SBC status
Four Main Purification Approaches
- Get rid of surplus cash by using in business
- Taxable withdrawal of funds (dividends, bonuses)
- Inter-corporate dividend to holding company (limitations due to anti-stacking)
- Trust sandwich structure (best solution for ongoing purification)
Trust Sandwich Structure
- Trust owns common shares of operating company
- Beneficiary company and individuals are trust beneficiaries
- Operating company and beneficiary company connected through common non-arm's length control
- Operating company pays dividends to trust, allocated to beneficiary company (no personal tax)
- Keeps operating company pure by extracting surplus regularly
- On sale, trust allocates capital gain to individual beneficiaries for exemption claim
- Caution: connection issue in year of sale (Vefghi case implications)
Crystallization Strategies
Locking in the capital gains exemption before losing SBC status
When to Crystallize
- Corporation may cease to qualify as SBC (U.S. subsidiary planned)
- Concerned about exemption being cancelled
- Too difficult to continue purifying
- Corporation becoming non-CCPC (sale to non-residents)
Three Crystallization Approaches
- Transfer to holding company with section 85 election recognizing gain
- Internal section 85 exchange of shares (incestuous section 85)
- Sale to non-arm's length party at FMV (spouse, children, family trust)
Holdco Crystallization Cautions
- Do not take note from holdco (immediate deemed dividend)
- Do not take high PUC shares (automatic PUC reduction)
- Must later sell holdco shares, not operating company shares
- May need to keep holdco pure (purchaser may not want bad assets)
- Prevents income splitting among multiple shareholders (fails TOSI excluded shares test)
- Danger: if forced to sell operating company shares instead, extracting proceeds creates dividend worse than original capital gain
Internal Section 85 Alternative
- Exchange existing shares for new class using section 85 election
- No new corporation required
- New shares must have low PUC or deemed dividend results
- Technical trap often missed
Sale to Trust with Reserve
- Sale to family trust for note
- Can claim exemption and spread gain over 5 years using reserve
- Spousal attribution applies unless note meets prescribed rate requirements
- Avoid subsection 75(2) attribution (settlor cannot be beneficiary or trustee with reversion)
- No ability to set gain amount, valuation important
Special Rules and Multiplying the Exemption
Trusts, farms, reserves, death, and family multiplication strategies
Family Farm and Fishing Property
- Separate $1 million exemption (not indexed)
- Not in addition to regular exemption, alternative up to combined limit
- Intergenerational transfer benefits including extended reserves
- Consider regular exemption if limit higher
Capital Gains Reserves
- Can spread gain over 5 years (10 years to child/grandchild for SBC shares)
- Claim exemption in future years as reserve drops
- Exemption limit fixed at amount in year of sale, not increased future amounts
- Useful for AMT planning
Special Death Rule
- Shares qualify as QSBC if qualified at any time in 12 months before death
- Allows access even if offside at death but onside earlier
- Example: corporation accumulates cash during year, pays dividend annually
- May fail 90% test at death but qualified when purified earlier in year
Becoming Non-Resident
- Deemed disposition on becoming non-resident
- Capital gains exemption available if conditions met
Multiplying the Exemption Among Family
- All approaches involve value increase (except spouse on death)
- Taxable sale to family member or trust, value increases afterward
- Freeze structure with new common shares to family trust
- Beware spousal attribution (subsection 75(2)) and section 74.4 clause preventing spouse and minor children from benefiting
- Spousal rollover on death allows double exemption
Documentation and Best Practices
- Check available exemption limit, CNIL, ABIL before claiming
- Prepare pro forma balance sheet at sale for 90% test
- Document all assumptions and calculations
- Make sure proceeds received personally
- Mistakes can be very costly to clients
- Client expectations often exceed technical realities
Meet Your Presenters
Michael Cadesky
Michael Cadesky is the managing partner at Cadesky Tax and a committed contributor to the tax and accounting professions since 1980, earning the title of Fellow from CPA Ontario. He is a past governor of the Canadian Tax Foundation, past chair of STEP Canada and STEP Worldwide, and past chair of the CPA Canada Tax Committee for Small and Medium-Sized Enterprises. Michael is also the co-author of 11 books on tax subjects and the author or co-author of numerous papers and articles on Canadian and international taxation.
Hugh Woolley
Hugh Woolley is an independent tax consultant who has taught income tax for over 30 years for many professional organizations. Hugh has written courses for CPA Canada and over 10 papers for the Canadian Tax Foundation and STEP Canada. From 1990–1992 he worked at the CRA's Rulings Directorate in Ottawa writing "butterfly" tax rulings. Hugh is a past Governor of the Canadian Tax Foundation.
FAQ
When can I access the course?
Immediately upon purchase. All course materials are available on-demand, allowing you to start learning right away.
How long do I have access?
You have 1-year all-access to the course materials. Watch and review the content as many times as you need, at your own pace.
Does the course provide CPD?
Yes. Upon completion, you will receive a verifiable CPD certificate indicating all instructional learning hours and required details.
What's included in the course?
Full video recording of the seminar, plus slides with detailed notes for your reference. Additional resources may be included.
Can I watch on any device?
Yes. Access the course from your computer, tablet, or phone — any device with internet access.