Every individual who is resident in Canada has a capital gains exemption that exempts from taxation the capital gains from dispositions of certain types of property. Although the amount is often referred to as an “exemption”, it is actually structured as a deduction in computing your taxable income.
Two types of property are eligible for the capital gains exemption: shares in a qualified small business corporation (QSBC), and qualified farm or fishing property.
The lifetime limit for capital gains from QSBC shares is currently $824,176, or $412,088 for taxable capital gains since only half of capital gains are taxed (2016 amounts). This lifetime amount is indexed annually to account for inflation. The lifetime limit for capital gains from dispositions of qualified farm or fishing property is $1 million, which is not currently indexed but will be indexed in conjunction with the QSBC limit, once the latter limit hits $1 million. However, the two limits are not cumulative. In other words, every dollar of exemption used for QSBC shares reduces the amount available for farming or fishing property, and vice versa.
QSBC shares
In general terms, a QSBC share at the time of the disposition must be a share of a “small business corporation”, which is a Canadian-controlled private corporation (“CCPC”), all or substantially all of whose assets are comprised of:
- assets used principally in an active business carried on primarily in Canada,
- shares or debt in other small business corporations with which it is “connected” (it either controls the other corporation or owns at least 10% of the shares (votes and value) of the other corporation), or
- any combination of the above.
The Canada Revenue Agency (CRA) takes the position that “all or substantially all” means 90% or more, and that “principally” or “primarily” means more than 50%. If the disposition occurs as a result of death (there is a deemed disposition of capital properties upon your death), the shares may qualify if the above criteria were met at any time within the 12 months before death.
In general terms, a CCPC is a private corporation resident in Canada that is not controlled by non-residents, public corporations, or a combination of the two.
There are also two holding period requirements for the shares. First, for the 24 months prior to the disposition by the taxpayer, the QSBC share must not have been owned by anyone other than the taxpayer or a related person. Second, throughout the 24-month period, more than 50% of the corpo-ration’s assets (on a fair market value basis) must have been comprised of assets used principally in an active business carried on primarily in Canada, or shares or debt in other CCPCs that met the same 50% threshold or in some cases the “all or substantially all” threshold. (The actual requirements are very technical in detail.)
ABILS reduce the exemption
The capital gains exemption that can be utilized in a particular year is reduced to the extent of allowable business investment losses (ABILs) claimed in the year or previous years. In general terms, an ABIL is one-half of a capital loss incurred on the disposition of a share or debt in a small business corporation; certain other conditions apply.
Generally, an ABIL is deductible against any sources of income, rather than just taxable capital gains. (Allowable capital losses can normally only offset taxable capital gains.)
Example
In 2016, you realize a taxable capital gain of $100,000 from the disposition of QSBC shares. You have more than $100,000 of your capital gains exemption remaining. In 2002, you claimed an ABIL of $30,000.
Because of the $30,000 ABIL, only $70,000 of the taxable capital gain is eligible for the exemption. The remaining taxable capital gain of $30,000 will be included in your taxable income.
CNILS also reduce the exemption
The capital gains exemption that you can claim in a year is also reduced by your cumulative net investment loss (CNIL) as of the end of the year. The CNIL account is essentially the total of your investment expenses deducted in excess of your investment income, cumulatively for all years back to 1988.
Qualified farm or fishing property
As noted, the capital gains exemption also applies to gains from dispositions of qualified farm or fishing properties. In general terms, these properties include real property used in a farming business, a fishing vessel used in a fishing business, and shares in certain corporations and interests in partnerships that carry on a farming or fishing business in Canada. Various other criteria apply, including a holding period similar to that for QSBC shares.