The lifetime capital gains exemption (technically called capital gains deduction) allows Canadian resident individuals to earn tax-free capital gains on certain kinds of property (active business shares and farm/ fishing property), up to the exemption amount.
The lifetime exemption is indexed to inflation. For the 2020 taxation year, the exemption amount is $866,912 of capital gains ($1 million for farm/fishing property). Technically, the exemption is expressed as being a deduction in calculating taxable capital gains, which is $433,456.
Since the exemption is a lifetime amount, the exempt amount for 2020 is reduced to the extent that you previously claimed the exemption (including in years up to 1994 when it was a $100,000 general exemption, not limited to specific kinds of property).
The exemption is allowed for taxable capital gains resulting from the disposition of shares in a qualified small business corporation (“QSBC shares”). In order to qualify, the following conditions must be met.
First, at the time of the disposition, the corporation must be a “small business corporation”, which is defined as a Canadian-controlled private corporation, all or substantially all of the assets of which consist of (on a fair market value basis):
- assets used principally in an active business carried on primarily in Canada by the corporation or by a related corporation (“principally” and “primarily” generally mean more than 50%);
- shares or debt in other small business corporations; or
- any combination of the above.
A Canadian-controlled private corporation (CCPC) is basically a private corporation resident in Canada that is not controlled by non-residents or public corporations.
Second, throughout the 24 months prior to the disposition, the corporation must have been a CCPC and more than 50% of the corporation’s assets (on a fair market value basis) must have consisted of assets used principally in an active business carried on primarily in Canada by the corporation or by a related corporation, or shares or debt in another corporation that was “connected” with the CCPC. The corporations will be connected, generally if the CCPC controls the other corporation or owns more than 10% of the shares in the other corporation on a votes and fair market value basis.
There is a general holding period for the shares. At the time of the sale of the shares, no person except you or a related person can have owned the shares for at least 24 months (there are some exceptions).
Exemption reduced by CNIL
The capital gains exemption is reduced by the amount of your cumulative net investment losses (CNIL), going back as far as 1988. Basically, this equals the amount by which your investment losses exceed your investment income over that period, if any.
Exemption reduced by ABILs
The exemption is also reduced by your claimed allowable business investment losses (ABILs). In general terms, an ABIL is an allowable capital loss incurred on the disposition of the shares or debt invested in certain types of CCPCs. Unlike regular allowable capital losses, an ABIL is deductible from all sources of income. As such, for tax policy reasons, the government decided that it should in turn reduce your capital gains exemption.
In 2018, you claimed a $70,000 ABIL. In 2020, you have a $200,000 taxable capital gain from the disposition of QSBC shares. Only $130,000 of the taxable capital gains will qualify for the exemption. The remaining $70,000 will be included in your 2020 income.
The capital gains exemption also applies to taxable capital gains from the disposition of qualified farm or fishing property. In very general terms, this category of property includes real property and depreciable property (e.g. equipment) used in a farm or fishing business. It also includes shares in a farming or fishing corporation or partnership, with conditions similar to those that apply to QSBC shares (although similar, there are some significant differences). The exemption for qualified farm or fishing property is $1 million of capital gains or $500,000 of taxable capital gains. As with the QSBC exemption, it is reduced by the amount of the exemption you claimed in previous years.