Capital Gains Tax: A Comprehensive Guide for Canadian Business Owners

As a business owner, you’ve worked hard to build your wealth. But with the recent changes to capital gains tax in Canada, protecting that wealth has become even more challenging. The good news is that you don’t have to navigate this complex landscape alone. In this comprehensive guide, we’ll explore proven strategies to help you manage and minimize your capital gains tax liability, allowing you to keep more of what you’ve earned and invest in your business’s future.

Understanding Capital Gains Tax

Capital gains tax is a tax on the profit your corporation makes when selling a capital asset for more than the original purchase price. Essentially, it’s a tax on the growth in value of an asset you hold.

What are Capital Assets?

Capital assets encompass a wide range of items, including:

• Investments: Stocks, bonds, mutual funds, exchange-traded funds (ETFs)
• Real Estate: Land, buildings, commercial property, rental properties
• Business Assets: Equipment, machinery, intellectual property
• Personal Use Property: Cottages, artwork, collectibles (though there are special rules for these)

How is Capital Gains Tax Calculated?

In the past, only 50% of a capital gain was included in your corporation’s taxable income. However, as of June 25, 2024, the inclusion rate increased to 66.67% for all capital gains realized by a corporation. This means a larger portion of your capital gain is subject to your corporate tax rate.

Important Note: For individuals, the 50% inclusion rate still applies to the first $250,000 of capital gains, with the 66.67% rate applying to gains above that amount.

For a deeper dive into the recent changes to capital gains tax, be sure to check out our blog post on Federal Budget 2024.

The following flowchart shows a visual overview of the key decisions and strategies involved in planning for corporate capital gains:

What’s best for you will depend on your specific circumstances and goals.

Strategies to Manage Capital Gains Tax

There are several strategies available to help you manage your capital gains tax liability. The following infographic provides a quick comparison of some key approaches and their potential benefits and drawbacks:

Since each strategy has its own set of advantages and disadvantages, do carefully consider your individual circumstances and goals when selecting the most appropriate approach. Let’s explore each of these strategies, starting with investment diversification.

A. Investment Diversification

As with your personal investments, diversification is a key strategy for managing capital gains within your corporation. Instead of putting all your resources into a single investment (which can be risky, especially if that investment is tied to your business itself), spreading your investments across a mix of asset classes can potentially reduce your overall capital gains tax liability and create a more resilient portfolio.

Here’s a closer look at some common asset classes:

• Stocks, ETFs, and Mutual Funds: Stocks represent ownership in individual companies. Exchange-Traded Funds (ETFs) and mutual funds offer a convenient way to invest in a basket of stocks, providing instant diversification. While they all have the potential for high growth (and therefore, higher capital gains), they also come with higher risk.
• GICs and Bonds: Guaranteed Investment Certificates (GICs) offer a fixed rate of return with low risk, while bonds are similar but can fluctuate in value. Both generally offer lower returns than stocks, but also lower risk and may generate less capital gains.
• Real Estate: Real estate can be a good long-term investment, but it’s important to factor in property taxes and the potential for capital gains when selling.
• Alternative Investments: This broad category encompasses a range of investments beyond traditional stocks and bonds, such as private equity, venture capital, hedge funds, real estate investment trusts (REITs), and commodities. Alternative investments can offer unique opportunities for diversification and potentially higher returns, but they often come with higher risk and complexity.  

The Correlation Between Risk and Return

Generally, investments with higher potential returns also come with higher risk. Diversification helps you balance this risk and potentially smooth out your returns over time, reducing the likelihood of realizing large capital gains all at once.

Working with Your Wealth Advisor

Your independent wealth advisor can help you find suitable, tax-efficient investments and create a diversified portfolio that aligns with your business goals and risk tolerance. They can also guide you on incorporating alternative investments strategically. If you don’t currently have a wealth advisor or are looking for a new one, we can introduce you to a trusted professional from our private, pre-screened network.

For more insights on diversification and alternative investments, check out our blog post: Diversify Your Portfolio with Alternative Assets and Life Insurance

B. Offsetting Capital Gains with Capital Losses

While everyone hopes for investment gains, sometimes losses are inevitable. The good news is that you can use capital losses to offset capital gains, potentially reducing your overall tax liability.

How it Works:

If you sell a capital asset for less than its original purchase price, you incur a capital loss. This loss can be applied against any capital gains you realize in the same tax year.

Carry-Back and Carry-Forward Provisions:

• Carry-back: You can carry capital losses back three years to offset any capital gains you had in those previous years. This can be helpful if you had a large capital gain in the past and want to reduce your tax liability retroactively.
• Carry-forward: If you can’t use all of your capital losses in the current year or carry them back, you can carry them forward indefinitely to offset future capital gains.

Example:

Let’s say your corporation realized a capital gain of $50,000 this year but also incurred a capital loss of $20,000. You can use the $20,000 loss to offset the gain, reducing your capital gain to $30,000.

Important Note: The Canada Revenue Agency (CRA) has rules against “superficial losses”. This means you can’t sell an asset at a loss and then immediately buy it back just to create a capital loss.

Consult Your Accountant:

It’s important to remember that tax rules can be complex and are subject to change. Your situation is unique, so it’s always a good idea to consult your independent accountant for personalized advice on how to best utilize capital losses within your overall tax strategy.

C. Timing Your Sales

The timing of your asset sales can play a significant role in managing your capital gains tax liability. By strategically planning when you sell assets, you can potentially reduce your tax burden and improve your overall financial position.

Here’s how timing can make a difference:

• Early in the Year: Selling assets early in the year can give you more time to plan for the tax implications and make any necessary adjustments to your financial strategy. It also allows you to take advantage of the longer time frame before taxes are due on April 30th.
• Delaying Sales: In some cases, it might be beneficial to delay the sale of an asset to a later tax year. This could be advantageous if you anticipate being in a lower tax bracket in the future or if you want to spread out your capital gains over multiple years.
• Market Conditions: Timing your sales also depends on market conditions. It’s essential to consider the current market value of your assets and the potential for future growth or decline.

Important Considerations:

While tax implications are important, they shouldn’t be the sole factor driving your investment decisions. It’s crucial to consider your overall investment goals, risk tolerance, and the long-term outlook for your assets.

Working with Your Advisors:

Your wealth advisor can help you assess the optimal timing for selling assets based on your individual circumstances and financial goals. They can also work with your accountant to ensure your decisions align with your overall tax strategy.

D. Tax-Advantaged Accounts

Tax-advantaged accounts offer a powerful way to shelter your investments from taxes, but their use within a corporation is limited.

TFSAs and RRSPs: Not for Corporations

While Tax-Free Savings Accounts (TFSAs) and Registered Retirement Savings Plans (RRSPs) are excellent tools for individuals to shelter investments from capital gains tax, they cannot be held within a corporation.

• TFSAs: These accounts allow investments to grow tax-free, and any withdrawals are also tax-free. This means you can completely eliminate capital gains tax on investments held within a TFSA. However, they can only be held by individuals, not corporations.
• RRSPs: While RRSPs offer tax-deductible contributions and tax-deferred growth, withdrawals are taxed as regular income. Earning capital gains can increase your RRSP balance. It’s important to consider your tax bracket in retirement when making withdrawals. You must convert your RRSP to a RRIF by December 31st of the year you turn 71, and take stipulated minimum withdrawals each year. Again, RRSPs cannot be held by a corporation.

Individual Pension Plans (IPPs)

For business owners and incorporated professionals, an Individual Pension Plan (IPP) can be a valuable tool for retirement planning and tax deferral. IPPs allow for higher contribution limits than RRSPs, and contributions are tax-deductible for your corporation. However, like RRSPs, withdrawals from an IPP are taxed as income.

Important Note: All of these registered accounts (TFSAs, RRSPs, and IPPs) have contribution limits, which can restrict the amount you can shelter from tax.

Is There a TFSA Equivalent for Corporations?

While there’s no direct equivalent to a TFSA for corporations, cash value life insurance offers some similar benefits. Like a TFSA, the cash value within a life insurance policy grows tax-deferred, and you can access it through tax-free loans. We’ll explore this strategy in more detail later in this post.

E. Charitable Donations

Donating appreciated assets to a registered charity can be a highly effective way to eliminate capital gains tax while supporting causes you care about.

How it Works:

Instead of selling an asset and donating the cash proceeds, your corporation donates the asset itself (e.g., shares of a publicly traded company, real estate). The charity will then sell the asset and issue a donation tax receipt for the fair market value. By donating the asset directly, you avoid realizing the capital gain, and therefore, you won’t owe any capital gains tax on the appreciated value.

Benefits:

• Eliminate Capital Gains Tax: Completely avoid paying capital gains tax on the donated asset.
• Tax Receipt at Fair Market Value: Receive a tax receipt for the full current market value of the asset, which can be used to offset other taxable income.
• Support Charitable Causes: Make a meaningful contribution to a charity of your choice.

Example:

Let’s say your corporation owns shares in a publicly traded company that were purchased for $10,000 and are now worth $50,000. If you sell these shares, your corporation would realize a capital gain of $40,000, and 66.67% of that gain ($26,668) would be added to your corporation’s income and taxed.

However, if you donate the shares directly to a registered charity, your corporation would receive a tax receipt for $50,000 and would not have to pay any capital gains tax on the appreciated value. In addition, your Capital Dividend Account gets a credit for the untaxed portion of the gain, which means $16,667 (33.33% of $50,000) can go to shareholders as tax-free capital dividends.

Important Note: This strategy also applies to personal donations of capital assets.

Want to learn more about incorporating charitable giving into your financial plan? Check out our blog post on Willpower: Leaving a Legacy of Giving.

F. The Role of Life Insurance

Life insurance, specifically cash value life insurance, can play a powerful role in managing capital gains tax for business owners. Unlike stocks or real estate, a life insurance policy itself is not considered a capital asset. This unique characteristic, combined with favourable tax treatment, makes it a valuable tool for tax planning.

Benefits of Cash Value Life Insurance:

• Tax-Deferred Growth: The cash value within a life insurance policy grows tax-deferred, meaning you don’t pay tax on the investment gains each year. This allows for faster compounding and greater wealth accumulation over time. With a properly managed policy, this tax deferral can be permanent.
• Preserving the Small Business Deduction (SBD): High levels of passive income can reduce a corporation’s Small Business Deduction (SBD) limit, leading to higher taxes on active business income. Investments within a life insurance policy do not generate passive income, helping to preserve your SBD.
• Tax-Free Access to Cash Value: You can access the cash value of your policy through tax-free loans. These loans can be used to do things like fund business investments or supplement retirement income.
• Tax-Free Death Benefit: The death benefit paid out by the life insurance policy is tax-free to the beneficiary. When your corporation is the beneficiary, this can provide significant liquidity to your business or estate, helping to cover capital gains tax liabilities and avoid forced asset sales.
• Capital Dividend Account (CDA): A portion of the death benefit can be paid out as a tax-free capital dividend to shareholders. Once the Adjusted Cost Basis (ACB) of the policy reaches zero, the entire death benefit can be paid out tax-free.

Addressing Concerns about Future Tax Changes:

While tax rules can change, the fundamental tax advantages of life insurance have remained relatively stable. The last major overhaul of life insurance tax rules occurred in 2017, with the previous significant change dating back to 1982.

Life Insurance for Liquidity:

One of the most significant benefits of life insurance is the liquidity it provides. When a business owner dies, there can be a substantial tax liability due to the deemed disposition of assets. Life insurance can provide the funds needed to cover these taxes, preventing the need to sell business or personal assets at a potentially inopportune time.

Example:

Imagine your corporation owns a $1,000,000 life insurance policy on you (the business owner) with a cash value that has grown to $600,000.

• Tax-Free Access: You can often access up to 90% of the cash value ($540,000) through tax-free loans.
• Death Benefit Liquidity: Upon your death, the $1 million death benefit is paid out tax-free to your corporation.
• Tax-Free Capital Dividend: A portion, or potentially all, of the death benefit can be paid out as a tax-free capital dividend to shareholders.

Timing of Capital Gains

As discussed earlier, capital gains don’t always happen on a schedule that you control. Understanding the different scenarios in which capital gains can occur is crucial for effective tax planning. This infographic illustrates the three key timings of capital gains:

By understanding these scenarios, you can proactively manage your tax liability and make informed decisions about your investments.

The Three Timings of Capital Gains:

1. Ongoing (Voluntary): This is the most common scenario. Capital gains arise from the ongoing buying and selling of investments, such as stocks, mutual funds, or properties. This requires less planning since it’s an ongoing process, but it’s still essential to be mindful of the tax implications of each transaction. Your wealth advisor and accountant can help you navigate this.
2. Significant Events (Generally Voluntary): These capital gains typically result from a major event, such as the sale of a business or a major asset. This might be planned, like selling your business at retirement, or unplanned, like a forced sale due to a buy-sell agreement. Careful planning is crucial to minimize the tax impact of these events.
3. Forced (Deemed Disposition): This is an involuntary scenario triggered by the government. It occurs when you die or leave Canada. At that time, you’re deemed to have sold all your capital assets at fair market value, potentially leading to a substantial tax bill. This often requires the most extensive planning, as it may necessitate selling assets to cover the tax liability. Life insurance can play a crucial role in addressing this. To learn more about deemed disposition, read our blog post: Preparing Your Legacy: Understanding the Deemed Disposition.

Realize, Defer, Eliminate:

These three timings highlight the different approaches to managing capital gains:

• Realize: Accept that ongoing capital gains are a part of investing. While taxes are involved, it’s still preferable to the higher tax rates on interest and dividends.
• Defer: Use strategies like the buy-and-hold approach to defer capital gains tax to a later date. However, remember that this eventually leads to a tax bill upon sale or deemed disposition.
• Eliminate: Explore options like tax-preferred accounts (RRSPs, TFSAs) or life insurance to eliminate capital gains tax on some of your investments.

Eliminating Capital Gains

While managing and deferring capital gains tax are valuable strategies, wouldn’t it be even better to eliminate it altogether? Here are some tax-preferred investment options that can help you do just that:

1. RRSPs/IPPs:

• Registered Retirement Savings Plans (RRSPs): These are a popular choice for individuals. Contributions are tax-deductible, and investment growth is tax-deferred until retirement. However, withdrawals are fully taxable as income.
• Individual Pension Plans (IPPs): These are essentially the corporate equivalent of RRSPs, designed for business owners and incorporated professionals. They offer higher contribution limits than RRSPs and provide tax deductions for your corporation. However, withdrawals are taxed as income.

2. TFSAs:

• Tax-Free Savings Accounts (TFSAs): These accounts offer valuable tax advantages. Contributions are made with after-tax dollars, but investment growth is tax-free, and withdrawals are also tax-free. This makes TFSAs an ideal way to eliminate capital gains tax. However, they are only available to individuals, not corporations.

3. Cash Value Life Insurance:

• The Corporate TFSA: Think of cash value life insurance as the closest equivalent to a TFSA for corporations. The cash value within the policy grows tax-deferred, and you can access it through tax-free loans. This allows you to bypass capital gains tax while enjoying other benefits like a tax-free death benefit and potential for tax-free capital dividends.

Important Considerations:

• Contribution Limits: All of these registered accounts (RRSPs, IPPs, and TFSAs) have contribution limits, which can restrict the amount you can shelter from tax.
• Corporate Restrictions: TFSAs are not available to corporations, limiting your options within a corporate context.
• Life Insurance Flexibility: Cash value life insurance offers unique advantages for corporations, such as higher contribution limits, tax-free access to cash value, and a tax-free death benefit that can provide liquidity for your business.

Deferring Capital Gains

The “buy and hold” strategy is a classic investment approach where you keep assets for the long term, allowing them to appreciate in value over time. This can be an effective way to defer capital gains tax, as you only realize the gain when you eventually sell the asset.

The Appeal of Buy and Hold:

• Simplicity: It’s a straightforward approach that requires minimal trading or active management.
• Potential for Growth: Allows your investments to compound over time, potentially leading to significant gains.
• Tax Deferral: You don’t pay capital gains tax until you sell the asset, giving you more time to plan and potentially reducing your overall tax liability.

The Drawbacks:

• Indefinite Deferral: While deferring taxes can be advantageous, it’s important to remember that the tax liability doesn’t disappear. It simply gets pushed to a later date.
• Higher Tax Bracket in Retirement: If you defer capital gains into your retirement years, you might end up in a higher tax bracket and face a larger tax bill when you eventually sell the assets.
• Deemed Disposition at Death: A big risk of deferring capital gains is the potential for a large tax bill upon death due to deemed disposition. This could force your beneficiaries to sell assets at an inopportune time to cover the tax liability.

Life Insurance as a Solution:

Life insurance, particularly cash value life insurance, can be a valuable tool to address the risks associated with deferring capital gains. The tax-free death benefit can provide the liquidity needed to cover the tax liability arising from deemed disposition, ensuring that your beneficiaries don’t have to sell assets under duress.

Building Your Capital Gains Tax Strategy

Managing capital gains tax effectively requires a proactive and strategic approach. Here’s how to get started:

1. Consult with Independent Niche Experts:

• Accountant: Your accountant is your primary resource for tax planning. They can help you understand the specific implications of capital gains tax for your business and guide you in making informed decisions.
• Wealth Advisor: A wealth advisor can help you develop a comprehensive financial plan that integrates your capital gains tax strategy with your overall investment and retirement goals.
• Taxevity Insurance: We can work with your independent accountant and wealth advisor to explore how life insurance can be used to create a tax-efficient strategy for your business, particularly by addressing the tax liabilities associated with deemed disposition and providing liquidity for your estate.

2. Develop a Personalized Plan:

There’s no one-size-fits-all solution for managing capital gains tax. The best approach will depend on your specific circumstances, including:

• Your business structure and industry
• The types of assets your business holds
• Your investment goals and risk tolerance
• Your retirement plans
• Your philanthropic goals

3. Regularly Review and Adjust:

Tax laws and your personal circumstances can change over time. It’s essential to review your capital gains tax strategy regularly and make adjustments as needed. Aim for an annual review or whenever significant changes occur in your business, tax laws, or personal circumstances.

4. Prioritize Proven Strategies:

While the allure of creative tax strategies might be strong, prioritizing proven, compliant methods are crucial to avoid audits and penalties. Collaborate with your independent advisors to develop a strategy that is both effective and compliant with current tax laws.

Capital Gains Tax: What You Need to Know

Here are answers to common questions about capital gains tax.

Q: How can I determine the capital gains tax liability for my business?

A: Calculating your capital gains tax liability can be complex. It involves determining your adjusted cost base (ACB), the inclusion rate, and any applicable deductions or exemptions. Your accountant is the best resource to help you with these calculations and ensure you’re paying the correct amount of tax.

Q: Are there any exemptions or deductions available for capital gains tax?

A: Yes, there are certain exemptions and deductions available, such as the lifetime capital gains exemption for qualified small business shares. Your accountant can advise you on any exemptions or deductions that may apply to your specific situation.

Q: What are the tax implications of transferring assets between shareholders?

A: Transferring assets between shareholders can trigger capital gains tax. It’s crucial to consult your accountant and potentially a tax lawyer to understand the tax implications and ensure proper structuring of any transfers.

Q: How often should I review my capital gains tax strategy?

A: It’s recommended to review your strategy at least annually or whenever significant changes occur in your business, personal circumstances, or tax laws. This ensures your plan remains aligned with your goals and takes advantage of any new opportunities or addresses any new challenges.

Q: How can life insurance help with capital gains tax?

A: Life insurance, particularly cash value life insurance, can offer several benefits:

• Tax-deferred growth of cash value: Allows your investment to grow without immediate tax implications.
• Tax-free access to cash value: Provides liquidity through tax-free loans.
• Tax-free death benefit: Creates liquidity to cover potential capital gains tax liabilities upon death, avoiding forced sales of assets.
• Capital dividend account: Allows for tax-free distribution of a portion (or all) of the death benefit to shareholders.

Q: What are the key things to consider when developing a capital gains tax strategy?

A: Several factors come into play:

• Your Investment Goals: What are you hoping to achieve with your investments?
• Your Risk Tolerance: How much risk are you comfortable taking?
• Your Time Horizon: When will you need to access your investments?
• Your Tax Situation: What is your current tax bracket, and how might it change in the future?
• Your Business Structure: How is your business structured, and how does this impact your tax liability?

Taking control of your capital gains tax requires a proactive and well-defined plan. Use this infographic as a guide to create your personalized action plan:

By working with your accountant, wealth advisor, and Taxevity Insurance, you can develop a comprehensive, personalized strategy to manage your capital gains tax liability effectively.

Conclusion

Navigating the complexities of capital gains tax can be a challenge, but with a proactive and informed approach, you can effectively manage your liability and protect your business’s financial future. By understanding the rules, implementing the strategies outlined in this guide, and seeking guidance from qualified professionals, you can make informed decisions that align with your business goals and personal circumstances.

Remember, there’s no one-size-fits-all solution. Your capital gains tax strategy should be as unique as your business.

Key takeaways:

• The timing of when capital gains are realized is important to consider.
• Utilize tax-advantaged accounts strategically.
• Consider charitable donations of appreciated assets to eliminate capital gains tax and support worthy causes.
• Explore the powerful role of life insurance in providing liquidity and addressing tax liabilities at death.
• Work with your accountant, wealth advisor, and Taxevity Insurance to develop a personalized plan.

Ready to take control of your capital gains tax strategy? Contact Taxevity Insurance today to schedule a consultation. We can help you explore how life insurance can be integrated into your financial plan to create a more tax-efficient future for your business and family.

Promod Sharma (FSA, FCIA) and Jeevan Sharma (CFP) YOUR FAMILY TEAM

At Taxevity Insurance, we’re passionate about bringing clarity to complex financial decisions. Let us empower you with personalized strategies to achieve your goals. We focus on life and health insurance solutions to protect your business, your family, and your legacy.