This article is written by Nicole Ewing, Director, Tax & Estate Planning, TD Wealth

As professional advisors, we often speak in generalities and paraphrase rules to make our complex worlds more accessible to our clients. But there’s a risk in this oversimplification – sometimes important exceptions become unknown and worse, underutilized.

For example, when we consider succession planning options for business owners, the Lifetime Capital Gains Exemption (LCGE) invariably takes centre stage. This is especially relevant with Federal Budget 2024’s proposal to increase the LCGE limit to $1.25 million of eligible capital gains for dispositions occurring on or after June 25, 2024, with indexation resuming in 2026. The LCGE is a significant tax reduction opportunity for incorporated small businesses and we should expect a business owner’s lawyer, accountant, and financial professionals to raise the topic to ensure the client knows it may be available (only the tax accountant can say for sure, of course). But what if the business owner is a sole proprietor – what should we expect the professional advisors to say about the LCGE? If they were to say a sole proprietor would need at least two years to plan in order to benefit from the deduction, they’d be wrong.

It’s well known there are qualifying tests that must be met in order for the capital gain to be exempted: the small business test, the active business asset test, and the holding period test. This latter test (found in subsection 110.6(2.1)) is often simplified to “must hold the shares for at least two years” which can lead to unfortunate oversights and the loss of a possible tax reduction opportunity for unincorporated business owners. Because in the right circumstances, there’s an important exception that would allow sole proprietors to gain access to the LCGE without needing a two-year timeframe.

A successful sole proprietor could incorporate a company and subscribe for shares from treasury. Using section 85, the proprietor would transfer their business interest to the corporation in exchange for newly issued shares and elect for this to happen at the cost base of the proprietor’s business assets. While generally the “holding period test” requires relevant shares to be owned only by the proprietor or a related party for 24 months prior to the sale, and treasury shares are typically deemed to have been owned by an unrelated party, subparagraph 110.6(14)(f)(ii) provides an important exception. As long as the business owner received the shares as part of a transaction or series of transactions that included their disposing “all or substantially all” of the assets used in an active business, the deeming rule does not apply. This, combined with section 54.2 which ensures capital property treatment, allows the sole-proprietor-now-shareholder to meet the holding period test and use the LCGE without waiting the full two years.

Simplifying the complex is what we do every day, but paraphrasing comes at a cost. Details matter and exceptions make the rule after all.