Donya Ashnaei articling student and Maddi Thomas, associate, Gowling WLG (Canada) LLP
Introduction
Following a year marked by low GDP growth, high inflation, and rising interest rates, the federal government unveiled several proposed measures in Budget 2024, including an increase in the capital gains inclusion rate from 50% to 66.67% for corporations and trusts, and from 50% to 66.67% on the portion of capital gains realized in the year that exceed $250,000 for individuals. In an apparent effort to alleviate some of the negative effects of the capital gains increase, Budget 2024 also introduced the Canadian Entrepreneurs’ Incentive (“CEI”). The incentive aims to encourage Canadian innovators to turn their ideas into businesses that will create jobs for the economy.
What is the CEI?
Presuming the legislation is passed, effective for dispositions of qualifying property on or after January 1, 2025, the CEI will reduce the capital gains inclusion rate for eligible individuals to 33.33% on up to $2 million of qualifying capital gains over a lifetime. This will provide a significant tax saving compared to the regular 50% inclusion rate for capital gains under $250,000 and 66.67% inclusion rate for capital gains over $250,000.
The $2 million limit will be phased in through $400,000 increments per year from 2025 to 2029. Combined with the Lifetime Capital Gains Exemption, the CEI could provide entrepreneurs tax relief on the disposition of shares worth up to $6.25 million once fully implemented.
How Will This Impact Estate Planning?
Once implemented, the CEI may have important implications for estate lawyers and tax planners. As individuals look to maximize the benefits of the CEI, they will require expert advice to navigate the complexities of the technical complexities of the relevant statutory language and eligibility criteria. Estate planning strategies will likely evolve to incorporate the CEI into clients’ overall tax and succession planning, which may enhance the value of business assets passed down to the next generation and smooth the transition to retirement.
By understanding the CEI and its provisions, estate planners can better assist their clients in achieving financial and generational wealth objectives, ensuring that this incentive effectively contributes to long-term wealth preservation and growth.
Proposed Statutory Scheme
The Department of Finance has released draft legislation (“Draft Rules”) adding section 110.63 to the Income Tax Act (“ITA”) to implement the CEI. Per the Draft Rules, to benefit from the CEI, capital gains must be derived from the disposition of qualifying Canadian entrepreneur incentive property (“QCEIP”), this exemption would be in addition to any capital gains exemption which may already exist for the taxpayer. Additionally, the QCEIP must be property of an individual (other than a trust) and not part of an “excluded business,” as defined in the Draft Rules. Excluded businesses include but are not limited to: law and accounting firms; health practitioners; consulting services; various real estate services; lodging services; restaurants; and cultural, entertainment and recreational services or facilities.
For a property to be QCEIP, it must meet several criteria.
- Type of Property
To qualify as QCEIP, the property of an individual must be either qualified farm or fishing property, as defined in subsection 110.6(1) of the ITA, or a qualified small business corporation (“QSBC”) share at the time of disposition. To be a QSBC, the shares must be of the capital stock of a small business corporation other than an excluded business, as defined in subsection 110.63(1) of the Draft Rules.
2. Ownership
Individuals must also meet specific ownership criteria for at least 24 continuous months prior to the disposition of their property. If the property is shares, the individual must own at least 5% of the issued and outstanding shares with full voting rights. For interests in a partnership, the individual’s specified proportion of the partnership for its most recent fiscal period must be not less than 5%. For situations not covered by these two categories, the individual’s interest must have a fair market value of at least 5% of the total fair market value of the property.
- Engagement
To qualify as QCEIP, the individual disposing of the shares must also have been actively engaged in the business on a “regular, continuous and substantial basis” as defined in paragraph 120.4(1.1)(a) of the ITA, for a total of at least three years.
Estate planners and practitioners should stay informed about the CEI provisions, eligibility criteria and updates in order to help clients enhance the value of their business assets and promote effective succession planning.
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