One of the goals of the 2024 Federal Budget was to invest in ways and introduce measures that would simplify the start-up process for new businesses and facilitate growth for existing ones by reducing red tape and providing businesses with the capital that they require to start-up. One of these measures include the new Canadian Entrepreneurs' Incentive designed to extend support to certain entrepreneurs in Canada by providing them with a reduced capital gains inclusion rate when they try to sell shares of their business. This new incentive is meant to minimize the effects of the new capital gains inclusion rate, which has increase from to 67% from 50%. For more information on that change, please see our other post on the topic here.
This guide will provide you with the essential information that you need to know about this new tax incentive for entrepreneurs.
When does the Canadian Entrepreneurs' Incentive come into effect?
This tax incentive is set to begin rolling out on January 1, 2025, and will continue over a 10-year period. The lifetime limit for this incentive will increase by $200,000 each year until it reaches a total of $2 million by January 1, 2034.
How does it work?
Once the Canadian Entrepreneurs' Incentive is fully implemented, eligible entrepreneurs may receive a combined full or partial exemption of up to $3.5 million on the sale of all or part of their business. The tax incentive will work to apply a reduced capital gains inclusion rate of 33.3% on a lifetime maximum of $2 million on eligible capital gains.
To be eligible for the Canadian Entrepreneurs' Incentive, a corporation's shares must meet the criterion for qualifying shares. This criterion differs from the qualifying criteria for shares for the Lifetime Capital Gains Exemption Increase of $1.25 million, which was put into effect on June 25, 2024. However, it is possible for a business owner to satisfy both sets of requirements, which means that one could potentially benefit from both tax incentives. In practice, this means that the reduced capital gains inclusion rate provided by the Canadian Entrepreneurs' Incentive would apply on capital gains that surpass the business owner's Lifetime Capital Gains Exemption.
For example, if an entrepreneur who started a fintech company years ago decides to sell their business to a larger fintech firm that will leverage its resources to expand its technology, and this hypothetical sale results in $2 million in capital gains for the entrepreneur. If the entrepreneur already used the increased lifetime capital gains exemption of $1.25 million previously, under the current tax regime, the entrepreneur would be required to include in income roughly $1 million from the sale. However, once the Canadian Entrepreneurs' Incentive is fully implemented, capital gains tax would only apply to 33.3% of the $2 million, thus reducing their taxable income on the sale of the business by approximately $333,000.
It is important to note that some of the criteria for the Canadian Entrepreneurs' Incentive includes that the shares sold by the business must have been acquired for fair market value consideration and that the shares must be part of the capital stock of a small business corporation, as defined in the Income Tax Act.
With regard to the claimant of the Canadian Entrepreneurs' Incentive, they must be a founding investor that have held the shares that they intend to sell for at least five years immediately prior and have also been actively and substantially involved in the business's activities during that period. Prior to the sale of the shares, the claimant must also have owned more than 10% of the fair market value of the corporation's total capital stock with more than 10% of voting rights at annual shareholder meetings since the initial share subscription.
What industries are eligible?
The Canadian Entrepreneurs' Incentive is proposed to only remain available to incorporated businesses in a select group of industries, including construction, technology, manufacturing, as well as others. According to the 2024 Federal Budget, this incentive will not be made available to professional corporations or those that operate in the financial, insurance, real estate, food and accommodation, arts, recreation, entertainment, consulting, or personal care services industries.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.