Capital Gains Deduction

Eligible Dispositions
The capital gains deduction allows shareholders of certain private corporations and owners of farming and fishing property to exempt from taxation a big portion of the gains they could make by selling their business.
The deduction is limited by what is commonly referred to as the lifetime exemption limit. For dispositions after June 24, 2024, the limit is set at $833,333.33. The limit is indexed and increases every year. Once a portion of the limit is used, it cannot be renewed.
The dispositions eligible for the deduction are [ITA 110.6(2)]:

• dispositions of qualified small business corporation shares (QSBCS)
• dispositions of qualified farm or fishing property (QFFP)
• reserves brought into income in 2023, from either of the above
• the allocation and designation by a trust of taxable capital gains reported in the trust’s tax year on the disposition of QSBCS or QFFP
• the allocation and designation by a trust of taxable capital gains resulting from a reserve brought into income in the trust’s tax year relating to a disposition of QSBCS or QFFP in a prior tax year of the trust.

Qualified Small Business Corporation Shares
The designation of qualified small business corporation shares (QSBCS) [ITA 110.6(1)] is one of the criteria needed to claim the capital gains deduction [ITA 110.6(2.1)].
Three conditions to qualify
In order for a share to be considered as a qualified small business corporation share (QSBCS), it must meet all of the following criteria:

• at the time of sale, it was a share of the capital stock of a small business corporation, and it was owned by you, your spouse or common-law partner or a partnership of which you were a member [ITA 110.6(1)(a)]
• throughout the 24 months immediately before the share was disposed of, no one owned the share other than you, a partnership of which you were a member, or a person related to you [ITA 110.6(1)(b)]
• throughout that part of the 24 months immediately before the share was disposed of, while the share was owned by you, a partnership of which you were a member, or a person related to you, it was a share of a Canadian-controlled private corporation and more than 50% of the fair market value of the assets of the corporation were:
  • used mainly in an active business carried on primarily in Canada by the Canadian-controlled private corporation, or by a related corporation
  • certain shares or debts of connected corporations
  • a combination of these 2 types of assets [ITA 110.6(1)(c)]

Calculation of the Capital Gains Deduction

*$833,333.33 for dispositions after June 24, 2024.
Quebec Particularities
The capital gains deduction for Quebec is very similar to the federal. However, resource property dispositions are also included amongst the eligible dispositions [QITA 726.20.2]. Resource properties are [QITA 726.20.1]:

• a flow-through share issued before June 13, 2003 (or after June 12, 2003, as part of a public issue further to an investment made no later than June 12, 2003, or further to an application for a receipt for a prospectus [or for an exemption from filing a prospectus] made no later than that date), or after March 30, 2004;
• An interest in a partnership that invested in such flow-through shares, or an interest in a partnership that incurred Canadian exploration expenses or Canadian development expenses (except where the interest was acquired by an individual before March 31, 2004, as part of a public issue of securities further to an investment made after June 12, 2003, or further to an application for a receipt for a preliminary prospectus [or for an exemption from filing a prospectus] made after that date);
• property substituted for a flow-through share or for an interest in a partnership described in the first and second points above (see the definition of “substituted property” that follows).

Factors to Consider When Dealing with the Capital Gains Deduction
When looking at the calculation of the capital gains deduction, the capital losses will reduce the deduction that can be claimed. Therefore, if there’s a balance of capital losses carried forward at the beginning of the year with an eligible disposition, a choice must be made between using the capital losses carry forward and the capital gains deduction. In this case, taking the capital gains deduction is always the better option. The deduction can only be used against gains from eligible dispositions; meanwhile, capital losses can be used against any type of capital gains.
Another factor to consider is the triggering of alternative minimum tax (AMT) when getting close to the lifetime limit. Although in theory the capital gains deduction exempts the gains from eligible dispositions up to the available lifetime limit, it can trigger AMT which will charge a parallel tax. This factor should be strongly considered when performing tax planning of future eligible dispositions.