Proposed tax reform’s impact on capital gains exemption – plan now for relief

On July 18th, our Canadian Department of Finance released their paper, Tax Planning Using Private Corporations, wherein it introduced a series of proposed tax reforms that will significantly, and negatively, impact the operation of small businesses in Canada, the growth of entrepreneurship in Canada, and the Canadian middle class; the backbone of our economy. One of the proposed reforms target multiplication of the Lifetime Capital Gains Exemption (LCGE) by persons under the age of 18, family trusts and adult children and spouses not involved in the operation of the family business. This is a major change and could translate into lost tax savings in the range of $83,000 to $223,000 per person depending on the marginal tax rate of the family member able to utilize the exemption. Since the proposed changes will make it difficult for family members to access this exemption, Finance has included a special election in the draft legislation to allow individuals 18 or over to utilize their LCGE in 2018 for shares that qualify as qualified small business corporation (“QSBC”) shares.

Planning will need to be undertaken to ensure the shares qualify as QSBC shares. This is necessary as the shares must meet specific criteria for 12 months and the relieving provisions are only available until December 31, 2018. Therefore, planning must start now and be implemented by December 31, 2017 at the very latest. Furthermore, the active business must be valued as part of the election which will determine the extent of the capital gain that can be sheltered from tax. As a result, many taxpayer’s may be enticed to overstate the value of the business in order to maximize the full exemption amount. To combat this, Finance will deny a portion of the exemption where the fair market value of the shares is overstated by 10% or more.

From a valuation perspective, we foresee certain issues with Finance determining that a valuation error is greater than 10%, including:

  1. How would a valuation error be determined by Finance?
  2. Would Finance use hindsight to refute assumptions made in the valuation?
  3. Would Finance argue that an overstatement was made when a range of values from low to high is presented, which is the typical methodology for a valuation of an operating company?

Next steps?

Although the draft legislation has only been proposed at this time, it is unlikely the Federal Government will abandon the proposed changes in this area. With Fall already upon us, there is not much time to undergo planning to utilize the election.  It is imperative that your tax and financial situation be analyzed as soon as possible to determine if any planning can be undertaken in order to benefit from the election in 2018.

Our valuation experts can assist in reviewing your current financial situation to ensure that the valuation conclusion is supportable to minimize the risk of a valuation error penalty.


By: Douglas Craig CPA, CA, CBV and Joe Figliomeni CPA, CA

The information in this article is of a general nature and is in summary form and may not include all the details noted in the consultation paper. Contact one of our tax and valuation professionals to discuss these matters in the context of your situation before acting upon such information.