Imagine Joe, an entrepreneur who has built a successful business over the years. He is considering an exit strategy in the next few years and is curious about various tax incentives he has heard about on the news and from colleagues.
For owner-managers like Joe who are planning to exit their businesses, there are several tax incentives to consider including the new Canadian Entrepreneurs’ Incentive (CEI). Although this incentive is not yet legislated, it offers promising opportunities by providing entrepreneurs with an increase in after-tax cash to fund new ventures or their retirement.
Overview of CEI
The CEI, introduced in the 2024 federal budget, aims to support entrepreneurs by generally reducing the capital gains inclusion rate to half the rate that would otherwise apply at the time of disposition of a qualifying property. With the proposed increase in the capital gains inclusion rate from 50% to 66.67% on the portion of capital gains realized in the year that exceed $250,000 for individuals (on capital gains realized after June 24, 2024), the CEI aims to mitigate the impact by enabling entrepreneurs to lower the capital gains inclusion rate by half, to 33.33%, for a lifetime total of $2 million in capital gains.
Certain criteria must be met to be eligible for the CEI. In August 2024, draft legislation was released that broadened access to this new incentive.
How it works
The CEI is a deduction from taxable income that generally reduces the capital gains inclusion rate on qualifying dispositions by half. It will be rolled out over five years, starting with a $400,000 maximum in 2025 and reaching a $2 million maximum in 2029. Thus, the amount of the CEI is $400,000 in 2025, $800,000 in 2026, $1,200,000 in 2027, $1,600,000 in 2028, and $2,000,000 in 2029.
To qualify for this incentive, applicants must meet certain criteria, including but not limited to the following:
- a qualified small business corporation (QSBC) share, but in determining whether all or substantially all of the fair market value of the assets is used in an active business, the requirement for purposes of the CEI is narrowed to exclude an “excluded business” (a defined term discussed below); or
- a qualified farm or fishing property (QFFP).
Note that similar to the lifetime capital gains exemption, there are anti-avoidance restrictions imposed on both the shares and the types of transactions that result in a gain that qualifies for the CEI.
Lifetime capital gains exemption
The lifetime capital gains exemption (LCGE) is generally available for eligible dispositions of QSBC shares and QFFP. It allows individuals to avoid paying taxes on qualifying capital gains up to a lifetime maximum amount when they sell QSBC shares or QFFP. The CEI is an additional incentive and where eligible, an individual can benefit from both the LCGE and the new CEI on a qualifying disposition.
The 2024 federal budget proposed to increase the LCGE from $1,016,836 to $1,250,000 of eligible capital gains for dispositions after June 24, 2024 to correspond to the proposed increased capital gains rate.
Example
Let’s assume entrepreneur Joe realizes a $4 million capital gain on the disposition of his company shares in 2029 and meets all the conditions to claim the LCGE and the CEI. Assuming that the current proposed legislation becomes law, the 2024 LCGE amount and a 50% personal tax rate apply for simplicity, we have summarized the difference between claiming the CEI and not claiming it in the tables below.
In both scenarios, the first $1.25 million of eligible capital gains is sheltered by the LCGE. In Scenario A, the CEI reduces the capital gains inclusion rate to 33.33% on the next $2 million in eligible capital gains. Note that we have assumed that Joe has not otherwise used his annual $250,000 threshold on capital gains, which provides for a 50% capital gains inclusion rate on the next $250,000 of capital gains. The remaining capital gains are subject to the increased 66.67% inclusion rate.
Applying an assumed 50% personal tax rate, the taxes owing is $562,500 (in Scenario A) if the CEI is claimed, or $895,833 (in Scenario B) if the CEI is not claimed. The tax savings when claiming the CEI is $333,333 (A – B). This is a significant amount of money that can fund Joe’s next investment or retirement.
For details regarding tax rates applicable in your province in the 2024 tax year, refer to Tax Facts.
| Capital gain | Capital gain inclusion rate | Taxable income | Taxes owing assuming a 50% personal tax rate and no minimum tax |
|---|---|---|---|
| For the first $1,250,000 | Nil (due to the LCGE) | Nil | Nil |
| For the next $2,000,000 | 33.33% (half of the 66.67% inclusion rate due to the CEI) | $666,667 | $333,333 |
| For the next $250,000 | 50% (due to the annual threshold under the proposed capital gain inclusion rate change) | $125,000 | $62,500 |
| For the next $500,000 | 66.67% (due to the proposed increase to the capital gain inclusion rate) | $333,333 | $166,667 |
| Total: $4,000,000 | $1,125,000 | $562,500 (A) |
| Capital gain | Capital gain inclusion rate | Taxable income | Taxes owing assuming a 50% personal tax rate and no minimum tax |
|---|---|---|---|
| For the first $1,250,000 | Nil (due to the LCGE) | Nil | Nil |
| For the next $250,000 | 50% (due to the annual threshold under the proposed capital gain inclusion rate change) | $125,000 | $62,500 |
| For the next $2,500,000 | 66.67% (due to the proposed increase to the capital gain inclusion rate) | $1,666,667 | $833,333 |
| Total: $4,000,000 | $1,791,667 | $895,833 (B) |
Key takeaways
The CEI is a valuable incentive for entrepreneurs looking to sell their business and wishing to minimize income tax on the sale. However, eligibility for the CEI is based on meeting specific criteria and many types of businesses are excluded. It should be noted that while the legislation has been drafted, it may undergo changes before becoming law.
BDO can help
For assistance in determining your eligibility for the CEI, please contact us. Planning may be required several years in advance of an intended sale to ensure that the extensive criteria of the LCGE and the CEI are met. We can help you navigate this new tax incentive to determine the best outcomes for you and your business.
The information in this publication is current as of November 15, 2024.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.