Proposed Federal Budget Changes Reduce Capital Gains Tax for Selected Entrepreneurs

MAY 29, 2024

With the recent budget the government chose to provide selected entrepreneurs with some relief that will help offset the impact of the general increase in capital gains tax. Most of the headlines went to the increase in the lifetime capital gains exemption of $1.25 million per person from approximately $1 million.

Also announced was a new Canada Entrepreneurs Incentive (CEI) which will lower the capital gains inclusion rate from 66.7% to 33.3% upon the sale of qualifying small business shares. The incentive will start at $400,000 of eligible gains in 2025 and rise by $400,000 every year until 2029 when it reaches $2 million. By the time this incentive is fully rolled out, certain entrepreneurs will have a combined full and partial exemption of at least $3.25 million when selling all or part of a business.

Qualification for this program is much more narrow then the capital gains exemption.  The following are the qualification criteria:

  • founding investors in certain sectors (the focus is on technology, manufacturing and construction) who own at least 5 percent of shares in their business throughout a continuous 24 months since the inception of the business

  • where the company has been their principal employment for at least three years

  • must be a CCPC and most of its assets must be used in an active business conducted primarily in Canada

Unfortunately, that leaves out many business sectors including restaurants, hotels, arts, entertainment, recreation, consulting, personal services, finance, insurance, real estate firms and professional corporations.

To illustrate the benefit consider an individual with a startup technology business that sells in 2027 for $2.5 million. Currently, they would utilize the exemption for $1.25 million and pay tax on the remaining $1.25 million resulting in tax of approximately $285,000.  With the upcoming rate increase they would expect to pay approximately $372,000.

Under the new rules the tax will approximate $170,000. This is comprised of:

  • $1.25 million using the exemption

  • $1,200,000, representing 3 years of CEI at $400,000 a year at the reduced inclusion rate will yield tax of $133,333 ($1,200,000 x 1/3rd taxable x 53% rate)

  • Remaining $50,000 will yield tax of $17,755  ($150,000 x 2/3rd taxable x 53% rate)

Please reach out if you have any questions.