Replacement Property – Small Business Investments
Are you planning on selling shares in your business in the immediate future? There are a few factors you should take into account from a tax perspective. The Income Tax Act (ITA) Section 44.1 offers a tax deferral opportunity for investors who sell shares of eligible small businesses.
By reinvesting the proceeds into shares of another eligible small business within 120 days, investors can potentially defer the capital gains tax. With the recent changes to the capital gains inclusion rate, this provision may be useful for investors looking to sell an existing business and purchase the shares of another.
This blog post, “Replacement Property – Small Business Investments,” will explore some of the factors to be aware of.
ITA 44.1
ITA 44.1 is a tax rule that allows investors to defer paying taxes on capital gains when selling certain corporate shares. If an investor sells shares of an eligible small business and uses the proceeds to buy shares from another eligible small business within 120 days, they can reduce their capital gain until the new shares are sold.
Criteria
A Small Business Corporation must meet specific criteria to be considered eligible for the deferral.
The first criterion that must be met is that the business must be a Canadian Controlled Private Corporation (CCPC). The CCPC must meet the following criteria to be eligible:
• All or at least 90% of the fair market value (FMV) of assets are allocated to active business activities.
• At least 50% of the active business activities must be conducted in Canada.
• A small business corporation and its related corporations must not have assets with a carrying value exceeding $50 Million.
Qualifying Disposition
To qualify for the deferral under ITA 44.1 specific conditions must be met. The conditions are:
• The capital gain must come from selling common shares of an eligible small business corporation.
• The investor must have owned these shares for at least 185 days before selling them.
• Also, the shares must have been purchased directly from the issuing eligible small business corporation.
Replacement Shares
Replacement shares are common shares of an eligible small business corporation that must be bought within 120 days after the year in which the original shares were sold to qualify for ITA 44.1.
They must be designated as replacement shares within the investor’s tax return. The investor can choose to defer less than the maximum allowed by designating fewer replacement shares.
Permitted Deferral
The amount that can be deferred depends on how much of the sale of proceeds are used to buy replacement eligible small business corporation shares.
• If all of the proceeds are used, 100% of the capital gain can be deferred
• If only part of the proceeds are used, the deferral is proportional.
Of course, every situation is unique, so it is important to contact a Tax Specialist prior to engaging in such transactions to ensure you have the perceived outcome.
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