Today I want to talk about a rule that catches many Canadian business owners off guard: how having too much cash inside your corporation can prevent you from using the Lifetime Capital Gains Exemption (LCGE) when you sell your business.
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The Value of the Capital Gains Exemption
As of 2022, if you sell shares of your small business in Canada, you can claim up to $913,630 of lifetime capital gains exemption.
Here’s a simple example:
- You sell your business shares for a $1 million gain.
- With the exemption, you only pay tax on $86,370 of that gain.
- Since only 50% of capital gains are taxable, just $43,185 is added to your taxable income.
The tax savings here are massive. But this benefit depends on meeting specific rules including how much cash you hold in your corporation.
The 10% Rule You Can’t Ignore
To qualify for the LCGE, no more than 10% of your corporate assets can be classified as non-business assets. Cash and investments inside your corporation fall into this category.
Let’s look at an example:
- Business assets: $4.25 million
- Cash: $750,000
- Total corporate value: $5 million
In this case, the corporation has 15% of its assets in cash ($750,000 ÷ $5,000,000). Because this exceeds the 10% limit, the shares would not qualify for the LCGE.
That could mean losing out on tax savings worth hundreds of thousands of dollars.
Strategies to Stay Eligible
If you find yourself in this situation, you do have options:
- Withdraw some cash: You may be able to take money out of the corporation. Depending on the structure, this could be tax-free (via a shareholder loan or capital dividend). If not, even paying some tax may be better than losing the exemption.
- Purchase business assets: Using excess cash for equipment, real estate, or other business-related investments can bring your ratio back in line.
- Use an investment corporation: You could transfer some of the cash into a holding or investment company, though this is a more advanced strategy requiring professional guidance.
Beware of Overlooking This Rule
Many business owners miss this issue because their advisors never mention it. Some investment advisors or insurance agents may encourage investing corporate cash without considering how it affects LCGE eligibility.
Keep in mind:
- Cash and investments inside your corporation count as non-business assets.
- Insurance policy cash values inside the corporation also count as non-business assets.
Both can push you over the 10% threshold.
Final Thoughts
The Lifetime Capital Gains Exemption is one of the most valuable tax breaks available to Canadian business owners. Holding too much cash in your corporation could disqualify you from using it, potentially costing you $200,000 or more in unnecessary taxes.
If you’re planning to sell your business, make sure you monitor your corporate balance sheet and take action well in advance. At Trans Canada, we help business owners stay onside so they can maximize their after-tax wealth when the time comes to sell. Come visit our website and book a free call with us.
