The proposed Canadian Entrepreneurs' Incentive (CEI) provides certain entrepreneurs with a reduced capital gains inclusion rate for when they sell their business. It’s intended to provide entrepreneurs with an opportunity to use more of the capital they’ve built towards their next goal. If enacted, this incentive would reduce the inclusion rate on eligible capital gains by half, up to a lifetime limit of $2 million per individual (to be phased in over five years).
This measure would apply to dispositions of qualifying property that occur on or after January 1, 2025.
How does the incentive work?
The CEI was introduced in Budget 2024 along with the proposed increase to the capital gains inclusion rate to 66.67% (from 50%). It’s intended to provide a tax break for entrepreneurs by reducing the tax rate on capital gains realized on the disposition of qualifying Canadian entrepreneur incentive property to 33.33%.
The limit would increase by $400,000 each year, starting in 2025, until it reaches a lifetime maximum of $2 million in 2029. An individual taxpayer can claim this incentive in addition to the reduced inclusion rate of 50% on the first $250,000 of capital gains as well as the lifetime capital gains exemption (LCGE). Note that the LCGE is also proposed to increase to $1.25 million (from approximately 1.07 million) for dispositions after June 24, 2024. Once the maximum limit of the CEI is available, entrepreneurs could benefit from a tax reduction on at least $3.25 million of capital gains realized on the sale of a business if they claim the CEI alongside the LCGE.
Who’s eligible to claim the Canadian Entrepreneurs’ Incentive?
Individuals (other than a trust) who are resident in Canada for tax years starting in 2025 that disposed of qualifying Canadian entrepreneur incentive property will be eligible to claim the CEI.
What’s “qualifying Canadian entrepreneur incentive property"?
To be considered qualifying Canadian entrepreneur incentive property, all the following conditions must be met:
- At the time of the sale, the property was a share of a qualified small business corporation (other than of an excluded business) or the property was qualified farm or fishing property.
- The individual must have an investment of 5% or more of:
- Shares of the business with full voting rights
- The partnership interest, or
- The fair market value of the property, if not shares or a partnership interest for a period of at least 24 continuous months prior to the sale.
- The individual must be actively engaged on a regular, continuous, and substantial basis in the activities of the business for any combined three-year period at any time since the founding of the business.
What’s an “excluded business”?
There are some industries that aren’t eligible for the CEI. The following would be considered an excluded business:
- The professional practice of accountants, lawyers, notaries, physicians, mental health practitioners, health care practitioners, veterinarians, optometrists, dentists, chiropractors, engineers or architects
- Consulting services and businesses whose principal asset is the reputation, knowledge, or skill of one or more employees
- Financial services
- Insurance services
- Real property services (e.g., appraisal services, or managing, selling or renting property for others)
- The purchase, sale and rental of real property
- Short-term lodging and complementary services (e.g., hotels, campgrounds, resorts)
- Food and beverage related services
- Operating facilities or providing services relating to cultural, entertainment and recreational interests (e.g., promoting concerts, exhibiting historic sites, operating a sports venue)
Don’t forget about other incentives
The CEI can be claimed by a taxpayer in addition to the LCGE, which could potentially result in a total or partial shelter from tax on at least $3.25 million of capital gains from the sale of a business. This incentive is also intended to complement other measures, such as the Venture Capital Catalyst Initiative and the Scientific Research and Experimental Development tax incentive program.
Other important considerations
To claim the CEI, the taxpayer must report the gain in their income tax return within one year following the due date for that tax year. If you fail to file the return within that time frame, the incentive could be denied.
In addition, the draft legislation doesn’t allow trusts to allocate gains to beneficiaries for purposes of claiming the CEI. Discuss with your advisor about alternatives that could be used if a trust is involved in ownership of qualifying Canadian entrepreneur incentive property.
The legislation also includes some anti-avoidance rules for certain situations where the CEI wouldn’t apply. For example, the incentive would be denied where dividends are converted to capital gains for purposes of claiming the CEI.
Takeaway
If enacted, the CEI would provide entrepreneurs with significant tax savings on capital gains realized on the sale of qualifying shares of their business. If you think this incentive could benefit you, make sure you contact your local advisor to help you navigate these rules and make sure your business qualifies.
Disclaimer
The information contained herein is general in nature and is based on proposals that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice or an opinion provided by Doane Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, specific circumstances or needs and may require consideration of other factors not described herein.
