Every business looks for ways to reduce its tax burden. You don’t have to avoid tax but use the various benefits the Canada Revenue Agency (CRA) gives small business owners to save tax. Using these benefits to optimal use is an art, as every situation has different tax-saving benefits. A professional tax consultant can guide you on the best way to operate tax efficiently based on your situation. While you can plan for other taxes annually, capital gains tax is something you need to plan well in advance.
Why Should Small Business Owners Plan For Capital Gains Tax In Advance?
In Canada, individuals and small business owners pay capital gains tax on 50% of the gain from selling an asset or property. So if you purchased a property for $500,000 and sold it for $700,000, you add $100,000 to your taxable income (50% of the $200,000 capital gain). Under Canada’s income tax regime, you may incur a tax rate between 26% and 33% on a $100,000 capital gain, depending on your annual taxable income. This amount is still manageable.
Imagine paying CGT on a capital gain of $10 million you earned from selling the business you spent building all your life. Your CGT could run into millions and eat up your lifetime of savings. Hence, small business owners should plan for such capital gains tax well in advance.
How Can Small Business Owners Reduce Capital Gains Tax?
As an entrepreneur, you plan to grow your business and make it reach new heights. While growing your business, look for ways to reduce the tax you will be liable to pay on the capital gains from your lifetime savings and investments.
When Is a Good Time To Sell Capital Assets?
Timing is of the essence when selling assets and properties. You always want to sell your assets at a time when there is demand and buyers are willing to bid the highest possible price. At the same time, you may strike a deal at that time, time it in such a way that the sale completes in early January. This way, you get 15 months to pay the capital gains tax in the following year, April.
You can also consider selling investments when the business income is low, and you get the desired price.
Small Business Owners Can Use Tax-Loss Harvesting
While small business owners can pursue an asset sale in the year when business income is low, they can also use capital loss as an opportunity to reduce CGT. This method is called tax loss harvesting. In it, you realize a capital loss by selling some low-performing assets at a loss to offset capital gains. It makes business sense, as holding on to low-performing assets for a long time is blocking your funds. You might as well use those assets to reduce your tax bill.
But do not use tax loss harvesting to create superficial loss, wherein you sell a loss-making asset to realize a capital loss and then buy an identical asset a few days later. If the CRA finds out, your capital loss advantage will go, and you will be liable to pay CGT plus any penalty or late fee. Always consult a tax advisor before buying or selling an asset of a significant amount.
Use Capital Dividend Account
Small business owners can use the capital dividend account to withdraw the tax-free portion of the capital gain on the sale of the property. If you sold a business property for a capital gain of $200,000, $100,000 is taxable, and an equal amount is free from CGT.
You use the $100,000 taxable gain in the business to pay CGT and use the remaining to reinvest or pay dividends. (Note: Dividends are taxable under income tax.) But you can shift the $100,000 tax-free capital gain to a capital dividend account and withdraw that money tax-free. It is better to take the help of an accounting expert for this transaction.
Defer Capital Gains Tax
Given the significant CGT liability, you can defer capital gains tax to a later date when your income is low. Gifting to a family member is considered a disposition of an asset and is taxable. You can use this rule to your advantage and gift assets that generate a capital loss. This way, the asset stays within the family, you realize capital loss without money changing hands, and you use the loss to offset capital gains from selling other assets. Later, your family member can reap the benefits of an increase in the asset value in the future.
You can also defer capital gain tax on shares of your business by freezing them at their current value or by transferring assets to a family trust. These are complex and expensive structures ideal for high-value assets.
Lifetime Capital Gains Exemption (LCGE) For Small Business Owners
The CRA gives small business owners a Lifetime Capital Gains Exemption (LCGE) under which farmers and fishers can sell their land and small business owners their shares without incurring CGT. The 2023 LCGE limit is $971,190, which means capital gain up to this amount will not be taxed. Any amount beyond the limit will be taxed like a CGT. But to qualify for LCGE, more than 50% of the fair market value of the corporation’s assets should be used in an active business, with 90% used in active business at the time of sale.
Apart from the above methods, small business owners can invest in their registered savings accounts like TFSA, FHSA, and RRSP. While RRSP and RRIF defer tax payments, TFSA and FHSA exempt capital gains tax. You can also donate shares to qualified charities to reduce capital gains.
Contact Ford Keast LLP in London for Expert Tax Planning
A skilled tax advisor can help you efficiently plan your asset purchases and sales tax. At Ford Keast LLP, our tax experts can provide services to support your tax planning, whether for one transaction or for your entire business. In addition, we can provide you with recommendations on the best structures to keep your tax liability to a minimum. To learn more about how Ford Keast LLP can provide you with tax planning, contact us online or call us at 519-679-9330.