Can I claim the capital gains exemption if I still partly control the buyer?

The exemption works as a deduction against a capital gain, so the first question is whether what you receive is a capital gain at all. When you sell your company’s shares to another corporation that you still partly control, the Income Tax Act stops treating the deal as a plain sale between strangers, and the tax result turns on how the rules classify the price.

Why control of the buyer matters

The CRA describes the capital gains deduction as a deduction against taxable capital gains, including those from qualified small business corporation shares. Section 84.1 of the Income Tax Act deals with a taxpayer resident in Canada, other than a corporation, who sells shares held as capital property in a corporation resident in Canada to another corporation with which the seller does not deal at arm’s length, where the two corporations are connected immediately after the sale. Where it applies, a dividend is deemed paid to the seller at the time of the sale, and a dividend is not a capital gain.

What “partly control” can mean

The test in section 84.1 is not limited to a majority holder. Paragraph 84.1(2)(b) deems a seller not to deal at arm’s length with the buyer where the seller was one of a small group that controlled the company being sold and, after the sale, is one of a group that controls the buyer, every member of which was in the first group. Being one of a controlling group can therefore matter even when your own stake is modest.

The exemption conditions and the reserve

The rule sits on top of the exemption conditions, which the CRA says you generally have to meet in full before claiming the deduction on line 25400. Timing is a second issue. If part of the price is paid over several years, the CRA says you generally cannot claim a capital gains reserve on property sold to a corporation you control in any way, so the gain may not spread across years.

Questions for your tax advisor before signing

• Will the buyer be a corporation that you, your family or your partners control, directly or through a holding company?
• How much of the price is paid later, and does the plan depend on a reserve to spread the gain?