Area of Law: Business Law
Answer # 0254
Tax implications of transferring sharesRegion: Ontario Answer # 0254
One of the biggest effects of the transfer of shares on a shareholder is the tax implications.
If a shareholder sells shares for a price greater than the purchase price, the gain is considered a capital gain. Capital gains are a type of taxable earnings under the Income Tax Act. Shareholders selling shares in a private corporation may be able to take advantage of the lifetime capital gains exemption. Shares in public corporations do not qualify for the capital gains exemption.
Lifetime capital gains exemption
The lifetime capital gains exemption allows people to realize tax-free capital gains if the property disposed of is a qualified small business corporation. The 2019 exemption limit was $866,912. The 2020 exemption limit is $883,384. The limit applies to all individuals, even those who have previously used the exemption.
Small business corporation shares qualify under this exemption when:
1. Throughout the 24 months immediately preceding the disposition of the shares:
- the shares have been owned by you or a person or partnership related to you, and
- more than 50% of the fair market value of the assets of the corporation were used in an active business, carried on primarily in Canada, and
2. At the time of the disposition of the shares “all or substantially all” (at least 90%) of the assets of the corporation were used to carry on active business.
If a shareholder sells shares for a price lower than the purchase price, the loss is considered a capital loss. Capital losses can be deducted from capital gains for the same year. If the calculation results in a loss, it is called a net capital loss to reduce a capital gain in any of the three previous years, or in any future year.
For more information on capital gains and losses and the LCGE, visit Capital gains and losses, and capital gains exemptions.
Dividends are payments to shareholders made by a corporation from its profits. In contrast to the payment of salaries, which are deducted from the corporation’s gross earnings, dividends are paid from the after tax income of the corporation.
Dividends are paid based on the type and the number of shares held by the shareholder. Some shares, traditionally called preferred shares, may come with the right to receive dividends in priority to other classes of shares. If a corporation has only one class of shares then all shareholders must receive payment at the same time, and at the same amount per share.
Dividends are a type of taxable income under the Tax Act. If an individual receives dividends, they will not be able to use the RRSP deduction to reduce this type of taxable income. However, because of the dividend tax credit, the individual will pay less tax on dividend income than on income earned from a salary.
Income splitting through shares in privately held corporations
Income splitting is a method that can be used by owners of private corporations with a high income to divert their income to family members with lower personal tax rates, as a way of reducing their tax payable. If a shareholder wants to income split with family members for tax purposes, they may be able to do so by transferring some of their shares. The rules regarding the tax on split income, or TOSI, and the ability to income-split with family members have undergone changes over the years limiting this option.
Generally, split income includes:
- certain taxable dividends,
- taxable capital gains and
- income from partnerships or trusts.
Previously, the Canada Revenue Agency (CRA) imposed a ‘ kiddie tax’ on dividends paid to family members who were under the age of 18.
Changes to Tax on Split Income (TOSI)
In January 2018, CRA made changes to the tax on split income (TOSI) rules. Some of the changes include:
- the TOSI rules now apply to ‘specified individuals’ (generally someone who is a resident in Canada at year-end) over the age of 17, but only with respect to income derived from a ‘related business’ (a business in which an immediate family member – spouse, parents, child or sibling – is involved at any time during the year);
- the TOSI rules do not apply to dividends an individual receives from a business in a taxation year if the individual has reached the age of 17 before the taxation year and is engaged on a regular, continuous and substantial basis in the business in at least five prior taxation years (the five prior taxation years do not have to be consecutive); and
- the definition of “split income” includes income received from certain debt obligations, and taxable capital gains or profits from the disposition of certain properties.
According to Canada Revenue Agency, the new rules apply to the 2018 and subsequent taxation years.
More information on TOSI and income splitting is available at canada.ca. However, both the existing and proposed TOSI rules are too complicated for most lay people to understand. For greater certainty, it is advisable to seek the help of a chartered accountant before transferring shares for the purpose of income-splitting. For legal advice and assistance with your corporation, and for all other business matters, consult with a business lawyer.
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