Small business gets tax break
If you sold a small business corporation and then reacquired another one in the year 2000, you may be eligible for lucrative tax savings, as a result of last year’s two federal budgets.
The new capital gains deferral on eligible small business corporations has been proposed to make investments in smaller, and generally higher risk, companies more attractive. The change enables a deferral of capital gains rather than the use of an exemption.
The deferral will be possible when an eligible small business corporation is disposed of and where the proceeds are used to acquire another ‘eligible small business investment’.
Conditions for deferral
The consequences will be as follows:
- The re-investment must be in ordinary common shares issued from treasury to the investor.
- The deferred gain will be used to reduce the adjusted cost base of the new investment.
- The proposals of the February 28, 2000 budget provided for a deferred gain on dispositions realized after February 27, 2000 and before October 17, 2000 on up to $500,000 of eligible investments.
- The subsequent investment must be in an eligible tive small business corporation, which is similar in definition to the existing small business corporation rules.
- Total value of assets cannot exceed $2.5 million before the investment and $10 million after it.
- This provision has been sweetened with the proposals of the October 18, 2000 mini-budget. Specifically, the $500,000 figure is increased to $2 million and the size of the small businesses eligible will increase from $10 million to $50 million immediately after the investment. The $2.5 million restriction will be eliminated.
- The investment must be held for more than six months from the time of acquisition. There are special rules regarding the timing of the replacement investment and eligibility of the investor, as well.
How deferral works
The following example illustrates how this deferral will work:
- Assume that a taxpayer sold an eligible small business corporation for $275,000 in the period after February 27 and before October 18.
- She then used the proceeds to acquire another eligible small business corporation in the amount of $600,000.
- She had a gain of $270,000 on the first corporation. However, under the new proposals, this gain can be deferred if all the criteria are met, as described above.
To calculate the capital gains deferral in this case:
- Take the cost of the replacement property
- Divide it by the proceeds of disposition relating to the eligible gain
- Multiply that amount by the eligible gain from the disposition.
This will give you the eligible gain for deferral purposes:
- $500,000 (divided by) 275,000 x 270,000 = $490,909
Similar transactions occurring after October 17 will be subject to the $2 Million maximum capital gains deferral described above.