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Reader Mail Bag Update: Lifetime Capital Gains Exemption

On July 2nd*, I published a response to a reader’s questions concerning tax free income in Canada [1]. I received a follow-up question from the writer yesterday concerning the lifetime capital gains exemption (LCGE).

* This article was originally published in July of 2008.

Does the LCGE cover only farm properties and qualified shares in stock exchanges or can it be used for residential properties capital gains, shares traded in foreign exchanges, or all shares traded in the Canadian or US exchanges ?

What is the basic tax rate in Canada? Is it on sliding scale that moves up, or is it a flat rate?
What is the tax rate for dividend income from overseas and the tax rate for interest income from overseas?
Are these taxes paid at end of year, or are they paid on a monthly basis ?

Lifetime Capital gains Exemption

The lifetime capital gains exemption applies only to gains realized on the disposition of “Qualified Farm Property” and “Qualified Small Business Shares.” Any share that is traded on a stock exchange is therefore excluded from the LCGE.

I’ll forego an explanation of qualified farm property as it does not and deal directly with the definition of qualified small business corporation shares. In order to qualify as a small business corporation share, the following criteria must be met:

(1) The shares must be shares of a Canadian-controlled small business corporation which, at the time of the disposition of the shares, uses 90% of its assets either directly or indirectly in an active business carried on in Canada or as a holding company for such a corporation.

(2) The shares must be owned by the taxpayer or their spouse.

(3) The shares must not have been owned by anyone else other than the taxpayer in the 24 months prior to the disposition.

(4) Throughout the 24 month period, at least 50% of the assets of the corporation must have been used principally in an active business or to finance a connected active business.

In order to be a Canadian-controlled small business corporation, the company’s shareholders cannot be controlled by one or any combination of a publicly traded corporation or a non-resident.

The phrase “active business” means that the corporation cannot be a “specified investment business” or personal services corporation.

A “specified investment business” (SBI) is a business whose principal purpose is to derive income from property (interest, dividends, rents, and royalties). However, if such a business employs five or more employees it will not be classified as a SBI.

The key facts are that the corporation must do its business in Canada, be owned by a Canadian citizen and not be for the purpose to generate investment income that would normally be earned as an individual.

Personal Tax Rates In Canada

In terms of tax rates, the personal tax rates can be found in the 2007 Tax Tables at Tax Resource Canada [2].

The tax earned on dividends received from foreign corporations is simply added to your personal income and taxed accordingly. Dividends from Canadian corporations receive a favourable tax treatment in the form of a dividend tax credit. The amount that is included in income for dividends from large Canadian corporations is 1.45 times the actual amount of dividends received. The extra amount is called the dividend gross-up. These dividends are eligible for an enhanced dividend tax credit of 18.97% of the grossed up dividend.

Interest income regardless of what location in the world it was derived is considered straight income and added to your personal income for tax purposes.

Corporate taxes are a little different and are assessed on any corporation that is resident in Canada. A corporation is deemed a resident of Canada if its management and decision making is in Canada. If the corporation is a resident of Canada it’s rate of tax can be between 16% & 30% depending on it’s provincial location and it’s status as a CCPC.

When Taxes Are Due

For the average Canadian, personal income taxes are calculated and are determined on a calendar year basis. The taxes are reconciled and a tax return is filed (and any tax balance owing is due) April 30th of the following year. If you are self-employed or a commission sales personal your tax return is due in June but any taxes owing are still due April 30th.