DFK Tax Newsletter

Summary of the new Canadian Entrepreneur Incentive rules coming into place for eligible capital gains starting January 1, 2025

*These rules were included in Budget 2024 and have not yet been legislated at the time of this article

As proposed in Budget 2024 (further revised August 12, 2024), Section 110.63 of the Income Tax Act introduced the Canadian Entrepreneur Incentive (“CEI”), which would reduce the inclusion rate on eligible capital gains to 1/3. The lifetime limit of capital gains that can be utilized under the CEI is $2,000,000 for individuals who are resident in Canada; but is phased in over 5 years at $400,000/year starting in 2025 (fully phased in by 2029). 

In order for a capital gain to be eligible under the CEI, it must meet the definition of Qualifying Canadian Entrepreneur Incentive Property (“QCEIP”), which is summarized below: 

Further to the bolded item in 110.63(a)(i), certain industries and business are defined as an excluded business and cannot utilize the CEI deduction, even if the shares of the corporation are qualified small business corporation shares:

• Professional corporations
• Any business whose principal asset is the reputation, knowledge, or skill of one or more employees
• Consulting services
• Financial services 
• Insurance services 
• Certain services relating to real property – appraisals, rental, management
• Purchase, sale and rental of real property
• Food 
• Accommodation
• Recreation and entertainment

It is also important that an individual’s tax filings are up to date and reflect the appropriate capital gains and CEI deduction in the applicable tax year. Assuming the criteria is met for a taxpayer’s capital gain to be eligible under CEI, the taxpayer is required to file his/her personal tax return within one year of the filing due date, or else the CEI deduction could be denied under 110.63(3). Further to that, if the individuals also fails to report the capital gain in the applicable taxation year, it would also result in a denial. 

110.63(4) and 110.63(5) also have similar anti-avoidance provisions as are applicable to the lifetime capital gains exemption rules in 110.6(7) and 110.6(8), where an individual will be denied the CEI deduction in respect to butterfly transactions and the annual rate of return tests. 

The CEI could be a useful tool for eligible taxpayers to utilize in addition of their lifetime capital gains exemption. However, there are certain issues when planning for the CEI that should be considered:

1. The shares or property must be held by an individual directly, a family trust cannot allocate the gains that would be eligible for the CEI deduction.
2. 110.63(7)(b) has a similar related person provision to the lifetime capital gains exemption, where a trust is related to all of the beneficiaries of the trust. However, the definition of QCEIP under (b) is silent on the continuity rule that is available in subsection 110.6, where the taxpayer can rely on the trust’s ownership period to meet the 24 month ownership requirement. In absence of this, the individual would have to hold the shares directly for 24 months in order to qualify under CEI. Unless this is further amended to align with the continuity rules applicable to the lifetime capital gains exemption, this could be an important planning consideration in respect to shares or property held by a family trust. 
3. It is currently unknown how the CEI deduction will interact with alternative minimum tax (“AMT”), as a result individuals and tax advisors should be careful when triggering capital gains and the utilization of the CEI deduction, until the impact on AMT is known.   
4. The addition of qualified farming and fishing property to the definition of QCEIP could be a useful tax planning tool for many individuals across Canada, particularly in the Prairie or Maritime provinces. 

“Qualified farming and fishing property” includes (refer to 110.6 for exact definition):

• real or immovable property or a fishing vessel that was used in the course of carrying on a farming or fishing business in Canada (see additional requirement in 110.6)
• a corporation, a share of the capital stock of which is a share of the capital stock of a family farm or fishing corporation 
• an interest in a family farm or fishing partnership
• a property included in Class 14.1 of Schedule II to the Income Tax Regulations, used in the course of carrying on a farming or fishing business in Canada;

To summarize, the CEI could be an available deduction to you starting in 2025, if the following criteria are met:

1. You are a Canadian resident taxpayer 
2. You held property that is either:
   1. Shares of a qualified small business corporation, other than the excluded business as mentioned above
   2. Qualified farm or fishing property 
3. You held at least a 5% interest in the shares/property for 24 months (full voting rights for shares)
4. You were actively engaged in the business related to shares/property for at least 3 years (any combined three year period since the business was founded) 
5. Cumulative limit of capital gains eligible for the CEI deduction:
   1. 2025: $400,000
   2. 2026: $800,000
   3. 2027: $1,200,000
   4. 2028: $1,600,000 
   5. 2029: $2,000,000

Please contact your local DFK advisor if you would like to discuss the CEI rules and potential impact on you.