New Proposed Tax Incentive for Entrepreneurs

On August 12, 2024, the Department of Finance Canada released new legislative proposals to implement the Canadian Entrepreneurs’ Incentive (the “CEI”), which was first announced in the 2024 Federal Budget.

What is the Canadian Entrepreneurs’ Incentive?

The 2024 Federal Budget increased the capital gains inclusion rate from 1/2 to 2/3, save for the first $250,000 of capital gains realized by individuals (excluding most trusts) that will be subject to a 1/2 inclusion rate. Accordingly, the sale of capital property, including the shares of a business will now be subject to a higher rate of tax. The CEI is intended to provide relief to eligible entrepreneurs who dispose of certain qualifying property in the form of a reduced capital gains inclusion rate of 1/3 (instead of 2/3). The CEI will provide access to the reduced inclusion rate for up to a lifetime maximum of $2 million on eligible capital gains, which will apply after the individual utilizes their lifetime capital gains exemption (“LCGE,” which has been increased to $1.25 million). The CEI will be phased in from 2025 to 2029 at $400,000 per year and will apply to dispositions that occur on or after January 1, 2025. Combined with the LCGE, the CEI will allow business owners to benefit from at least $3.25 million in tax-free and low-tax treatment of the gain on the sale of a business.

The charts below provide a comparison of the tax treatment of a gain of $10 million in connection with a disposition of property that qualifies for the CEI (once the CEI is fully implemented in 2029) compared to a disposition of property that does not qualify for the CEI.

Chart 1: Qualifying Disposition with CEI – $10 Million of Eligible Capital Gains

Chart 2: Dispositions without CEI – $10 Million of Capital Gains

Eligibility Criteria

The Department of Finance Canada’s draft legislation released in August 2024 has significantly amended the CEI from what was previously announced in the 2024 Federal Budget in an effort to expand its application and ease the eligibility criteria.

Generally, the CEI is applicable to capital gains realized on the sale of “qualifying Canadian entrepreneur incentive property,” which refers to shares of small business corporations that meet certain requirements regarding ownership and the nature of the underlying business assets. These requirements include: (1) the individual vendor held shares representing 5% or more of outstanding voting shares of a company throughout a period of at least 24 continuous months prior to the disposition; (2) that individual vendor was actively engaged on a regular, continuous and substantial basis in the activities of the business (generally, at least an average of 20 hours per week) for a total period of not less than three years; and (3) the active business of the company is not an “excluded business” as defined in the draft legislation, which captures a broad cross-section of sectors that cannot benefit from the CEI, including professional services, financial services, insurance, real estate, food and accommodation, arts, recreation and entertainment sectors.

While the CEI eligibility requirements can be restrictive, with the right facts and appropriate tax planning, it is possible for entrepreneurs of certain businesses to generate significant tax savings on the disposition of a qualifying business in technology, manufacturing, life sciences and other sectors that are not excluded from the CEI rules.

If you have any questions with respect to the matters discussed above, please contact Mariam Al-Shikarchy at [email protected], Sam Fata at [email protected] or any other member of our Tax practice group. The authors gratefully acknowledge the assistance of articling student Ella Rowley in the preparation of this update.

This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.

If you would like further information regarding the issues discussed in this update or if you wish to discuss any aspect of this commentary, please feel free to contact to us.