Selling Your Business in Canada: Capital Gains, the $1.25 Million LCGE and Employee Ownership Trusts
Quick answer: When you sell shares of a Canadian private corporation, half of the capital gain is taxable, and if the shares are qualified small business corporation (QSBC) shares you can shelter up to $1.25 million of gain per person with the lifetime capital gains exemption, indexed to inflation from 2026. Selling to an employee ownership trust can shelter up to $10 million more, and that exemption is now set to be permanent. The tax result depends on preparation done two or more years before the sale.
Key takeaways
- The capital gains inclusion rate is still 50%; the proposed increase was cancelled in March 2025.
- The LCGE is $1.25 million per individual and only applies to share sales that meet the QSBC tests.
- Buyers usually prefer asset purchases; sellers usually prefer share sales. The price should reflect the difference.
- A company holding too much cash or investments can fail the QSBC tests — “purify” it well before a sale.
- Family members who own shares (directly or through a trust) may each be able to claim their own LCGE.
Why exit planning starts years before the sale
Most business owners think about tax when they have a buyer. By then, many of the most valuable options are gone. The tests for the lifetime capital gains exemption look back 24 months. Bringing family members into ownership takes time. Moving surplus cash out of the operating company has to happen before the clock starts. If a sale is possible within the next three to five years, the planning should start now.
The basics: how a sale is taxed
Capital gains
When you sell shares or capital property for more than their adjusted cost base (ACB), the difference is a capital gain. In 2026, 50% of the gain is included in income and taxed at your marginal rate. In Ontario, the top combined rate on capital gains is roughly 26.8%.
You may remember the 2024 proposal to raise the inclusion rate to two-thirds on gains above $250,000. It was deferred in January 2025 and cancelled on 21 March 2025. For now, the 50% rate stands.
The lifetime capital gains exemption (LCGE)
The LCGE lets an individual realize a lifetime total of capital gains on qualified small business corporation shares (and qualified farm or fishing property) tax-free. The limit rose to $1.25 million for dispositions on or after 25 June 2024 and is indexed to inflation from 2026.
The exemption is per person. If you, your spouse and two adult children each own qualifying shares, the family could potentially shelter several million dollars of gain — but only if ownership was set up properly and the tax on income-splitting rules (TOSI) and attribution rules are respected.
The QSBC tests
To be qualified small business corporation shares at the time of sale:
| Test | Requirement |
|---|---|
| Small business corporation test (at sale) | All or substantially all (generally 90% or more) of the fair market value of the corporation’s assets is used principally in an active business carried on mainly in Canada |
| Holding-period asset test | Throughout the 24 months before the sale, more than 50% of the asset value was used in an active business in Canada |
| Holding-period ownership test | Throughout the 24 months before the sale, the shares weren’t owned by anyone other than you or a related person |
| CCPC test | The corporation is a Canadian-controlled private corporation |
The most common reason businesses fail: too much passive cash and investments sitting in the operating company.
Purification: getting the company sale-ready
“Purifying” a corporation means removing non-active assets so it passes the QSBC tests. Common techniques include:
- Paying out surplus cash as dividends (taxable to the recipient, so it’s best planned in stages).
- Moving excess cash or investments to a holding company through a tax-free intercompany dividend, after a reorganization in which a holding company owns the operating company. Care is needed with the safe-income rules in section 55 of the Income Tax Act.
- Paying down debt or making business investments with excess cash.
- Using surplus to fund an individual pension plan or corporate-owned insurance.
Because the holding-period test looks back 24 months, purification done the month before a sale may still leave you short. Start early, and test the company’s asset mix every year-end.
Share sale vs. asset sale
| Share sale | Asset sale | |
|---|---|---|
| What’s sold | The shares of the corporation | Individual assets (equipment, inventory, goodwill, customer lists) |
| Who’s taxed | The shareholders, personally | The corporation, then shareholders when cash is paid out |
| LCGE available? | Yes, if QSBC tests are met | Not directly |
| Buyer’s preference | Less attractive — inherits history and liabilities; no step-up in tax cost | More attractive — picks assets, gets higher tax cost (more CCA), leaves liabilities behind |
| HST | Generally not applicable | Usually applies, though a joint election (Section 167) can often remove it when substantially all assets are sold |
| Seller’s tax outcome | Usually better | Often more tax overall, especially on recaptured CCA |
Because the tax results differ, a share sale and an asset sale at the same headline price are not the same deal. Negotiate on after-tax proceeds. Many transactions end up as a hybrid.
Other strategies to know
Crystallizing the exemption
If your company qualifies today but might not later (for example, because cash is accumulating), you can crystallize the LCGE by triggering a gain on paper — usually through an internal share exchange — locking in a higher ACB without selling. It can protect the exemption, but watch the alternative minimum tax (below).
Family trusts
A discretionary family trust that owns shares can allocate the gain on a sale to several beneficiaries, each of whom may claim their own LCGE. This “multiplication” is one of the most effective exit-planning tools — but it must be in place well before the sale, and the trust has its own filing obligations, including annual T3 returns and beneficial-ownership reporting.
Capital gains reserve
If part of the price is paid over time (a vendor take-back), you may be able to spread the capital gain over up to five years, matching tax to cash received.
Earn-outs
Payments tied to future performance can create complex tax results. Structure them carefully so that they are treated as part of the sale price and not as ordinary income.
Employee ownership trusts: now a long-term option
An employee ownership trust (EOT) is a trust that holds shares of a business for the benefit of its employees. Since 2024, owners selling a qualifying business to an EOT can exempt up to $10 million of capital gains, shared among the sellers. The exemption was originally available only for sales between 1 January 2024 and 31 December 2026.
On 28 April 2026, the federal Spring Economic Update announced that the $10 million EOT exemption will be made permanent. For owners without a family successor — and who would rather reward the team that built the business than sell to a competitor — an EOT is now a realistic plan, not a race against a deadline.
Key conditions include that the trust is resident in Canada and exists for current and former employees; beneficiaries’ interests are determined fairly (often by hours worked or pay); at least one-third of trustees are employees; and the business operates actively in Canada. EOT sales are usually financed over time from the company’s own profits, so a realistic valuation and cash-flow plan are essential.
Watch the alternative minimum tax
The alternative minimum tax (AMT) was overhauled starting in 2024. In a year with a large capital gain, especially one sheltered by the LCGE, an individual may owe AMT. AMT paid can be recovered against regular tax over the following seven years, but it’s a real cash cost in the year of sale. Model it before you sign.
A sample timeline (owner planning to sell in about three years)
- Now: get a valuation estimate; review the QSBC status at year-end; clean up the balance sheet and bookkeeping.
- Two to three years before the sale: consider a holding company reorganization and family trust; begin purification; formalize contracts, leases and key-employee agreements.
- Twelve to 24 months before: confirm the 24-month tests are being met; prepare normalized financial statements and a data room; decide between share sale, asset sale, or an EOT.
- At the sale: negotiate on after-tax proceeds; structure earn-outs and reserves; file the right elections.
- After the sale: report the disposition on your T1 (Schedule 3 and Form T657 for the LCGE); plan for AMT; invest proceeds.
Frequently asked questions
The LCGE is $1.25 million per individual for qualified small business corporation shares and qualified farm or fishing property, and it is indexed to inflation from 2026.
No. The proposed increase to a two-thirds inclusion rate was cancelled on 21 March 2025. Half of a capital gain remains taxable.
Not directly. The LCGE applies to the disposition of qualifying shares, not to assets sold by your corporation.
Owners who sell a qualifying business to an employee ownership trust can exempt up to $10 million of capital gains. The 2026 Spring Economic Update announced it will be permanent rather than ending after 2026.
Ideally at least two to three years, because the QSBC tests look back 24 months and reorganizations take time.
It means removing passive assets — excess cash and investments — so that the company’s shares meet the active-asset tests for the LCGE.
Plan your exit with Solstice Partners
Solstice Partners helps Ontario owner-managers prepare for a sale: QSBC reviews, purification planning, financial statements buyers trust, and the tax filings that follow. Learn about our tax planning service or book a confidential consultation.
Sources
- Canada Revenue Agency — Capital gains deduction
- Canada Revenue Agency — Update on the administration of the proposed capital gains changes
- EY Tax News — Canada: employee ownership trusts are here to stay (May 2026)
- Canada Revenue Agency — Line 41700: Minimum tax
This article is general information, not tax or legal advice for your situation. Business sales require advice from your accountant and lawyer based on your specific facts.
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