How to Purify Your Corporation Before Selling Shares in Ontario

Many owners let cash and investments build up inside the company. When it is time to sell the shares, that surplus can put the lifetime capital gains exemption at risk.

Purification is the process of dealing with that surplus. This article explains the idea and the timing, and why the steps need individual advice.

Why surplus cash is a problem

An individual who sells qualified small business corporation shares may claim the capital gains deduction, also called the lifetime capital gains exemption. For 2025 and for dispositions after June 24, 2024, the exemption is $1,250,000 of capital gains, which is a maximum deduction of $625,000. Only one-half of a capital gain is taxable in the first place.

To be qualified small business corporation shares, the company must be a small business corporation, meaning 90% or more of the fair market value of its assets is used mainly in an active business carried on primarily in Canada, or is shares or debts of connected small business corporations. Over the previous 24 months, more than 50% of asset value must also be used in an active business or invested in qualifying connected corporations.

A company holding too much cash or investments not used in the active business must bring its non-active assets below those thresholds, at the right times, for the shares to qualify.

The two timing rules

This means a company can be fine on the 90% test after a clean-up just before closing, but still fail the 50% test if its non-active assets were too high at some point in the 24 months. That is why planning should start well before a sale.

When deciding whether the corporation is a small business corporation or a Canadian-controlled private corporation, a right under a purchase and sale agreement for a share is not counted. Signing an agreement with a non-resident or public buyer therefore does not by itself end that status.

Common approaches and their risks

Owners and advisors often discuss paying out dividends, repaying debt, or moving surplus to a holding company. No single method suits every company, and each has tax consequences. Some clean-up steps, such as moving money between corporations, can raise other tax issues, so each case needs tax advice from an accountant or lawyer.

Also remember that the deduction can be denied where a significant part of the gain can reasonably be attributed to dividends not being paid, or being paid at less than 90% of the average annual rate of return.

Other points to keep in mind

• The 24-month holding rule applies, so shares must not have been owned by an unrelated person during that period.
• Newly issued shares start their 24-month clock when issued, with some exceptions, such as shares issued in exchange for other shares or as a stock dividend.
• Any deduction used in earlier years reduces what remains of the $625,000 formula amount. That amount is indexed to inflation for taxation years that begin after 2025.
• A cumulative net investment loss balance reduces the deduction available, and an allowable business investment loss claimed for 2025 reduces the deduction for 2025 and future years.
• Deferred capital gains, such as gains held back under a reserve, do not qualify for the deduction.
• Only an individual resident in Canada throughout the year can claim the deduction, with a rule that can treat a part-year resident as resident throughout.
• If an owner dies, a share that would have qualified except for the 90% asset requirement can still be treated as qualifying if it qualified at any time in the 12 months before death.
• A large gain sheltered by the exemption can trigger alternative minimum tax, calculated on Form T691.

What to do next

To claim the deduction, you complete Form T657, and you must also complete Form T936 if you had investment income or expenses in any year from 1988 to 2025. How all of this applies depends on your facts, so it is worth confirming with a lawyer or accountant before you act.

• Get a current balance sheet and a fair market value estimate of each asset.
• Separate assets used in the active business from cash, investments and other passive assets.
• Review the asset mix across the last 24 months, not only today.
• Meet with your accountant and a lawyer well before signing a letter of intent.
• Ask about the tax cost of each clean-up step before taking it.

Frequently asked questions